Orkla ASA
Q3 2016 Earnings Call Transcript

Published: 1 Nov 2016

[Executives:]

Peter Ruzicka - President & CEO Jens Bjørn Staff - CFO & EVP

[Analysts:]

Martin Stenshall - Danske Bank

[Peter Ruzicka:]

Okay. Good morning, everyone, and welcome to Orkla’s Third Quarter Result Presentation. I'm very happy to, also this quarter, report progress both in Branded Consumer Goods and in Orkla Investments. And actually this is the 10th consecutive quarter where we report organic growth in Branded Consumer Goods. In Branded Consumer Goods, we have seen sales growth, cost reduction but also M&A activities and they have all contributed to both top line and bottom line improvement. We also continue to see very strong development in Sapa, as well as good profitability in Jotun. Our earnings per share increased by 31% in Q3 2016 versus 2015. During the quarter, we have completed the acquisition of Harris paint tool business in U.K. as well as food ingredients business Broer in the Netherlands. Of course during the quarter, we continued to work more as One Orkla, utilizing the strengths, the capabilities and resources that lies within Orkla both on innovations, supply chain and of course also taking on synergies from the M&As we have conducted in the last years. We see - we have a positive organic growth also this quarter to present which is somewhat lower than we have had the previous quarter this year, and the main reason for that is substantially lower raw material prices in our Orkla Food Ingredients, and especially butter and dairy products and almonds. However out of the 2% organic growth, most of it is volume mix increase and very small portion is price, so regard that as a healthy growth. We grow approximately in line with the markets that we operate as we also have communicated as a target in our 2016-2018 plan. But we have also managed to keep costs under control and our very advanced KPI, black over red, where black represents the organic growth and red represents development in fixed costs. We see that we have solid gap between the black and the red, and this is actually despite inflation and volume increase and we managed to keep the fixed cost at a stable level. And this is mainly achieved through supply chain initiatives. We are reducing costs through everyday improvement, but also through closing down factories footprint projects. And of course, we also have contribution from synergies from the M&As we have conducted. And Cederroth is a very good example of how we manage to realize synergies. When we acquired or announced the acquirement of Cederroth, we announced saving synergies of NOK 60 million to NOK 80 million and we are now slightly above NOK 80 million, so we are somewhat ahead of plan. And that is mainly through new organization in five countries. We have consolidated warehouses in three countries. We have established Wound Care as a separate business unit, and altogether we have reduced workforce by approximately 100 employees after we acquired Cederroth. But we also see positive synergies on sales, especially in Wound Care. And we have also identified additional synergies going forward. One is in factory footprint. We have decided to close down our HPC factory on the Northwest coast of Norway and moving that production partly to our factory at Ski outside Oslo and partly to our factory in Falun in Sweden, and we also see some more top line synergies going forward. As mentioned, Sapa continue to deliver strong results, and I think we can say we are now three years into the JV with Norwegian Hydro. I think we can say that this JV has been successful. EBITDA has increased from NOK 1.1 billion to NOK 3.3 billion, and that is mainly due to the synergy plan that we outlined three years ago and we have delivered ahead of plan and both regarding time and regarding cost. However we still see potential going forward but that is more on the organic part of the business. And for those who are very interested in Sapa, I hope you take the time to join the Capital Markets Day on November 3 in Oslo. Then I will leave the floor to Jens, who will go through the financials in detail.

[Jens Bjørn Staff:]

Thank you, Peter. And as Peter mentioned, we saw a solid progress both from the Branded Consumer Goods part and the investment area this quarter. We achieved the revenue growth on the back of good innovations, campaigns and distribution agreements. Sales increase and cost improvements lifted results, and despite dilutive effects from M&A and distribution agreements, we saw a small increase in margins this quarter. Let's now review and look at the most important items on the P&L this quarter. First, I'm pleased to report that the EBIT improvement by 19% is due to good progress, both in the Branded Consumer Goods part and the investments area. The line, other income and expenses, includes a write-down of assets and restructuring costs within Orkla Food Ingredients, totaling NOK 79 million. And this is primarily related to our frozen cakes business in Denmark. This line also carry costs regarding restructuring and M&A activities. Strong growth in Sapa lifted profits from JVs and associates totaling NOK 313 million. And I’ll revert to the development in specifics later on in the presentation. Overall, profit before tax, increased by 24% ending at almost NOK 1.3 billion. This equals earnings per share of NOK 1.05 and that's an increase of 31% year-on-year. And the next slide shows the main drivers behind the sales growth. Overall, revenues from Branded Consumer Goods grew by 14%, of which organic growth was 2%. This rise was mainly driven by acquisitions such as Cederroth, Hamé and Harris. However increased sales in our existing operations also added to this results progress. As Peter mentioned, Cederroth has now been in the company for a year and will be in the like-for-like figures from Q4. Harris on the other hand, was consolidated in September and contributes with only one month of structural growth in Q3. For the first time in a while, we have minimal currency consolidation effects due to a stronger Norwegian kroner, and if this exchange rate that we see today remains unchanged, we will start to see a negative translation effects going into the fourth quarter. Looking now at more details regarding our aggregated Branded Consumer Goods results. Higher sales, cost improvements and acquisitions resulted in an EBIT growth of 15%. All business areas had positive EBIT growth. As I mentioned, our reported EBIT margin improved slightly in Q3 last year - compared to last year despite the dilutive effects from the acquired companies and distribution agreements. Looking at underlying margin, the improvement is about 50 basis points both Q3 and year-to-date. Cost improvements, organic sales and synergies from acquisitions are the main drivers behind this underlying margin development. Let's look at Orkla Foods. Orkla Foods had significant top line growth and profit growth in Q3. The improvement versus Q3 ‘15 was helped by the acquisition of Hamé which increases our presence in Central Eastern Europe. Successful innovations, sales activities and expanded PepsiCo agreements resulted in volume-driven organic growth in the quarter. However as we said at Q2, the temporary delivery challenges continue to impact performance in Q3. These issues relate to the recent changes in the factory structure. We have now resumed stable production, but we have delivery backlog which has impacted some sales activities, and this will also have some impact going forward. As expected, the EBIT margin was diluted by the inclusion of Hamé and distribution agreements with PepsiCo. Let's now look at Confectionary & Snacks. This business reported volume-driven sales growth in the quarter with the Norway and Sweden being especially strong. The agreements for pick-and-mix candy with coop stores in Norway and the distribution agreement with PepsiCo also contributed to this sales increase. Sales growth was the main driver behind the EBIT improvements but cost reductions also made positive contribution. And after several quarters with decline in Latvia, we now see that the implemented actions have resulted in EBIT growth in Q3. Moving on to Orkla Care. We are pleased to report positive growth of the recent period of lower sales growth. This top