Orkla's (ORKLY) CEO Peter Ruzicka on Q2 2017 Results - Earnings Call Transcript

Orkla ASA ADR (OTCPK:ORKLY) Q2 2017 Results Earnings Conference Call July 14, 2017 2:00 AM ET

Executives

Peter Ruzicka - President & CEO

Jens Staff - CFO

Analysts

Preben Rasch-Olsen - Carnegie

John Ennis - Goldman Sachs

Hans-Marius Lee Ludvigsen - Swedbank Securities

Peter Ruzicka

Good morning everyone, and welcome to Orkla's Second Quarter Presentation. I'm very happy to also this quarter and for the first half-year report continued growth in Branded Consumer Goods area. And actually, this is the 13th consecutive quarter with organic growth.

In my short presentation, I will focus on the first half-year figures and happenings and Jens Staff will go more in detail on the second quarter. But first let's look at some of the highlights during this quarter.

As I guess all of you have noticed on Monday, we announced that we finally have sold or entered into an agreement to sell our shares, 50% shares in Sapa to Norsk Hydro. This is exactly in line with the strategy we have communicated over time, and I will come back to the Sapa transaction in more details shortly.

Branded Consumer Goods area continued to grow both organically and through several smaller M&As in the quarter. We have experienced substantial higher input costs on some important raw materials during the quarter especially meat and some dairy products in Central Europe and this has impacted profit as we will show especially in foods.

We have of course taken action to counteract these effects by - partly by price increases but also by more cost initiatives that will be visible in the figures as we move along towards the second half of 2017.

But now let me show you some more details on the Sapa transaction. On 10 July, Monday this week we announced that we finally have entered into agreements with Norsk Hydro to sell our 50% shares in Sapa. This is as I said exactly in line with the strategy we had communicated first in Capital Markets Day 2011, then we repeated it 2013 and in 2015 and also 2017 at Gardermoen, here in Norway

We have also been very clear that we have not yet been in a hurry to exit Sapa. We wanted to capture our fair share of the value creation that we saw coming from the joint venture. And the joint venture has been a huge success since we entered into the agreement with Norsk Hydro 3.5 years ago, the EBITDA has more than tripled.

And that has been achieved partly through very successful integration where we realized synergies a little bit ahead of NOK1 billion cost synergies. And in addition to that, we also had a successful transformation going from commodity profiles with low margin into more value add product with higher margins.

The transaction price Sapa has enterprise value of NOK27 billion on a debt-free basis. And actually based on - of course based on the final purchase price at the closing of the transaction, we will have realized since we entered into the JV more than NOK20 billion from Sapa. That includes IPO and the sales of Granges. It includes the two dividend payments we received. We received NOK1.8 million when we entered into the JV and NOK1.5 billion from Sapa just the second quarter. And of course of the final proceeds we get when we receive or when we now sell the last 50% of the shares.

The Board of Directors in Orkla will propose to pay out a special dividend of NOK5 per share and that is approximately NOK5 billion when that transaction is finalized. And we expect the transaction to be finalized latest by the end of 2017. We are awaiting clearance from competition authorities in seven different countries but as I say, we expect this to be final and closed by the end - latest by the end of 2017.

And as we also have stated several times, when we have excess capital or excess capacity in Orkla, our first priority is to find attractive assets to buy to strengthen our Brand Consumer Goods business. We are not in a hurry. We will take the necessary time to find attractive assets and if you don't find attractive assets, we have a history of paying out special dividend. But let me just show you some example from the second quarter regarding M&A.

In line with our strategy, we continue to allocate capital from Orkla investments or the non-core assets into Branded Consumer Goods. We just bought the company, Riemann, they have new categories for us, sunscreen category that strengthens the Care portfolio. This new category, new geography and partly also new channels, very experienced, higher growth than we do in traditional categories we have in food, grocery, retail.

