(Debtwire) Upfield price increases drive sales growth but rapid deleveraging required ahead of approaching refi

Upfield price increases drive sales growth but rapid deleveraging required ahead of approaching refi

23 August 2022 | 17:04 BST

Upfield pleasantly surprised investors with a solid 2Q22 earnings beat and guided deleveraging towards around 8.0x by FY22. The Netherlands-headquartered plant nutrition company can also keep improving metrics given decent free cashflow generation as one-off costs reduce. Its secured loans therefore look a solid investment, but its unsecured bonds are still risky given expected hefty leverage ahead of a possible 1H24 marketed refi attempt, according to four buysiders and two analysts.

Management gave an encouraging presentation on the company's earnings call held on 18 August, as reported. Upfield's increased prices have helped offset cost inflation pressures, which are starting to ease on commodities such as edible oils. Its products also offer many advantages over more expensive animal butter products, while management also expects to paydown more of its RCF drawing, pointing to net leverage of around 8.0x at FY22.

Click HERE for the 2Q22 earnings call transcript.

Upfield’s earnings beat led to a surge in its bond prices following the results. Its Caa2/CCC/CCC+ rated EUR 685m 5.75% senior unsecured 2026s were indicated around 8.5 points higher since the results’ release at 73.625 yielding around 15.3% while its USD 525m 7.875% senior unsecured 2026s are indicated around 10 points higher at 72.75-mid with a 18.3% yield, according to Markit.

The company’s term loans also rallied. Upfield’s (Sigma Holdco) EUR 2.375bn Euribor+ 350bps TLB1 and its GBP 710.29m Libor+ 400bps cov-lite TLB4, both due in July 2025, were up over 4.5 points at 87.85/88.68 and 84.56/86.68 after being quoted at 82.92/84.39 and 80.06/82.16, respectively, last Tuesday (16 August), according to Markit.

Upfield’s results beat investor expectations as a rise in prices of its products meant that the company was able to generate higher sales and drive an uptick in earnings. The company had 16.5% YoY sales growth in 2Q22 at constant currencies with the sales growth driven by a positive 24.3% impact from pricing and a negative 7.8% impact from volumes and mix effects (see chart below). Company 2Q22 normalized EBITDA was up 6.7% YoY to EUR 162m, as reported.

The near-term outlook appears promising, and the company should have even greater sales growth next quarter given it implemented a “Third Wave” of price increases in July that have not been included in its 2Q22 financials to end-June.

Another positive for revenue growth is that competing butter products have surged higher in recent quarters and animal butter products at 2Q22 were 1.9x as expensive as Upfield’s plant-based products.

One buysider noted that investors have the hypothesis that people will be trading down from butter to margarine as butter prices rise. Investors had low expectations and Upfield outperformed, so the results were quite positive, but the company is still highly levered, he added.

Cost inflation remains a challenge. Positively, management noted on the earnings call that edible oil cost rises have started to ease and that the company is 100% hedged on vegetable oils for 2H22. Energy production and logistics costs could still increase but these two cost types only make up around 11% and 14% of the company’s costs of goods sold, respectively, versus around 70% from materials.

“They have fixed pricing in store so put through a third wave of prices increases which is not reflected in current numbers,” a second buysider said. “Prices were up over 24% and the Third Wave could mean 10% more and a near 35% rise for 3Q22 – it is a strong number and fixed costs are hedged.”

However, demand has been inelastic and could hit an inflection point if prices rise 35% YoY, the second buysider noted. This is the key variable, and it is unclear how sticky demand is relative to price, he added.

A third buysider was impressed. “The operations were splendid, and they have shut down unprofitable stock keeping units [SKUs],” he said. “The butter price differential helps, and they have dealt with inflation pressure since 2020.”

Holy cow

Upfield net leverage metrics are still high and were reported at 8.7x at 2Q22. The company has guided to be around 8.0x net levered by FY22. But with EUR 4.456bn of loans maturing in July 2025, the company may need to be in a position to refinance its capital structure in 1H24 which would mean having FY23 financials under their belt.

Metric improvement after this 2Q22 reported period could accelerate. The company at 2Q22 had an LTM normalised EBITDA of EUR 651m. It could face around EUR 100m of annual capex, EUR 236m in interest costs and EUR 60m cash of taxes, while its EUR 114m one-off costs could eventually reduce. On the most bullish assumptions, this could therefore mean EUR 255m of annual free cashflow or 0.4x deleveraging per year through free cashflow with upside as earnings grow.

Whether company earnings can grow fast enough in time is questionable. Upfield LTM normalized EBITDA of EUR 651m at 2Q22 is down versus the EUR 666m at FY21. Based on bullish buysider assumptions, if the group maintained 2Q22 16.5% quarterly sales growth trends for each annual period, this would mean that FY21 revenues at constant rates of EUR 2.831bn could climb to EUR 3.298bn at FY22 and EUR 3.842bn at FY23. With LTM 2Q22 adjusted EBITDA margins of 21.3% on Debtwire sister service Credit Rubric estimates this could mean a forecast of EUR 818m FY23 adjusted EBITDA with polled investor forecasts ranging from EUR 750m to EUR 800m. A EUR 818m FY23 adjusted EBITDA would require the company to have reduced net debt of EUR 4.910bn at FY23 versus EUR 5.696bn at 2Q22 to be 6x net levered and at a lower level where investors consider they could be able to refinance the capital structure.

“I’m not sure they can refinance. The 2Q22 results were a turning point and better than expectations. But I’m still unsure they can maintain gross margins and grow EBITDA enough,” one analyst said. “They need to refinance in 1H24, which could be 18 months from now.”

The first analyst expects LTM EBITDA to be just EUR 700m by 1H24. He noted there will be good cash generation but too much net leverage.

“They have 2025 maturities that will have to be addressed one year before,” the second buysider said. “This leaves two years to grow earnings, and if they have a good 2H22 they will be on track. With 35% price rises this can boost revenues and they can generate growth.”

They paid a high multiple in 2020 for [vegan cheese business] VioLife but are now turning it around, the second buysider noted. The cheese business’ US market share has grown while they are rolling out plant-based spreads like a Philadelphia cheese plant version, which can become positive, he added.

The company has time to execute on its turnaround with covenant headroom. Upfield has 23% headroom versus its net senior secured leverage test on its RCF with the company reporting 6.6x covenant defined leverage (defined as term loan debt only minus cash divided by LTM normalized EBITDA) versus the 8.5x covenant defined net leverage test. The test only kicks in if the RCF is more than 40% drawn with Upfield having only drawn EUR 286m of the EUR 700m facility (40.9%) and hoping to reduce drawings further in 2H22. Upfield had a EUR 191m cash balance at 2Q22.

The Upshield

There remains the scenario that sponsor KKR could step in to support its investment if required. KKR acquired Upfield and issued bonds back in 2018 as part of a EUR 6.987bn total capitalization leveraged buyout. This included a EUR 1.926bn equity cheque (based on final bond prospectus) and meant an enterprise value of around 8.5x working off the marketed EUR 820m normalized EBITDA, as reported.

“How they get below 6x net leverage is uncertain, but they have liquidity, cashflow and optionality to see what happens,” a fourth buysider said. “If they can’t refinance, they can do an amend and extend. This is food and defensive – the senior secured debt is fine, but the unsecured bonds are more risky.”

Any refinancing attempt could be pitched as an attractive ESG story. The CEO on the earnings call highlighted the “problem of the cow” and emphasised how cows used for competing animal butter products can emit large carbon dioxide emissions versus its greener plant-based nutrition products. Upfield published an ESG report earlier this year.

One negative for senior unsecured bondholders is the large senior secured loan debt ranking ahead of them. With around EUR 4.456bn of senior secured bank loans and overdrafts and the EUR 286m drawn EUR 700m capacity RCF ranking ahead of senior unsecured bondholders at 2Q22, the notes could have low recoveries in any potential restructuring.

The senior secured debt is likely 80%-100% covered in most realistic scenarios but the recovery for the unsecured portion of the debt on the other hand could vary from 0% to 35%, according to Debtwire analyst calculations in an Upfield 1Q22 credit report.

“They need time, and the value does not break in the bonds given the loans are so chunky,” the first analyst said. “I don’t see an amend and extend of the bonds unless extra PIK interest or an equity kicker.”

The first analyst noted that the company can’t blame the Ukraine crisis as the business was already highly levered going into this and Upfield has been slow on the execution of the separation from Unilever. There are still question marks on execution, he added.

The third buysider was pleased with Upfield as retailers adapt to price increases. “KKR won’t let this go and it is one of their biggest European investments. People underestimate the organic deleveraging potential,” he said. “If they get towards 6x net leverage they can refinance.”

Upfield was seen as a tough near-term credit story at the start of the year given high leverage and cost inflation pressures, as reported.

Independent special situations firm Sarria had expected late 2022 or early 2023 would be the inflection point but noted it is now happening so much earlier. They were confident in Upfield pricing power, but the speed of the pass through highlights their good position in the market.

Upfield and KKR declined to comment.

by Adam Samoon and Jelena Cvejic with capital structure by Adeline Bockarie