Premier Foods slims down

Just a few months ago, the cupboard looked bare at Premier Foods. There seemed to be no way out of the debt nightmare that resulted from a string of expensive acquisitions, apart from turning to distressed disposals, which could further undermine Premier's credibility and for which it would most likely receive lousy prices. It was a perfect case study of the dangers of over-gearing a balance sheet when the going was good.

But if Premier's latest results are anything to go by, management has achieved the almost-impossible and stabilised the group's financial position. City analysts give much of the credit to Premier's finance director, Jim Smart, who, since his arrival in October 2009, has overseen a major operational improvement and, more important, a significant reduction in debt.

The two initiatives have gone hand in hand. Rising cash flow as a result of better working capital management practices meant net debt fell by £103m to £1.26bn during 2010. The disposals of non-core meat-free and canning businesses, which will be completed this year, mean that debt will fall to around £900m by 2012. That will be less than half the £2bn peak hit in 2008 after a flurry of deals. Mr Smart has also re-structured unsuccessful and expensive hedging plans put in place by his predecessor and agreed the closure of a final-salary pension scheme with trade unions.

As well as unlocking latent value, these moves mean Premier gets a better rating from the debt-rating agencies. That should allow it lower its average cost of borrowing from its current 8.5 per cent average, maybe by as much as two percentage points. That lays to rest worries that Premier will be forced to offload its more valuable brands, such as Hovis bread and Branston pickles. "The financial position has now been fully addressed," Mr Smart told us earlier this month. "It is time to change our focus onto the business strategy and the upside consequently available for shareholders."

Yes, but one area, especially, still needs attention - Premier's private label business, Brookes Avana. It struggled to pass on higher costs and saw its profits collapse from £15m to zero in 2010 as volumes slipped 7.2 per cent, faster than the 5 per cent fall for all retailer-branded groceries. As a result, management hacked £125m-worth of goodwill from Brookes's book value. That pushed Premier into losses for 2010 (see table) and prompted City analysts to speculate that it could be the next major candidate for disposal.

Keeping Brookes makes little sense, especially since the high raw material prices that wiped out its profits last year aren't likely to abate soon, and private-label suppliers always face a long haul to claw back extra costs. The retailer-branded pricing environment is unlikely to improve, either, given the failure of rivals Northern Foods and Greencore to tie up a merger. If, as expected, Northern is instead bought by food entrepreneur Ranjit Boparan, overcapacity will continue to dog the industry, and supermarket customers will retain the upper hand at the negotiating table. Analysts reckon Greencore, in particular, may instead turn its interest to Brookes Avana, and Evolution's Warren Ackerman thinks it may pay between £80-£100m.

Of course, selling branded product isn't easy either, but at least most of Premier's leading brands are still increasing their share of a tough market. Volumes sales of its branded goods climbed 3.1 per cent in 2010, although price promotions meant that overall sales were 0.3 per cent lower at £1.67bn. Meanwhile, buying and operational improvements saved £33m and helped the group deliver a trading profit of £311m; flat over the year, but achieved without cutting marketing spending. Analysts expect another year of flat trading profits in 2011 as price increases and further cost savings are offset by cost increases and promotions, but Mr Smart is confident that the group can deliver another £80m of free cash flow to further trim the debt.