Orkla Food Ingredients have also strengthened their position both in the bakery sector and also in ice cream ingredients and accessories. And we now have actually become market leader in ice cream ingredients accessories in the Nordics, in U.K., in Germany, and in the Netherlands.

And not at least we have now a very good platform for further growth in this segment where we also see higher margins that we do on average in Food Ingredients.

Orkla's Food Ingredients have also bought the company, SR Food, a Danish company. They are very strong in fresh dough segment which is becoming more and more important for the bakery industry but they also have strong position both in organic and vegetarian food which is important to meet the very strong consumer trends we see in these two areas.

But we are not only buying companies, we are also pruning our portfolio continuously. Earlier this year, we announced that we will exit mayonnaise-based salads in Norway. We don't believe we are the right owner of - and be able to create growth in this category. So we have decided to exit mayonnaise-based salads.

We have also exited industrial marzipan production in Italy and just recently we announced that we have sold our professional laundry business in Norway. And that is in the Brand Consumer Goods area.

In addition, we have also sold an asset that I will not regard as a core for us, that's Rygge Airport. It's finally out of our portfolio and when we do this portfolio pruning, that also helps us to be more focused on our core business, focus on growth companies, growth categories both when it comes to management attention but ultimately when it comes to capital.

So let's now have a look at Brand Consumer Goods performance. As I said, I will focus on the half year figures and Jens will come back to the second quarter. For the first half-year, we report an organic growth of 1.1%. Q1 was positively affected by the timing of Easter and Q2 was negatively affected by Easter but year-to-date 1.1% organic growth.

We've also seen that the growth in the markets where we operate is slowing down. I think 1.5, 2 years ago we anticipated growth of 2% to 3% closer to 3% than 2%. By the end of last year, we saw that the growth came down to the area of 2% and so far this year we see a growth approximately on 1% in the market.

But what is really - I'm happy to see is that we are growing in line with the market, so we are maintaining or capturing market shares in a slow growth market, and that was not the case in 2016 where we said that we are growing somewhat slower than the markets and I was not happy about that.

As you see on the right side, Confectionery & Snacks they continue in a very strong growth figures. Care is also in very good progress with 2% organic growth and I think this is also very nice to see that HPC in Norway is gaining substantial market shares during the first half year.

Food experienced lower growth and Orkla Food Ingredients is the only business area with negative organic growth and that is mainly due to - as we have exited some contracts with low profit abilities on some private label contracts on better brands.

All in all I of course would love to see much higher market growth than we see in the area of 1%. So we are continuously looking into areas with higher growth, higher growth categories, higher growth channels like pharmacy, online channel, DIY, international sales, so on. And of course also very important to meet the strong consumer trends we see for organic, healthy, convenient food, vegetarian, good-for-you products, and of course also indulgence which is important.

Also during the first half year we have been working much more as One Orkla utilizing our scale and taking out cost in the whole value chain. And that is working. I think this figure is quite familiar to you. It's the - my famous black over red where the black illustrates development in organic growth and the red is development in fixed cost.

And we have first half-year managed to keep the fixed costs at level or slightly negative while we have a topline growth. So we have a healthy gap black over red due to cost initiatives throughout the value chain. But unfortunately especially during the second quarter, we have experienced that variable costs are moving in the wrong direction.

As I said, we have experienced substantial price increases on meat and dairy products especially in Hamé, in Czech Republic. On top of that, we also experienced a stronger euro versus especially NOK and SEK which also makes our purchase in foreign currency more expensive. This has been compensated by price increases and also more cost initiatives.

But we also know that this initiative takes time but we expect to see results of this throughout 2017. And needless to say, I'm not happy with an underlying margin improvement of only 12 basis points but we expect to see much stronger second half of 2017 due to the actions that we have initiated as I said price increases and more cost initiatives.

So now Jens will take you through more of the details in the second quarter figures.

Jens Staff

Thank you, Peter. And as Peter mentioned, we saw continued progress in the Branded Consumer Goods area in the second quarter. Let's start by looking at some of the details in the P&L.

Group EBIT improved by 3% in the second quarter and 6% year-to-date. The improvement is driven by the Branded Consumer Goods area. We have continued restructuring M&A activity and M&A activity within Branded Consumer Goods and you can see the impact of this on the line item other income and expenses. And the size of these line items will fluctuate from quarter-to-quarter.

For the first half of 2017, other income and expenses has been impacted by costs related to the decision to exit certain products - the product groups. These exits will allow us to focus more on the core and we expect some positive impact from restructuring items like property sales and so on, on this line item in the second half of 2017.

As Sapa is now booked as discontinued operations, the majority of the profits from associates is related to Jotun. As expected profits from Jotun were lower in the second quarter and first half year compared to last year because of weaker markets for offshore and shipping newbuilds. I will revert to more of the details in the associates later on.

Last year's Q2 profit from associates included an impairment of shareholding in Rygge Airport of approximately NOK70 million, just to remind you of that. Further on the impairments of Rygge also impacted the net financial costs last year of approximately NOK100 million which explains the reduction in the net financial costs year-on-year.

Overall profit before tax increased by almost 3% in the quarter ending up NOK967 million. The contribution from Sapa is booked as discontinued operations and was down in the quarter mainly due to unrealized negative derivative affects.

Earnings per share for continuing operations were up 9% in the quarter but slightly down for the first half year and the reduction year-to-date relates to timing of other income and expenses and lower results for Jotun.

Let's take a closer look at the second quarter performance in the Branded Consumer Goods area and then starting with the revenue bridge. Revenues grew 4% in the quarter and as we can see, M&A was the main contributor mainly related to the acquisition of Harris, as well as the positive impact of M&A we grew revenues organically by 0.7% largely because of growth in price.

The organic growth rate was negatively impacted by the timing of Easter in the second quarter as Peter mentioned as there were fewer selling days mostly in Norway. As Peter mentioned, the organic growth for year-to-date is in line with the market growth. Negative foreign exchange rates resulting from a stronger Norwegian Krone since Q2 last year reduced the reported avenues slightly.

Let's now look in more details at each business area within the Branded Consumer Goods and then we always start with largest one, namely foods. In foods we grew organic sales by 0.4% in the quarter despite the negative Easter effects and the negative impact on sales related to the introduction of the goods and services tax in India.

In addition to these negative effects, profits were down in Q2 due to the following two factors. First, we saw increase in key raw materials primarily animal products like meat and dairy. For example, the prices of pork and beef have risen by 19% year-to-date in the Czech Republic and the majority of this increase came in Q2.

Second, the timing effect that resulted - timing effects resulted in higher advertising investments in the second quarter. We have implemented price increases but we have not yet been fully offset by the increased input costs. And as a result, we experienced a negative lag effect on both EBIT and margins. Further price increases are being implemented which will have a positive effect as from the second half year.

Let's move on to Confectionery & Snacks. Organic sales rose by 4% in the second quarter. This was primarily due to volume growth with especially good progress in chocolate and confectionery.

Confectionery & Snacks had a strong innovation and campaign activity in the first half year boosting the sales growth. Profit were lifted through sales growth and improvements primarily related to carryover effects from the turnaround that we did in - last year in 2016. The adjusted EBIT margin improved by 1.4 percentage points and ended at 12.2% for the quarter.

Let's look at the performance for Orkla Care. The revenue growth in Care was driven by last year's acquisition of Harris. The performance in Harris was negatively affected by lower sales activity. This is mainly a result of internal focus as we are currently merging the two companies that we have in the U.K.

However, synergy realizations from the merger is according to plan. Organically we continue to grow despite the negative Easter effects that we saw in Q2. The competitive environment in Norway within Home & Personal Care is still tough as we've said many quarters but we had good progress this quarter. We've considerably increased market shares in Norwegian retail.

We also improved performance in Orkla Health. Margins in Care were lifted from operational improvements and synergies. It's more than offset the dilutive effects from the highest acquisition. So to sum up, we are pleased with the progress that we see in the Care area.

