Upfield - margarine margin
All,
Please find our first analysis of Upfield here.
In the current geopolitical and inflationary environment, it is easy to understand the cost pressures that Upfield are facing. Vegetable oils prices are at record high following the invasion of Ukraine. But the price to the end customer has also risen significantly, as seen by frequent news reports of food inflation. Upfield with its significant leverage is in the middle of these competing forces.
Company Fundamentals:
- Although there are other moving parts, the last couple of quarters, Upfield has experienced declining margins due to increased commodity costs, increase logistic costs and unfavourable reductions in volume/mix, which is only partially offset by the price rises Upfield has managed to achieve.
- There is no doubt that the main competition to margarine, butter, has undergone similar inflationary pressures but the reality is the overall butter and margarine market is declining.
- Upfield's overall volumes continue on a downward trend, 1-2% on average, which was the fundamental reason Unilever sold the business in 2017.
- Upfield have and continue to take out significant costs from their cost base, reducing the number of SKUs and rationalising their production facilities.
The future:
- We have modelled a further deterioration in Gross Profit and EBITDA due to further inflationary pressures that are only partially offset by price increases.
- However, even as margins decline, the business remains cash generative.
- Our model calculates the business is cashflow neutral, after interest payments at c. 25% Gross Profit margins. To put into context, Gross Profit margins in Q1 2022 was c.30% versus FY20 and FY21 was 37% and 35% respectively.
- We envisage GP margins will decline further to low 20% by the end of the year.
- But inflationary pressures will eventually reduce. We are not modelling an increase in volumes for Upfield, but expect margins to start to recover by the end of FY23.
Lack of Triggers:
- Overall leverage is likely to increase significantly from current c.9.0x to above 12x by FY23 and potentially further depending on the inflection point of gross profit margins.
- However, apart from one financial covenant attached to the RCF, there are no financial maintenance covenants for Upfield to maintain.
- There are no upcoming maturities for Upfield until July 2025, so bondholders and Senior Lenders have no levers to apply any pressure to the Company.
Recent Results:
- The call related to the Q1 results was a torturous affair as all analysts struggled to comprehend the full impact of the inflationary pressures facing the Company.
- Upfield have managed to pass through price increases in Q1 of 16.5% but this is insufficient to compensate for the cost increases in both raw materials and logistics that Upfield face.
- Raw materials/Commodity inflation had a 15.6% negative effect on Gross Profit margins, and when logistics and materials costs are included, Gross Profit margins decline by 2.5 percentage points.
- Additionally, partially as a result of the price increases, there was unfavourable changes in volume and mix, further reducing gross profit margins.
Outlook:
- The Company were unwilling to provide any guidance for Q2 and the remainder of FY22.
- They acknowledged that both Gross Profit and EBITDA margins will continue to decline due to costs rising faster than the price increases they are able to pass through.
- There was an added focus on controlling working capital and one-off costs, and in turn acknowledging they have little control over the main margin drivers of the business.
Investment Considerations:
- We are not taking a position in Upfield currently. The Company has guided further pressure on Gross Profit and EBITDA margins for Q2 but is hoping that these will improve in H2. We expect margins to be under pressure for the remainder of FY22 as the Company fails to pass on sufficient price increases to offset cost increase.
- However, it must be acknowledged that despite the reduction in Gross Profit margins to c.20% the business will remain cashflow neutral to marginally positive. Our projections show no need for the Company to draw further on its RCF than currently. The covenant on the RCF applies when the RCF is 40% drawn, which is c. €40m less than current levels. Although we forecast that the covenant will be breached, we think Upfield can reduce its RCF usage to a level where the test is not applied.
- Our model does envisage a return in Gross Profit margin to c.30%, which would reduce leverage back to current levels, but the direction of travel is definitely negative in the coming quarters.
Happy to discuss
Tomás
E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk