Orkla ASA (OTCPK:ORKLY) Q2 2019 Earnings Conference Call July 12, 2019 2:00 AM ET
Terje Andersen – CEO
Jens Staff – CFO
Good morning, everyone, and welcome to today’s presentation of Orkla’s second quarter results. My name is Terje Andersen, and I’m acting CEO of Orkla. This will be the first, but also my last time — and also the last time I present or disclose financial results as CEO. As you all know, the Board of Orkla has appointed a new President and CEO, and Jaan Ivar Semlitsch will take up his position in a month’s time. But first in this presentation, I will go through some highlights. And then as usual, our CFO, Jens Staff, will go through the financials in more details. The progress we saw in Q1 continued in the second quarter. Our Branded Consumer Goods business delivered both organic sales and profit growth, and underlying 12 months rolling EBIT margin improved by 0.3 percentage points. The overall progress was, however, set back by weak results in Care. Performance in the quarter was mainly driven by broad-based sales and profit growth in Orkla Foods and Confectionery & Snacks. We also had good progress in Orkla Food Ingredients, especially considering the very strong ice cream sales we saw last year in the same quarter.
In Care, however, we are disappointed to report decline in both sales and profits. Both Jens and I will talk more about our response to the challenges in Care later in this presentation. On a positive note, Jotun has increased its operating profit by 45% so far this year. This improvement was driven by sales growth, improved gross margin and good cost control. And in total, this contributed to a year-to-date improvement in adjusted EPS of 12%.
If you look at organic growth in more detail, you can see that we had organic growth in Branded Consumer Goods of approximately 1% both in the first and the second quarter. Three out of our four business areas grew the top-line organically in the first half year. Orkla Foods had broad-based growth, and we are especially pleased to see growth in the Norwegian market.
Confectionery & Snacks also had good progress with volume growth in all the Nordic markets. In Norway growth was helped by positive effects from customers restocking after the reversal of the sugar tax increase from January 1st and we estimate this effect to be less than 1 percentage point for Confectionery & Snacks.
Overall organic growth was however offset by sales decline in Care. And we see especially weak figures from HPC or Home & Personal Care in the Norwegian market and also in our health related categories across markets. Food Ingredients had moderately positive organic sales growth. This is, however, somewhat impacted by exit from some less profitable businesses. So more importantly, they have a stronger growth in contribution and margins.
And now let’s see how we will respond to the challenges in Care. Turning the negative trend in Care is of course a top priority for us going forward. Portfolio is relatively broad, and we see the different challenges in the different categories and markets. And in order to reduce complexity and to allow management teams to focus on the key issues that business is facing, we have therefore split the Care portfolio.
The core part of Orkla Care consists of Orkla Home & Personal Care, Health, Wound Care and HSNG. And we’ll — from now or from June 1, we had bid by one of our most experienced leaders, Atle Vidar Johansen. Pierre Robert, Orkla House Care and Lilleborg are all companies with different strategic profile and will be operated more as an independent business. These changes will simplify the organizational structure and strengthen the operational focus. We have strong brands and market position within Care and with experience and motivated management teams, we are quite confident that we can turn this trend in some quarters.
And then I leave the floor to Jens that’s because he will go through the financials in more detail.
Thank you, Terje. Let’s start with the top-line growth. We saw an overall growth in the Branded Consumer Goods of close to 4% in Q2, both from 1.1% organic growth and 2% structural growth. We are pleased to see a broad-based growth across Foods and Confectionery & Snacks. This growth was partly offset by negative growth in Orkla Care.
We had minor positive currency translation effects in the quarter primarily due to a weakened Norwegian kroner versus euro. Structural growth was driven by acquisition, both in Foods and Food Ingredients. And for Foods, the biggest acquisition was — is the Food and Lecora. For Food Ingredients, we already made several transactions. The most recent ones are Kanakis, Zeelandia and Risberg.
Part of our efforts to prioritize our portfolio as part of this, we announced the sale of the Danish seafood business, Glyngore. This business was deconsolidated from July, and the gain on this sale is booked on the other income and expenses item. We also announced the sale of a former industrial site in Oslo to the City of Oslo. And this sale is conditional on approval of the Oslo City Council. And we expect this to be in place in the second half of 2019.
Next, let’s look at the profit and EBIT margin performance for the Branded Consumer Goods, including HQ. We are pleased to see good growth in the Branded Consumer Goods, driven by good progress in Foods, Confectionery & Snacks and Food Ingredients. This was partly offset by the weak results in Orkla Care. Underlying earnings improved for the Branded Consumer Goods by 5% in the quarter. The inclusion of HQ costs, which was unusually low in Q2 last year, largely offset this improvement year-over-year and resulted in 0.3% improvement as you see in the graph to your left.
HQ costs can vary between quarters, but this is normally around NOK 90 million. The large delta that you see from last year is related to share price adjusted bonus costs and some non-periodic items. Profits from acquired business in the Branded Consumer Goods area added 1.5% to the EBIT growth that you see in Q2. On a rolling 12-month basis, our underlying EBIT margin improved by 30 basis points. Revenue management and positive mix effects are the key drivers of this improvement that you see. And we continued to face headwind from higher inputs costs both related to FX, but also raw material prices.
Next, let’s look at the business area specifics, and then we start with Orkla Foods, the biggest business area. I’m pleased to see continued progress in Orkla Foods, broad-based organic growth in the quarter of 3.1% comparing to somewhat weak Q2 last year where we had organic growth of 0.4%. The quarter reflects good progress in our revenue management agenda supporting this overall growth.
Price increases for compensating for significant cost increases in previous quarters are now contributing to this top-line growth. All markets contributed to a strong EBIT growth of 13% from a healthy combination of increased sales and reduced costs. Foods continued to experience headwind on the currency side from a weaker Swedish kronor and increased raw material prices. But these effects were compensated for by price increases — by the price increases that I previously mentioned.
In sum, we continue to see an improved EBIT margin in overall progress of 80 basis points in the quarter.
Let’s look at Confectionery & Snacks. In Confectionery & Snacks, we grew our business organically by 5.4% compared to a rather weak Q2 last year. This increase was mainly volume driven in all our Nordic markets. Successful revenue management also added to this good progress.
Organic growth year-to-date was helped by a strong start to the year with customers restocking after reversal of the sugar tax. And just to mention, an innovation or a relaunch. So this quarter, we have had success with many new launches and one of them under the well-known Norwegian chocolate brand, Stratos. Not only was the new Stratos Salty Caramel the most repurchased chocolate, but it also grew the original Stratos by double-digit.
Overall, we see good market growth in Confectionery & Snacks, especially in the snacks category in all our markets. And in Norway, we are glad see the Confectionery market that this market has returned to growth. Revenue growth and positive effects from ongoing cost improvements drove the EBIT up by 12% and this is despite headwind from a weaker Swedish kronor.
In total, we improved EBIT margin in Confectionery & Snacks by 70 basis points from a rather soft comparable.
Moving on to Orkla Care. We’ve seen a weak performance in Care and that continued in Q1 where Care had an organic sales decline of 4.5% and EBIT was down 8.3%. Our main challenges are within Home & Personal Care categories in Norwegian grocery and also weight management across the markets. Part of the weak results that we see in the Q2 are due to lower campaign activity compared to last year. We have a strong position within the Home & Personal Care categories in Norway and should clearly perform better than we do.
The channel shift that we see and that we have talked about in earlier presentations is part of this challenge. But this is not an excuse for underperforming over time. With our strong positions and strong brands, I’m confident that we and our customers can turn this trend. But to turn this trend, this is hard work and it will for sure take some time. And as Terje mentioned earlier, we have split the Care portfolio to reduce complexity and to allow the management teams to focus on regaining momentum in the market.
Let’s look at the last business area in the Branded Consumer Goods, namely Food Ingredients and Food Ingredients improved sales organically by 0.1% in the quarter. And as you remember, this is compared to a very strong quarter last year with a strong ice cream ingredient season.
Deliberate actions to exit less profitable business had a negative impact on the organic revenue growth that has a positive mixed effect on the margins. EBIT in Food Ingredients increased by 11%, and the improvement was broad-based. Successful revenue management and portfolio mix contributed positively to the progress. Food Ingredients also strengthened its position through several margin accretive acquisitions within ice cream ingredients and bakery ingredients.
Let’s now look at the performance in Kotipizza. In Kotipizza, the good sales growth that we saw in Q1 continued and even improved during Q2, driven by increased chain sales and growth from our wholesale business Foodstock. We had 17% growth in chain sales and 8% growth in like-for-like sales and this confirms our strong customer offering. We see a normalization of marketing spend as communicated in the last quarter. And combined with operational leverage from good cost control, this translated into improved EBIT, both in absolute and relative terms for the quarter.
In Q2 last year, the results contained several non-periodic items, including cost for management incentive scheme and additional payments for Social Burgerjoint, which was taken as costs. When it comes to expansion, we opened up during this quarter four new Kotipizza restaurants and two new Social Burgerjoints.
Let me continue with walking you through the Jotun’s performance. Jotun reported continued sales growth in the second quarter, increasing 5% compared to the same quarter last year. Sales growth reached 7.5% in the first six months, driven by price increases and stronger growth in the Protective and Marine Coatings segment. Reported sales growth that we see in Jotun was also influenced by positive currency translation effects of 2%.
After lengthy period of challenging market conditions within shipbuilding and offshore industries, sales have started to pick up in both these markets.