Let's now turn to Orkla Food Ingredients. Several smaller add-ons that we have done in Food Ingredients increased revenues and profits in this quarter. Organic sales declined by 0.9% mainly because we have exited contracts with loan profitability. This will limit organic growth throughout most of the year.

Most of the remaining portfolio had a good sales development in sub. EBIT was negatively impacted by weaker profit development in Romania as for what was the case in Q1. The minimum wages in Romania has been raised and packaging fees was raised also sharply.

In addition, raw material cost have risen this quarter specially for dairy products including butter. And as I mentioned in Q1, we have taken action on this and we are starting to see results but the majority of the positive effects will come in the second half of 2017.

Let's look at the investments area. And the main message of course from an investment area is the sale of Sapa. And this transaction as you know will free up significant to capital that we overtime want to reallocate to the Branded Consumer Goods area. Until closing, Sapa will be reported as discontinued operations.

Let's turn to the fully consolidated businesses, which is Hydro Power and Financial Investments. And for Hydro Power higher power prices and increased volumes resulted in improved EBIT. There has not been any large transaction in the real estate area in the second quarter and the book value is approximately 1.5 billion at the end of the quarter. This book value will of course increase as we go along with the progress of constructing our new headquarters.

As I mentioned, Sapa will be booked as discontinued operations until closing. Let's have a quick look at the performance in the second quarter. Sapa improved its underlying EBIT in the second quarter of 2017 compared to the last year's quarter. The quarter is in fact the best quarter in Sapa's history.

The increase was driven by a higher share value-added business and internal improvements in all areas. Reduction that you see in net profit after tax is due to the negative unrealized derivative effects for the quarter. Net interest-bearing debt increased to NOK3.1 billion at the end of the quarter mainly reflecting the dividend payments of NOK3 billion to the owners.

Now moving on to Jotun. Jotun continues to deliver growth but as expected revenues were below last year mainly because of weaker markets in shipping and offshore. Weaker markets in combination with increasing raw material costs hampered profit for performance coatings.

Underlying growth continues in Decorative Paints with profits in line with last year. Price increases and tight cost control will partly offset the effect of rising raw material costs with positive effects going into the second half of 2017.

Let's look at the development of the net debt. At the end of June, our net interest-bearing debt was NOK9.3 billion representing roughly 1.7 times, 12 months rolling EBITDA. The increase from Q1 was related to dividend payments and the acquisition of companies.

After closing of Sapa transaction in the second half of 2017, we plan to reduce our debt by approximately NOK4 billion. This will roughly half of interest costs going forward. We do believe it's smart to keep some leverage headroom to execute on our strategy and grow our cash flow. But we will of course, not sit within inefficient balance sheet over time. We will look for opportunities to grow the cash flow, enhance future dividend capacity by making profitable and value attractive acquisitions.

So to sum up, we continue to deliver organic growth in line with the market growth. Cost improvements from working like One Orkla gives results. The EBIT margin is negatively impacted by increased raw material prices.

So with that, I leave the floor back to Peter for his final remarks.

Peter Ruzicka

Thank you, Jens.

Just before we go to the Q&A session, I would just like to sum up first half year. We continue to grow our Branded Consumer Goods area both organically and through M&A as I showed some examples of what we've done the second quarter.

We also continue to realize synergies working as One Orkla utilizing our size, utilizing our scale, working much more together across business areas, business units and geographies. Business valid both topline and of course on bottom-line or on the cost area. We will share much more innovations, consumer insights and product development and so on across geographies and business areas.

During the quarter we have experienced higher input cost that puts pressure on our margin especially in food and we have taken actions by increasing prices and further cost initiatives to mitigate this effect. And as we have said several times, this takes some time but that will have a gradual effect as we move into second half of 2017.

