Upfield - All about the "Spread" - Positioning
All,
Please find our existing Upfield model here. We will update it after the call this afternoon.
Headline numbers for Upfield for Q2 have beaten expectations on the back of stronger top-line performance, which has led to a 10pt jump in their bonds. The stronger performance is driven by price increases which has more than compensated for the volume/mix decline. We have been modelling the elasticity of demand for Upfield’s products and the influence that dairy prices are having on the relative pricing between plant-based and dairy-based spreadable products (margarine versus butter). Today’s Q2 results fit a previously identified narrative and have consolidated our views.
Pricing versus Volume:
- The hardest part of modelling Upfield’s upcoming quarters is to estimate the elasticity of demand for its product. Upfield management continue to guide and in fact, it is visible in the market, that the Company are pursuing a policy of increasing prices to compensate for the raw material inflation that all spread producers are incurring. We have noticed from the retail market that Upfield have acted earlier than their competitors in prices rises and therefore volume was expected to be lower than previously.
- However, the volume decline has not been as severe as we had expected in Q2, with volume/mix decline having a c.8% impact on top-line performance. This has been more than compensated by the 24% impact that prices increases have had.
- We had previously that in Q1 Upfield had largely exceeded in achieving price increases with limited damage to volumes, but had not been sure if was indicative of future demand elasticity. Now we have another quarter - deeper into the world of inflation, we are gaining confidence at the relatively resilient Q1 and Q2 figures are in fact the path on which this Company should continue. Our modelling suggests that the Company is cash flow neutral at 25% margins and these levels now look increasingly conservative to us.
- Annoyingly the Company has changed its reporting segments to Europe, Americas and AMEA (Asia, Middle East and Africa). Despite this, the Company have reported that the volume decline in the Americas had a 4% impact on top line, with price increases having a 23% impact on top line.
- The impact of Volume/Mix decline is greater in Europe at 10%, with price increases contributing to 20% increase in top line. The fear was that price increases would be more difficult in Europe. Price increases have been easier than expected in Europe due to the dairy prices increases that customers are seeing. Further dairy price increases are expected in H2, due to the lower yields likely after the prolonged heatwave across Europe.
Gross Profit:
- More important than top line, is the performance of Gross Profit margin at Upfield. On a comparison versus Q2 ’21, the Company was 480bps lower, reflecting the squeezing of margins due to raw material price increases. However, we focus on the sequential performance and the 260bps improvement in margin versus Q1. This reflects the gradual catch-up in price versus cost inflation. We had not expected the inflection point to be this early and it is a testament to the Company’s priority to continue to price to protect their Gross Margin.
- We expect further details on cost inflation from the Company’s presentation.
Guidance:
- With majority of the Company’s pricing program agreed with their customers, Upfield are confident in giving FY22 guidance, including mid-to-high teens sales growth, growth in EBITDA and leverage ratio to be approximately 8x. The improvement in EBITDA is faster than we had anticipated, with our model showing EBITDA improvement delayed until Q4 or early part of FY23. This renewed confidence is the driving force in the Company not drawing down more of their RCF in Q2.
Positioning:
- We are taking an initial 2.5% long position in the Euro bonds today. This is a starting position for us and we expect to buy more in the coming days/weeks.
- We are pulling forward our previous model assumptions of a recovery in H1 2023. We had expected the lag between price increases and raw material impact to be longer, and are encouraged by the EBITDA and more specifically the Gross Profit margin trajectory.
- We have been seeing offers indicated at 74c/€, almost 10 points up, but we take this as the price for the increased confidence in the operating case, which also means that the severe downside case (see sr. leverage) is receding somewhat. Please let us if you are seeing different ‘real’ prices.
- We acknowledge the margin is still behind prior years, but we share the Company’s projections that Net Leverage will be c.8.0x at year-end.
- Our previous model had the Company drawing down the RCF in Q2 as a precaution for Q3 and Q4 covenants. The Company has in fact, not drawn the RCF further (reduced it marginally) and headroom for the RCF has increased.
Happy to discuss following the Conference Call today.
Tomás
E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk