Upfield - margarine on top! - Positioning
All,
Please find our updated model here.
We initiated our long position in mid-August on the back of the Q2 numbers with a view to increasing the initial position over the following days/weeks. Unfortunately, due to an oversight, we never increased the position,. However, we remain confident in the performance of Upfield and we are now increasing the position despite the price haven risen 10pts. Tthe guidance from the Company of further improvement in Gross Profit and overall EBITDA levels and year-end leverage of 8.0x is conservative, and we would expect leverage by the end of FY23 to be below 7.0x. We have seen in the recent Q3 results the impact of further price rises, which more than compensates for the commodity inflation and volume decline. In fact, elasticity continues to improve quarter on quarter as competitors force through their price increases.
Positioning:
- We are increasing our long from 2.5% to 5% at current levels in the sub bonds, with the expectation that the bonds will continue to tighten with a further 10pts of upside bringing yields to the 12-14% range, from the current 18%. We acknowledge leverage remains relatively high at 8.0x, but given the significant equity cheque from KRR and more importantly the momentum in the underlying business, we are comfortable that the bonds have sufficient equity cover even at this high leverage multiple. Furthermore, liquidity is not a concern for Upfield. The expectation is for the RCF to be repaid by the end of the year.
- Additionally, there are no near-term maturities, with the Term Loans due for refinancing in July 2025. The added wrinkle for holders of the Senior Notes (Unsecured) is their relatively small size (20%) versus the senior secured bank debt (80%).
Recent Results:
- Upfield posted a strong set of numbers for Q3, with the main takeaway that elasticity estimate was -0.34, i.e. 37% price increases, with volume decline was only 12.6%. The Company also pointed out that some of Upfield’s own actions (removing SKUs etc) attributed 4.4 percentage points of the 12.6% volume decline.
- The relative pricing of Upfield’s products versus Butter continues to improve, making it easier to push through price increases as demonstrated by the results.
- However, commodity inflation still exists, with Palm Oil and Soybean Oil both experiencing 10% inflation in the month of October. Upfield have disclosed their hedging position for H1 23, with 50% of their raw materials (Oils etc) hedged. Additionally, Upfield have hedged 50% of their energy and 75% of their gas exposure for H123.
Outlook:
- Annoyingly, Upfield have been unwilling to provide any guidance beyond FY22, but have reiterated their 8.0x leverage target.
- We suspect this will be easily met, and in fact we expect FY23 leverage to end below 7.0x. This is based on relatively modest growth in Gross Profit margin, but not for a return to the 40% margin Upfield used to enjoy (FY19) prior to the recent inflation in the Commodity sector.
- We have also increased the marketing spend as we expect the Company to focus on new markets and products in the coming quarters. This should provide new growth opportunities, which are not included in our model.
Potential pitfalls:
- The recent price rises have lost Upfield volumes across the board, allowing unbranded competitors to take some market share. We calculate, from the data given by Upfield, volumes to be down c. 10% over the last two quarters. We remain optimistic based on the relative pricing of butter versus margarine, encouraging further switching from butter to Upfield’s products.
- The other area of concern we have is the potential for Upfield to do further small acquisitions. In Q1 2022, Upfield made two small investments (minority stakes). We would expect further investments by Upfield to expand beyond their main margarine business. There are some limitations, and we don’t expect any major acquisition in the short term, but we are flagging it to potential investors as a potential outflow of cash in the coming years.
Happy to discuss.
Tomás