Operating profit improved by 45% year-to-date, compared to last year. This improvement is explained by higher gross margins and good cost control. Last year’s implemented price increases in Jotun combined with stabilizing raw material costs gradually improved margins throughout Q1 and this development also continues throughout the second quarter.
Let me sum up the Q2 financials and go into some more details on our investment divisions and other material items. As already mentioned, the Branded Consumer Goods area report good earnings growth of 7%. HQ cost in Q2 was more of a normal level compared to a low level last year. And the negative delta that I’ve talked about is primarily related to share price adjusted bonus costs, some non-periodic items.
The earnings from Orkla Investments include Hydro Power and Financial Investments. And as you know, Kotipizza was consolidated from February. When it comes to earnings in Hydro Power, earnings were down 29% and this is primarily due to lower production volumes.
Financial Investments reported an adjusted EBIT of NOK 10 million compared to NOK 14 million Q2 last year. This quarter includes our loss negative accounting effect in conjunction with the completion of Orkla’s new headquarter, and there were no other property transactions affecting this quarter.
We have non-recurring items of minus NOK 39 million in the quarter. The largest items include M&A transaction costs and restructuring costs related to our ongoing initiatives. This is partly offset by, again, when selling Glyngore in Denmark.
Profit from associates is almost entirely related to Jotun. And as I’ve just talked about today, they completed another very strong quarter. The increase in net interest and financial items is driven by higher interest bearing debt and increased pension costs. The Group’s borrowing costs for the quarter was 2.6%.
Orkla’s effective tax rate in Q2 was higher compared to the Q2 last year, where the tax rate was positively impacted by some non-periodic items, primarily in conjunction with some resource rent tax. Good progress in both our consolidated business and Jotun contributes to an increase in adjusted earnings per share of 5% in the second quarter. Reported earnings per share increased by 10%.
Let me just briefly walk you through the working capital and cash flow. As you know, a part of our financial targets for the 2019 to 2021 period is reducing working capital where we target to reduce our net working capital position by 3 percentage points over the three year period.
Following an increase that we saw in 2018, we are pleased to see an improvement in the year-to-date period. There are several ongoing initiatives when it comes to working capital improvement, but it will be some time before the effects materialize into figures. And this relates both to supply negotiations as well as inventory optimization.
Also, the top-line development in Care is challenging for the working capital development. We had positive cash flow from operations during the first six months of approximately NOK 500 million. Cash conversion is strictly weaker in the first half of the year where we have seasonal buildup of working capital. We continue to deploy more capital to strengthen our Branded Consumer Goods business and we have increased our M&A activity with seven completed acquisitions during the first six months.
Kotipizza, Easyfood and Kanakis are the largest transactions. We have also completed the sale of Chaka in Russia and Glyngore in Denmark. The net M&A spend was NOK 2.6 billion. And in addition, we had organic expansion investments of around NOK 300 million. We paid our ordinary dividend with NOK 2.60 per share in May, and this corresponds to a total of NOK 2.6 billion.
As a result, our net interest bearing debt has increased from approximately NOK 3 billion to NOK 7.8 billion since the year-end. And this corresponds to a net interest bearing debt to EBITDA of approximately 1.2 times. Including the debt from capitalized leasing following the implementation of IFRS 16, this brings the total level to NOK 9.4 billion.
I will now leave the floor back to Terje for a summary before we open up for Q&A.
Thanks, Jens. Then I will briefly sum up before we go on to Q&A. Our Branded Consumer Goods operation delivered good sales and profit growth in Q2, but overall progress would offset by weak performance in Care. The performance was mainly driven by a broad-based sales profit growth in Orkla Foods and Confectionery & Snacks, but we saw also good profit improvement in Orkla Foods Ingredients especially compared to a strong Q2 last year.
The challenge we see is in Care and turning the weak performance in Care is a top priority. We have split the Care portfolio to reduce complexity and to focus management teams on regaining momentum in the market. We have a strong position and brands in Care and we are quite confident that we can turn this trend together with our customers over some quarters.
Jotun continued its strong recovery from last year and has a year-to-date increase of 45%. So even though we have some challenges in part of our business, we regard first half to be satisfactory for Orkla and we have a year-to-date adjusted EPS increase by over 12%. And in Norwegian kroner that is NOK 1.78 for the first half.
And then we continue with Q&A, and Jens will join me for that. And as you see, we are backed by some of brands and product that has contributed to the progress in second half. So please?
Everything clear, Jens? Seems so.
Jens is very well prepared, so ask difficult questions, but it’s sunny outside. So if there’s no question from the audience and not from the web? No? Then we round it up by wishing everybody a nice summer in a sunny weather, hopefully. Thank you, everyone.
End of Q&A