line and EBIT growth was driven by acquisitions and organic sales. Organic growth are positive in HPC, Wound Care, Painting Tools and Professional Cleaning. I’m especially pleased to see the growth in HPC unit again, however there is still challenging competitive climate, and it’s also worth mentioning that comparables for Q3 with good Q3 ‘15 is somewhat weak. In Orkla Health, the loss of the distribution agreement in Denmark had a negative effect and the weight management category is still declining. Our textile business had a negative organic growth in Q3, partly due to the timing of advertising and the marketing campaigns. Overall acquisitions, synergies and cost reductions contributor to the EBIT growth, although the EBIT margin decreased due to dilutive effects from the acquisitions and the loss of the Unilever agreements. Let's look at the Food Ingredients. Several add-on acquisitions resulted in top line and profit growth in the quarter. As significant drop in raw material prices has led to lower prices for marzipan and better blend products and that is then resulting in organic sales decline. The market situation on butter blends also challenge profitability as competition has increased in this segment. In addition, the sale of bakery ingredients in Norway decreased due to a loss of an industrial consumer customer contract. Despite these effects, Food Ingredients lifted EBIT margin overall in the quarter, partly due to a greater share of sales from high margin categories, such as ice cream, ingredients and accessories. With that, I'll move on to the Orkla Investments side. And then starting with our two fully consolidated areas namely, Hydro Power and Financial Investments. And in Hydro Power, doubling of the power prices more than compensated for a lower production and this resulted in almost tripling the EBIT from NOK 22 million to NOK 63 million. Reservoir levels are lower than in ‘15, so we expect production in Q4 to be lower than last year. And in line with our strategy, we continued to free up capital to the sales of share from our portfolio and the real estate assets. In the third quarter, this amounted to approximately NOK 74 million. At the end of September, our remaining share portfolio had a market value of NOK 0.2 billion, while the real estate portfolio had a big value of approximately NOK 1.6 billion. Let's look at the two biggest assets within the investment area namely, Sapa and Jotun. And as Peter mentioned, Sapa has improved steadily over many conservative quarters. In Q3, underlying EBIT continued to increase with the European business as the main driver, effects from improvement programs and increased share of value-added products also made a positive contribution. Demand for extruded products increased in both Europe and North America. In Europe, the level of growth has increased and we expect moderate growth rates to continue. However growth in North America is expected to flatten out in certain market segments. Looking at Jotun. Jotun reported financial reports - financial results on a four-monthly basis and therefore we cannot present official figures for Jotun for this quarter. However you can see the performance from January to August here on this slide. On the first eight months, Jotun reported revenue and volume growth and continued improved profits. The Decorative Paint segment had continued strong growth in the Middle East and Southeast Asia. This was partly offset by lower activity within Marine Coatings and Protectives due to a slowdown in the Marine segment towards the end of the period and generally weak offshore sector. To finish off the financial section, let's look at the changes in the net debt. Cash flow from operations and FX more than offset the net expansion this quarter. This resulted in a reduction of the net debt. At the end of September, net interest bearing debt to EBITDA is around 1.8 and that is well below the target that we had set, which is in the range of 2.5x to 3x and the average maturity on net interest bearing debt was 3.4 years, with an average interest costs of 1.6% in the quarter. Now Peter will finish with his concluding remarks.

[Peter Ruzicka:]

Thank you, Jens. Before we open up for Q&A, I would like to share with you some examples of the new launches we have done, launches that meet or based on our in-depth consumer insight, but also the consumer trends we see in the market. And I will start with the famous brand in Norway, TORO. This is the number one brand in Norway on rice soups, sauces and casseroles. However we have also in last years have huge success with baking mixes and now we are adding also into dessert mixes. And this is answering the trend we see from consumers. They want more convenience but not compromise on taste. This is a great example how we meet consumer demands. Then to Denmark. As most of you know, we have historically not been present in confectionary and snacks or chocolate in Denmark. However we have a very strong snack brand, KiMs. And last year we launched chocolate under the KiMs brand in the Danish market, and now we have expanded the range with choko bites and bars and that meets the consumer demand or trend we see that people want to share, but also another insight we have from Norway is that from the Norway is that consumers really like the mix of sweet and salt, so we had taken this insight from Norway and introduced it to Denmark. And actually the Peanutbar you see up there scores extremely good in consumer taste in Denmark and we have - fortunately we have received very good listings of all our products in Denmark. And of course if you eat too much chocolate, you need to think about weight control. And as we have mentioned several quarters, and also as Jens mentioned, we have struggled somewhat in the weight management segment and now we have two new launches snack bars that are more natural low-sugar but also meet the need, the consumer need for healthy snacking between meals. And actually the caramel bar as you see here is actually the test winner among all bars when it comes to taste, at the same time it is very healthy. We have also received on this two products very good listing but this is very new, so it's far too early to conclude whether this will be a success or not and the way so far it looks great. Also in Food Ingredients in Denmark, we expand the range of organic and vegan food in the Danish market under the brand Naturli'. This also has been a great success and actually 80% of all goods sold in Danish food retail stores are organic, and that is the highest proportion in the world. And we see a very strong growth in organic and vegan consumption both in Denmark and Sweden, and of course we want to meet this demand. And with the One Orkla approach, we will of course also see, we can launch these products or similar products in the other markets where we operate. We have - in our long-term plan we have also stated that export or international sales is an important driver for growth in the future. We have a lot of unique Nordic products, they are regarded to be healthy, safe from a food safety perspective, produced in cleaner environment with clean air, clean water and so on. And as we know, China is a quite big market, actually it's the world's largest e-commerce market and we have now entered into cooperation with Alibaba or their web shop, Tmall. So we are now on with our own Orkla Store at Tmall with our Nordic brands, Nordic approach, natural healthy and safe food. And so far we have 25 SKUs and we will expand at the beginning of next year with more SKUs. And of course in short-term, we don't expect a huge sales but we think this is an important way to learn the Chinese consumer and to learn Chinese market and the e-commerce market, and we think this will give great opportunities going forward. So if you like to look at the page, you can go into orkla.tmall.hk. So before we go to Q&A, just to sum up the quarter. We are - we continue to deliver on the strategy. We are allocating capital from Orkla Investments on the non-core into Branded Consumer Goods area. As we have shown, we see progress in Branded Consumer Goods both top line and bottom line, but we also see more challenging comparable quarters ahead. We see continued growth in Sapa. However we see a somewhat weaker Marine segment for Juton. 31% increase in earnings per share is, in our opinion, it's quite solid and we have - during the quarter, we have completed acquisition, important acquisition of Harris the paint tool company in U.K. and the Food Ingredients business Broer in the Netherlands. And we will continue to focus on the One Orkla approach really to share best practices, sharing innovations across business units, business areas, geographies and so on. Orkla has a quite good history in acquisitions over time. A lot of companies have been bought and have been successfully integrated, where we have realized substantial synergies. That has been an important value creation path for Orkla and we will continue. At the same time, we also will continue to work on our supply chain, efficiency, reduce factory footprint and optimize our production into fewer bigger units that also allow us to invest more in new technology. And of course we will focus on all kind of activities that drive organic growth. I showed you now some examples of the launches. I showed an example of our export initiative, and we will focus more on fewer bigger innovations, share innovations across markets taking successes from one market into another market and so on, which we have done quite successfully actually. And of course, we will improve profitability by keeping strict cost focus also going forward. So with that, I'd like to open up for Q&A.

[Q - Martin Stenshall:]

Thank you. This is Martin Stenshall, Danske Bank. I’ve got two questions. First, great to see 10 quarters with organic growth in positive territory for Branded Consumer Goods. It seems like the organic growth has been approximately 3% year-to-date. Could you please provide some more comments or color on the market share developments per segment or per, let's say, important category in Branded Consumer Goods?

[Peter Ruzicka:]

Yes. As I said in the beginning, we believe we are developing approximately in line with the market. We had some difficulties to follow this very exact because we have Nielsen figures for approximately 45% of our sales, so 55% is outside the Nielsen universe. That means that we need to do some assumptions when it comes to market share development but we believe we are approximately in line with the market development.

[Martin Stenshall:]

And then secondly, very interesting to see your initiative with Alibaba and Tmall. How should we think about your strategy and goals with this initiative, and how will this actually work in terms of sales, logistics and so on?

[Peter Ruzicka:]

Can you repeat the first question please?

[Martin Stenshall:]

Yes. The first question is basically what's your strategy and your goals with Alibaba and Tmall? And then the second, how do you see this work in terms of sales and logistics?

[Peter Ruzicka:]

The first is that - as I said, we see this first launch more as a way for us to learn about first-hand the Chinese market like maybe the Asian market more in a broader perspective to learn about Chinese consumers and so on. So we don't expect to see very high sales figures in the short-term from this but this is a beginning. And it is quite - it takes some effort actually to launch. One thing is to launch the web page and the setup. One thing is to have all the products aligned with Chinese regulations with the texts and so on. When it comes to logistics, Tmall. They have their own set-ups that we deliver goods to Tmall and they do the distribution directly to the Chinese consumer. And by the way you are not able to shop on this website without having a Chinese password [ph].

[Martin Stenshall:]

Just one follow-up there, where is Orkla with Chinese consumers in five years?

[Peter Ruzicka:]

It's a good question.

[Unidentified Company Representative:]

Yes, I had two questions from the web from Ole Martin Westgaard at DNB. First question, what was the dilutive impact on BCG margins from acquisitions in Q3? And the other question, how much did the loss of the industrial contract in Food Ingredients impact the negative organic growth in this segment?

[Jens Bjørn Staff:]

Yes. Well, the reported margin progress was 0.1%, and then I said that underlying margin improvement, which then contains this structural changes is 0.5%. So that I hope that answered your question, Ole Martin.

[Unidentified Company Representative:]

And the second question was how much did the loss of the industrial contract in Food Ingredients impacted negative organic growth in the segment?

[Jens Bjørn Staff:]

I can - the loss of the industrial contract had not that big impact in this quarter but will have a greater impact going forward and throughout the next year. And of course, we will just capacity accordingly, and then having said that, we always strive to win contracts to new tenders every day in the Food Ingredients.

[Unidentified Analyst:]

[indiscernible]. Very interesting that you go on it by Alibaba but this is our experience not - this is a global company, so why don't you sell by this company all global? And then also a question about Facebook. Your site on Facebook, do they - it written that is the 10 quarter with growth. You said 12th quarter today, didn’t you?

[Peter Ruzicka:]

I said 10.

[Unidentified Analyst:]

You said 10?

[Peter Ruzicka:]

Yes.

[Unidentified Analyst:]

Okay. But what do you think about Facebook as a platform for going on the web for selling products? You are already there and this is a global company, and China has blocked Facebook but the rest of the world is open by Facebook.

[Peter Ruzicka:]

Well, your first question was about Alibaba and why don't we sell worldwide. Is that right?

[Unidentified Analyst:]

It's not a global company you cooperate with when you go to China?

[Peter Ruzicka:]

Well, Alibaba is - actually Alibaba is the marketplace. They don't offer logistics support for distributing items from a company to a consumer but they have system for joining businesses to businesses in different countries. While they have this Tmall, which is a subsidiary - Tmall Global, which is a subsidiary of Alibaba, they have this setup to sell products from company via Tmall to consumer. And that setup is for the time being only in China but of course we expect that this will be expanded. Regarding Facebook, we - of course we want to be present in all channels where the consumer expect to find our products and that is, as we know, that is changing every day or every week, so we will consider all relevant channels for selling our products going forward and maybe also Facebook.

[Unidentified Analyst:]

A question regarding Sapa. You mentioned that there are improvement opportunities still. Could you please talk about what kind of improvement opportunities you see?

[Peter Ruzicka:]

Yes, as I said, we are now finished with integration process and the synergies that we expected ahead of the time plan and also somewhat more synergies than we anticipated. What we see now is more the continuous improvement and I would say there are several areas, but one area is moving from more commodity profiles into more value add profiles and that we have done that over time but we still see that we can do more to improve margins. Secondly, we see that European market is - actually for the first time since the financial crisis 2008, the European markets shows very strong signs of picking up. It has been quite slow since 2008, but now it slowly starts to pick up again. On the other side, we see that - as Jens mentioned, that we see that North American market is cooling down somewhat but we believe that there is a potential upside that also going forward, especially in Europe and by continuous improvement and more value-add products.

[Unidentified Analyst:]

Is there a very different model for value-added products within different verticals and then between Europe and the North American?

[Peter Ruzicka:]

I think the European market is more mature market when it comes to aluminum especially in the automotive industry, but we - and even though we see that the general demand for aluminum in U.S. is cooling down, it's still growing but not at the same rate. The growth in automotive industry is still very high and is expected to be very high and that will also - they will also require more high-value or added-value products.

[Unidentified Analyst:]

Thank you.

[Peter Ruzicka:]

Okay, no further questions? Okay, thank you everyone for coming and joining us during this presentation.