Looking forward, we see that the market growth is slowing down and we are continuously looking into higher growth areas either when it comes to categories, channels or geographies. After the sale of Sapa and even after that extra dividend of NOK5 per share, we will have a very strong balance sheet. And our first priority for excess capital is to find attractive assets to buy, assets that fits with our Branded Consumer Goods strategy where we can realize synergies and of course pay a favorable multiple price where we can create value.

And we see a lot of M&A opportunities out there. But we are patient as we have been with the sale of Sapa, we said that we are not in a hurry for the sale of Sapa. We want to wait in order to capture our fair share of the value. The same goes for M&A, so we are not in a hurry. We will not rush into any deals just to spend the proceeds from Sapa.

And as Jens said, overtime we course we want to have an efficient balance sheet and we have a history of paying out special dividends when either we have done sales for some assets or when we have had balance sheet that is not efficient enough.

I’ll just show you one recent example of an acquisition we just didn't and I mentioned that also in the first part of my presentation. And that's the Riemann Company in Denmark which have the brand P20 sunscreen. And for us this is a new category and also category with higher growth that may see in many of our other categories on HPC.

This product is free from colorants, it's free from perfumes, and it's free from preservatives. And actually it was just recently tested by Consumer Counsel in Norway and not surprisingly, this product came out best in test both for your body and also for the environment which is becoming more and more important especially for young consumers.

Since we took over the company, we have experienced very strong performance in Riemann with P20 brand and we also see opportunities of extending distribution of this brand throughout our existing sales organization in other geographies and other channels. And you will have a sample of this product in the gift bag that you can collect when you leave this presentation. I hope you will like this and also hope that you will have a very sunny summer so you can enjoy and try this product.

Thank you. And then we go over to the Q&A.

Question-and-Answer Session

Q - Unidentified Analyst

[Foreign Language]

Peter Ruzicka

Okay. I will just repeat the question in English for those who are following us on the web. The question was about the sales price of our shares in Rygge Airport and why that was kept secret? Jens will answer this.

Jens Staff

We haven't disclosed this sales price but what I had explained in the presentation was that last year we did an impairment of the values that we had in our balance sheet at Rygge Airport and that was twofold.

First of all, we then impaired the - call it assets that was NOK70 million and then it was a shareholder loan that was also written down that was NOK100 million and it's - is then booked at two different line items. So the first one is on the associates and the later one is the net financials.

So that was call it the values that we had in our balance sheet last year and was written down last year because of the performance in Rygge. So it has nothing directly to do with this - the costs and so on that you referred to.

Preben Rasch-Olsen

Preben Rasch-Olsen, Carnegie. Two questions. First, can you say something about the size of the P&L contracts in the ingredients that you have chosen to go out of? And also are you willing to say something about the organic growth in Foods and split it between the Nordics and the markets outside the Nordics.

Jens Staff

We don't disclose the size of the contracts in Food Ingredients but this was a main explanation for the negative organic growth this quarter and it will also affect the organic growth going forward. But these were contracted, very limited EBIT effect and then of course as you know we also lost this tender contract in Norway.

And then commenting on the organic growth in Foods, as I explained in my presentation, the effects that we see from specially the Easter effects in the Norway and then also to quite larger extent in Sweden is of course very negative for this quarter and on top of that, we saw this - call it the introduction of, common, call it VAT initiative in India which created a lot of uncertainty on the later part of this quarter.

So in some this explains and then also adding on the timing of the advertising, all of these elements in some more than explains the deviation compared to the consensus for Foods this quarter. That's the level of detail I want to give you today Preben.

John Ennis

Okay. So I have a lot of questions from - John Ennis, Goldman Sachs here, so I'll take them one by one. Starting with - you say you have 1% market growth now. Is that a new norm for market growth or do you expect this to recover towards 2% in the second half as pricing picks up?

Jens Staff

It's hard to predict especially about the future of course but this is a lower market growth and what we have seen in the last several years actually, so I would expect it to pick up but I cannot be certain and I don't know when it will pick up but I will expect it.

And I think we see clear signs now in Europe on several areas that we see clear signs of an increased inflation as we mentioned the raw material prices but also wage inflation in Central Eastern Europe and in other parts of Europe. So I think we will see more inflationary environment going forward which will help also organic or the top line growth.

John Ennis

Can you also break out the market growth by division between Foods, Confectionery and HPC?

Jens Staff

No, I don't have - I don't have those figures here that we will have to revert to that question.

John Ennis

Moving on to costs, in regard to the black over red shot, the fixed costs in H1 were broadly flat but you have exited certain products group and closed factories. Do you expect fixed cost to decline more materially in the second half here?

Peter Ruzicka

We don't disclose any expectation for our costs going forward or profitability going forward but what I can say is that we will continue our cost initiatives throughout the company both in supply chain and also in SG&A.

So this is not over and we will continue this for some time going forward. So we expect fixed cost to continue down yes.

John Ennis

Okay. Finally on India. Can you remind us how big this is for the Food Division as a percentage of sale? What the magnitude of sales decline was and whether this will continue as a drag into the second half?

Peter Ruzicka

I think when it comes - I think as Jens said when it comes to - we report figures on the business area level and we don't disclose figures for each business unit within a business area. When it comes to India, I think for those who are not aware that India they have had several different sales taxes in each province or region. Now they have introduced a national, call it VAT tax, GST they call it, goods and service tax which varies from 5% to 28% depending on category or area or service.

This has created a lot of uncertainty, also uncertainty about what will happen with the stock the retailers have today, will that be taxed or is it only for the purchase of new goods and so on and will the tax go up or will it go down because this is replacing an existing local tax that they have today.

So the uncertainty, I think will last maybe for a couple of months and then this will settle, we expect this to settle. And in general this is a good thing for the Indian economy.

Jens Staff

Just continue on the note and then referring back to Preben's earlier question. I'm not sure that I was precise enough on this raw material increases in the Czech Republic in addition explaining being a big part of the negative deviation in Foods. Just to be precise on that.

Unidentified Analyst

Just a short follow-up. Peter you mentioned that you expected to see much better margin improvement in the second half of this year. Is that across the Board or there are some specific divisions where you really expect to see margins coming up.

Peter Ruzicka

We don't guide on margin or on business areas but quite obviously we expect to see improvement in foods area because of - the reason we said that we have initiated price increases and more cost initiatives to contract the negative raw material increases. So we expect to see that especially in the Food Division.

Unidentified Analyst

[Foreign Language]

Peter Ruzicka

I’ll repeat the question in English. The question is about our acquisition of Harris that is in a way competitor to our existing paintbrush activity Jotun, or Jordan, I think you meant Jordan. And is it now time to sell out Jordan? And answer to that is no, because we are mainly operating in different markets.

We used the Jordan brand especially in Norway and in the Nordics and Harris is a brand for U.K. mainly U.K. and also in Belgium, the Netherlands and so on. And this is a very good complement to the paint tool activity or business we had in the U.K. We had company with the brand name Hamilton and they have very strong position in the professional painting market for the professional painters but we had no position in the DIY, do-it-yourself segment.

And Harris complements our U.K. business and now we have a strong foothold both in professional painting business and in the DIY business. So I think we can live with those both brands by well also going ahead. And as you probably thinking about, is that Harris is also sold in Norway in some discount stores and I think we can live with that.

Hans-Marius Lee Ludvigsen

Hans-Marius Lee Ludvigsen, Swedbank. Can you comment on the magnitude of the cost increases in Romania, just to get a grip on its impact on Food Ingredient margins?

Jens Staff

We don't disclose details in each business unit but it's a big part of the deviation - of the Food Ingredients results.

Peter Ruzicka

Okay. No further questions or any questions more from the web, no? Okay, thank you everybody for joining us this morning, and I wish you all good summer holiday for those of you that will have that. And let's hope for a sunny summer so you can try our great P20 sunscreen. Thank you.