Back in February, the new chief executive of Premier Foods (PFD), Gavin Darby, said the maker of Mr Kipling cakes and Ambrosia cream was "a place for people who really like a challenge". He's certainly been proved right by recent events. Since reporting a rather upbeat set of results in July, Premier has lost its finance director, seen sales continue to deteriorate and is now looking at the possibility of outside investment to prop up its ailing breads business. Add to that a balance sheet that is so highly geared that analysts believe a rights issue will be needed in the next six to nine months, and we think the scale of the challenge is such that it's time to cut Premier loose.
- Could be a turnaround story
- Cost savings coming through
- High borrowings
- Big pension deficit
- 'Power brands' not delivering
- Uncertainty in breads business
- Possibility of rights issue
The balance sheet is really at the heart of Premier's problems. At the half-year stage in June, net debt stood at £890m, almost three times its market capitalisation. Analysts forecast that by the year-end in December, the figure will be closer to £858m, which is a hefty net debt-to-cash profits ratio of 4.8, falling to £827m and 4.3 in 2014 - still far too high. The trouble for Premier is that it's dependent on good trading to slash the debt pile, but isn't getting the level of sales it needs to generate sufficient free cash flows. Instead, it has used money gained from business disposals to cut debt and cost-cutting is propping up profits.
This helps explain why a recent third-quarter trading update sent the shares tumbling when Premier reported a 3.2 per cent fall in underlying sales, along with a 9.8 per cent slide in revenue from support brands. Its so-called 'power brands' managed just 0.4 per cent growth, while sales growth from 'grocery power brands' halved compared with the first half. "While 2013 profits are being supported by cost savings, underlying operating leverage is modestly negative," says Martin Deboo, an analyst at Investec. "Operating de-leverage plus financial leverage is not a happy combination if it outlives the cost savings."
| PREMIER FOODS (PFD) | ||||
|---|---|---|---|---|
| ORD PRICE: | 132p | MARKET VALUE: | £317m | |
| TOUCH: | 131-132p | 12-MONTH HIGH: | 59p | LOW: 186p |
| FWD DIV YIELD: | nil | FWD PE RATIO: | 5 | |
| NET ASSET VALUE: | 189p* | NET DEBT: | 197% | |
| Year to 31 Dec | Turnover (£bn) | Pre-tax profit** (£m) | Earnings per share**(p) | Dividend per share (p) |
|---|---|---|---|---|
| 2010 | 1.88 | 100 | 29.6 | nil |
| 2011 | 2.00 | 73.0 | 22.3 | nil |
| 2012 | 1.76 | 85.0 | 26.8 | nil |
| 2013** | 1.50 | 83.0 | 26.6 | nil |
| 2014** | 1.49 | 84.0 | 27.0 | nil |
| % change | -1 | +1 | +2 | nil |
Normal market size: 10,000 Matched bargain trading Beta:1.95 *Includes intangible assets of £1.37bn, or 572p a share **Investec forecasts ^Adjusted PBT and EPS | ||||
Furthermore, bread sales, excluding milling and the loss of a contract to supply the Co-op, fell 1.5 per cent in the third quarter and the division is undergoing a major restructuring at a cost of £28m. Management recently confirmed it has appointed advisors to look at "developing investment options" for breads, which it says could include co-investment by a partner.
Admittedly, the cost savings programme is progressing well, but even if sales miraculously improve and costs continue to fall, it will be difficult to deflate the debt pile given that from 1 January, pension deficit contribution payments will resume, having been suspended in March 2012. Annual payments are expected to total £75m a year until 2016, while higher debt interest payments and tighter debt covenants will also kick in. That means a considerable chunk of the company's cash generation will go to pension deficit contributions.
Analysts at Panmure Gordon believe, therefore, that the best solution is a rights issue to raise £250m to £300m, which they expect in the next six to nine months, ideally together with a corporate bond issuance to lengthen the term of the debt maturity. Investec's Mr Deboo agrees, saying the "right way" for Premier is to pursue refinancing that would "embrace the issue of new equity, refinance of a proportion of its debt in the bond market and conclude a new framework agreement with its pension trustees".
