Upfield - Updated model - Elasticity

All,

Please find our updated model on Upfield here.

We published an update note prior to the conference call yesterday, Despite the Company not taking our questions (and some other analysts) the mood of the call was substantially different to their Q1 call in May. As part of the conference call, Upfield management shed some additional light on recent inflationary pressures and gave additional colour on the drop in volumes due to mix and price. This has solidified our modelling of the elasticity of demand for Upfield’s products and further consolidates our views.

Reduction in SKUs:

- Volume and mix had a negative 7.8% impact to Gross Profit margin on a year-on-year comparison. But more importantly, half of this impact was due to management decisions to reduce the number of SKUs in the portfolio. On a like-for-like basis, a 24.3% price increase has seen a 3.5% drop in volume/mix. Passing through pricing is made substantially easier given the market dynamics in the butter market. Butter futures are up 88% to June 2022.

- Upfield have refocused their SKUs, especially in the European market, with over 80% of the European sales are from products which have been renovated or innovated over the last two years. Over 270 SKUs have been removed in the quarter. Upfield have reduced the number of active recipes in Europe from over 350 to below 100, and SKUs from over 1,000 to below 800.

Guidance:

- In addition to the stronger sales and EBITDA, Upfield’s cashflow has continued to impress. Free cashflow in H12022 of €179m is ahead of last year and in an environment of lower EBITDA margins Upfield continue to demonstrate their ability to deleverage. This is on the back of still slightly inflated inventory levels, which are likely to continue over the coming quarters.

- Management didn’t give any guidance during the Q1 call, which caused some discomfort in the market. Not surprising, given we are more than half way through the year, management feel more comfortable in giving FY22 guidance. The Company have already commenced Phase 3 of price increases in July, and it is on the back of this, that management expect absolute EBITDA to grow versus FY21. More importantly, the Company guided a continued improvement in cash generation and expect to end the year close to 8.0x leveraged. This is on the back of a continued improvement in margin from Q1.

Modelling:

- Fundamentally we have reduced the lag between pricing and inflation from9-12months to barely a quarter, bringing forward the inflexion point for a recovery in Gross Profit margin. We had seen the strong pricing in Q1 but were fearful that it was under annual contracts and further inflationary pressures during FY22 would keep margins under pressure for the remainder of the year.

- We have modelled a modest recovery in Gross Profit margins, but below FY19 and FY20 levels. The reduction in SKUs and increased efficiency in production will no doubt improve margins.

- Looking out to FY24, prior to refinancing of the Term Loans in June 2025, we expect Upfield to have reduced leverage to c.5.5x. Although high leverage, given the strong market position Upfield enjoys, we would envisage a normal refinancing at that time.

Positioning:

- Yesterday, we took 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.

- As outlined, ultimately it is due to pulling the inflexion point of recovery forward due to the stronger pricing power displayed by Upfield.

Happy to discuss

Tomás

E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk