Orkla ASA

OSE:ORK

Earnings Call Transcript 2018-Q3

[Operator]

Hello, and welcome to the Orkla Q3 2018 Conference Call [Operator Instructions]Today, I am pleased to present CEO, Peter Ruzicka, and CFO, Jens Staff. Please go ahead with your meeting.

[Peter Arne Ruzicka, CEO, President & Member of Group Executive Board]

Well, good morning, everyone, and welcome to today's conference call. With me here today I have our CFO, Jens Staff, and also our team from IR are present in the room here in Oslo. We will spend approximately 20 minutes presenting the quarter. And after the presentation, we will be happy to take any questions. The presentation material is available at our website orkla.com, and we will refer to each slide number so that you can follow the presentation as we go along. But first, we'll go through the highlights for the quarter, which you will see from Page 3. So I will -- as you might understand, I will skip the disclaimer page. Looking at Page 3, we achieved moderate organic sales growth in the third quarter. I am pleased to see that performance in our Confectionery & Snacks business has turned positive, and Food Ingredients continued to grow steadily. This progress was offset by a decline for Orkla Care. Orkla Foods saw growth in all its companies outside Norway but was hampered by its continued weak performance in Norwegian grocery market.So far in 2018, our organic sales growth has been too weak. I'm not happy with the levels we see. In addition, our fixed cost had increased and the higher costs are partly explained by targeted investments, like the investments in Naturli' brand in -- from Orkla Food Ingredients, but we still see an imbalance that I am not happy about. We continue to shift the portfolio towards higher growth categories, channels and geographies. In addition, we have launched a number of actions in the third quarter to address the rising costs. In Orkla Foods companies in Czech Republic and Slovakia, we have decided to merge Hamé and Vitana into a single company, Orkla Foods Cesko and Slovensko. At the same time, Orkla Food Ingredients has decided to establish a common management structure for all its companies in Denmark. Efforts to achieve cost improvements will be given high priority going forward. And as you all know, my KPI, black-above-red is an extremely important KPI for us. And over time, we -- it's not acceptable to see that our fixed costs are increasing more than our top line organic revenue growth. The drastic increase in sugar tax, which was implemented in Norway in the beginning of 2018, has had a negative impact on sales volumes in Confectionery. We're pleased that the government has proposed to reverse this decision as from 2019. Needless to say, I'm disappointed about Orkla Care. The decline is primarily related to our operations in the U.K. and in Poland. In the U.K., the actions we have taken to turn around performance in Harris have not yet produced results we wanted. As the main actions we have initiated are changed -- changed management in the U.K. and changed management at our factory in China. We have cut cost to compensate for the loss of distribution to Bioquelle and we are constantly working on the -- reducing complexity and reducing number of SKUs. Poland is an important health care market for us. The challenging situation has developed more recently, and we will address this during Q4. I'm following up these actions closely. It is important that we achieve real improvements on these operations over the next quarters. Overall, our progress in Branded Consumer Goods and investments resulted in our adjusted operating profit improvement of 7% for the group in Q3. If you look at Branded Consumer Goods and HQ together, we had an improvement of 7%. In Jotun, sales growth continued and raw material prices stabilized. I am also glad to see that the order book in the shipping market is improving. Earnings per share from continuing operations improved by 3% in Q3. So let me take you through some more details on our organic growth performance. I am now moving over to Slide 4. Our Branded Consumer Goods operations have grown organically by 0.7% year-to-date, adjusted for the loss of Wrigley distribution. We see increased sales in Orkla Foods businesses in Central Europe, Finland and India in the third quarter. You can also see that Orkla Confectionery & Snacks had good organic growth when adjusted for the loss of Wrigley distribution agreement, with strong sales growth in Norway, Denmark and Sweden. In addition, ice cream ingredients and Wound Care progressed nicely. But on the opposite side, Orkla House Care in the U.K. and Orkla Health in Poland saw organic sales decline in the quarter, and we need to turn this around in the coming quarters. This growth pace is clearly too slow, and as I mentioned, I will follow up the turnaround initiatives in U.K. and Poland closely going forward.Let's have a look at our margin performance. I'm now turning to Slide #5. If you look at our margin progress for the previous 12 months, you see that underlying EBIT margin improved by 0.4 percentage points, whereas reported margin was up 0.2 percentage points. The difference from the 0.4 to 0.2 is mostly related to M&A because acquired businesses on average have lower EBIT margins. Variable margins improved because we have exited less profitable businesses.In addition, our actions to compensate the high input cost were effective. Raw material prices have stabilized, but we still face significant headwinds related to currency and, especially in Sweden, where we see that the Swedish currency has weakened substantially, especially versus euro. Other costs consist of fixed cost, advertising and depreciation. We continue to see good progress from our costs and supply chain initiatives. The improvement in Q3 in isolation was however driven by positive effects from a change in the entitlement model related to the group's long-term incentive program. This had an estimated impact of in NOK 20 million in the quarter. So with that, I will now leave the word to Jens, and he will take you through our financials in more detail.

[Jens Bjørn Staff]

Thank you. Peter. Let's start with the top line performance illustrated on Page 7. We increased revenues in Branded Consumer Goods by 3.1% in the quarter. This progress was a mix of organic growth and M&A. As Peter showed, organic sales improved by 0.8% adjusted for lost Wrigley distribution. M&A added 2.3% to growth. HSNG in Care as well as add-ons in Food ingredients were main contributors. Divestments, including K-Salat in Denmark, had the opposite effect. Let's have a look at the performance of each business area in more detail, starting with Orkla Foods on Page 8. Outside Norway, we had good growth, especially in Finland and Central Europe. In Norway, the lower campaign activity and higher grocery retail prices reduced our sales. We had a significant negative effect on input costs from a weakened Swedish kroner in Q2 and Q3. Despite this input cost headwind, we have succeeded in increasing EBIT and the EBIT margin. This progress was mainly driven by cost improvements. For example, we have set up a more efficient organization in Denmark after disposing of the Salat business as of December last year. Let's now have a look at Confectionery & Snacks, turning to Page 9. Orkla Confectionery & Snacks had a positive organic top line growth of 3.5% when adjusted for the loss of the Wrigley distribution agreements. They had positive effects from timing of campaigns and launches. This next category had good progress, but confectionery markets are slower. We still see challenges in the Norwegian confectionery market after the increase in sugar tax from January 1. Our Swedish kroner impacted our margins negatively also in this business area. We have compensated for this by reducing costs throughout the organization. So in sum, our EBIT margin improved by 110 basis points. Let's have a look at Orkla Care, moving on to Page 10. I am sorry, you're disappointed about our performance in Care this quarter, and I can assure you that so am I. Orkla Health delivered negative organic growth. Our sales in Poland declined mainly because the largest wholesaler reduced their stock level. However, retail sales are relatively stable. We are still experiencing sales decline in our House care operations in the U.K. As many of you remember, we lost a contract there in 2017. In addition, weaker demand and increased competition among retailers have pressured prices in the U.K. market. So this means our performance in the U.K. resulted in organic sales decline for the overall House Care business. As Peter mentioned and described, we have launched actions to turn the U.K. business around. In sum, the other Care business units have decent progress in the quarter. EBIT for Care declined mainly because of the weak performance in Poland and U.K. Lower sales, higher input costs and diluted effects from M&A also led to a margin decline in the quarter. Lastly, let's turn to Orkla Food Ingredients on Page 11. Food Ingredients grew the top line by 8% in the quarter, of which 1.4% was organic improvement. Ice cream ingredients under the gum portfolio contributed positively. We exited some less profitable distribution businesses, and this reduced our organic top line that had a positive effect on the contribution margins. This organic performance and add-on M&A drove EBIT up by 17%. Improved viable margins contributed to a margin improvement of 0.5 percentage points. We continue to have relatively high fixed costs in Food Ingredients. This is a trend we are not pleased with and that we are addressing. Let's now turn to Page 12 for an update on our sales growth relative to the growth, the black-over-red graph. As you can see, the gap between our growth in organic sales and underlying fixed costs have narrowed lately. This is a challenge for us and we need to improve. As Peter mentioned, the pace of our organic sales growth in 2018 is too low. Growth in our biggest market, Norway, has been impacted by lower campaign activity and increased retail prices. To reduce our dependency on the Norwegian grocery sector, we continue to grow in channels and geographies outside grocery in the Nordics. As mentioned, we have a few turnaround cases in Care that have been a drag on growth. Our patient care is limited. Moving on to costs, we continue to reduce fixed costs both in supply chain and our go-to-market organizations. Some of the fixed cost growth is related to the investments we make in new growth areas, such as ice cream ingredients and vegan food. We are addressing the rising costs and have launched a number of actions in the third quarter to turn this negative trend around. One example is an ongoing project in Denmark that Peter also mentioned, where we are simplifying the go-to-market organization. Also, the other example from Peter is the process we have started earlier in October to merge our go-to-market organizations in the Czech Republic and Slovakia. We continue to make our supply chain more efficient. We are in the process of closing eight of our factories, and several factory turnaround projects are ongoing. We'll talk more about cost actions next week at our Capital Markets Day. I'll now show you cash flow performance, which is presented on Page 13. Our periodic cash flow from operations the first nine months was lower than last year because of higher working capital and replacement investments. Our net replacement investments have increased because of the ongoing ERP project and supply chain restructuring. Working capital has been relatively stable in the recent years, but with a slight weakening since Q1, and this is clearly below our ambition. We have obtained positive effects by reducing our supplier base. Payables have improved some 10% since 2016. On the other hand, we have tied up more capital in inventory and -- versus in receivables. The decline in performance is entirely driven by our Care business which has the broadest portfolio, and we are not pleased with this development. Foods and Confectionery & Snacks have both improved. We will address working capital specifically at our Capital Markets Day next week. Now a few words on Jotun on Page 14. Jotun continues to grow in all segments, except Marine. Marine Coatings continues to be challenging. The decline in gross margins have leveled off, partly due to price actions. And Jotun may continue to adjust prices to compensate for a period of rapidly increasing input costs. Operating results year-to-date for August were down by 11% compared to last year. And this is mainly due to the increase in raw material prices. Looking ahead, Jotun sees signs of improvement in the shipping markets and the order book for new building contracts is up year-on-year. Jotun also expects to see continued improvements in Protective segment, as the oil and gas market is considered to have bottomed out. Jotun's CEO, Morten Fon, will do a presentation on the Capital Markets Day next week. Let me summarize the highlights this quarter looking at the P&L slide on Page 15. Earnings from Branded Consumer Goods were up 3% year-on-year. All Branded Consumer Goods areas contributed positively, except Care. Higher power prices gave a strong result in Hydro Power, and this increased the contribution from Orkla Investments. We had lower net costs in HQ than usual, and this was partly explained by a change in the long-term incentive program, as also Peter mentioned earlier. As a consequence provisions of approximately NOK 15 million for Q1 and Q2 were released in Q3. And going forward, this will be reported on a accrual basis over the entire entitlement period. As a result, adjusted operating profit for the group improved by 7% compared to the previous year. Other income and expenses will, as you know, vary over time depending on the restructuring and M&A activity. The amount in Q3 is primarily related to both of these two items. Profit from associates was up 13%, predominantly related to Jotun. And the lower financial net and adjust tax contributed positively to Orkla's share of Jotun's net profit in this quarter. As a result, earnings per share from continued operations reached NOK 1.01 per share. I'll now hand back to Peter for his final remarks.

[Peter Arne Ruzicka, CEO, President & Member of Group Executive Board]

Okay. Thank you, Jens. Yes, I actually have seen -- we see mixed picture in our different business areas. But overall, I'm not happy with our total performance, and we need to improve. I will come back to that in a little bit. But on the other side, I'm glad to see that growth in Confectionery & Snacks has turned positive, despite the higher sugar tax in Norway. We also see a steady improvement, in Food Ingredients and good growth in our food businesses outside Norway. As we have explained in Norway, Norway campaign activity has -- and increased retail prices to consumers have led to volume decline in the grocery retail channel. We are working on actions to address this. Another concern this quarter has been the poor performance in some of our Care businesses, relatively Poland and the U.K. We have implemented measures to turn around the U.K. business. And I'm following up these actions closely, and it is important that we see real improvements from these operations over the next quarters. In Jotun, we have seen continued sales growth, more stabilizing raw material prices, and the order book in the shipping market is improving. In sum, earnings per share from continuing operations improved by 3% in the third quarter. We will give you a more comprehensive update on our plans and priorities at our Capital Markets Day next week in London. And I hope to see you all there, also those of you who are not able to participate physically, I hope you will listen in on the webcast available at orkla.com. Before we open up for Q&A, I would will like to show you some examples of recent product launches in our businesses. And I am now turning to Page 18. And as you can see from the slide, we have some exciting innovations coming out this autumn. They are all spot on the main consumer trends that we see. First, which is a new Toro ready-made sauce, our convenience, made with good ingredients and free from preservatives. The chocolate-coated licorice from Panda has a fantastic taste and texture and meets consumer's need for indulgence, and this product is launched in all our confectionery markets where we are present. The Jordan Green Clean is a toothbrush made from 100% recycled plastic and with environmental friendly packaging. And lastly, we continue to expand our Naturli' range of vegan products and have now launched a plant-based mince, which is also organic and gluten-free. And actually we're also launching a few of those Naturli' products in selected stores in the U.K., Switzerland, Poland and Germany. And with that, we also contribute to better health for our consumers in many European countries. So with that I would like to ask the operator to open up for Q&A, please.

[Operator]

[Operator Instructions] And the first question is from the line of John Ennis from Goldman Sachs.

[John Mark Ennis, Equity Analyst]

I've got three, actually. My first one's on organic growth, and then particularly within the Orkla Care business. I wondered if you could tell us how big the House Care business is within that Orkla Care division? And then I wondered if you could give us bit of an idea for the magnitude declines you're seeing in U.K. and Poland versus the rest of the business? I know you mentioned the rest of the business is healthy, but if you could just maybe give us a few more numbers around that, that would be useful. And then related to that, could you give us a bit more color on what you are doing there to try and improve and around the performance? So that was the first question. The next one was actually on the balance sheet because you're gearing ratio is very low. And I wondered if you could give some color on what you think you are going to do with that strong cash position? Do you think high dividends or buyback is a plausible cash use going forward? And then the last question is on your BCG EBIT target, which was 6% to 9% for 2016 to '18. Because that excludes some of the bigger acquisitions, I wondered if you could tell us the EBIT growth you think you achieved in 2016, in 2017 on the way you measure it?

[Peter Arne Ruzicka, CEO, President & Member of Group Executive Board]

Okay. Thank you for those three questions. When it comes to organic growth in Orkla Care, we don't disclose figures -- exact figures for each business unit, but what I can say is that House Care in U.K. -- and the impact of House Care in U.K and impact of Health in Poland has a substantial impact on total organic growth figures for Orkla Care. House Care sales total share of Care, do you have that figure, Jens, approximately?

[Jens Bjørn Staff]

Yes, 15%.

[Peter Arne Ruzicka, CEO, President & Member of Group Executive Board]

15% of the Care's total sales. And then the other question, what do we do about this? Well, as I mentioned, we have changed management in our House Care business in U.K. and in our factory in China. We have continuously reduced cost to meet the lower sales volumes that we are facing and especially due to loss of the quite big contract to Bioquelle. And we are reducing complexity in the organization, the factory and warehouses with also by reducing number of SKUs. And these things take some time. And, of course, our patients are not unlimited, so we need to see substantial improvement in the coming quarters before we are satisfied and confident that this will turn around in the right direction. When it comes to Orkla Health in Poland, the situation is somewhat different. It's more -- we believe of a more temporary character, as we see that our sales into the distributors, the wholesalers are substantially reduced, while sales to consumer out of the -- out of stores, out of retail is at a stable and quite good level. And we see that distributors, wholesalers are reducing their inventory. And so we expect this negative sales impact to disappear in the coming months and quarters. So that was answer to question #1. Your second question was about our strong balance sheet and what do we intend to do with it. I think as we have said many times that our first priority is to find attractive assets to buy to use the excess capital for M&A, to buy companies that fit with our strategy where we can extract synergies or enter into higher-growth, either geographies or higher-growth categories. So as -- and, of course -- and that way create shareholder value. So that's our main priority. But we have also -- during the last 12 months, we have paid out a special dividend of NOK 5 we did last year and we sold Sapa. And we have bought back approximately 2% of the shares, own shares during this year. So we have also returned a substantial part back to shareholders through either ordinary dividend, special dividend or share buyback. Then you have -- on the last question, it was about the Branded Consumer Goods' EBIT growth target of 6% to 9% in the period '16 to '18 and specifically, you asked about performance in '16 and '17. And according to the definition, we announced in Capital Markets Day in London in the fall of 2015, we grew 6.8% in 2017 (sic) [ 2016 ] and 6.1% in 2017. That is including smaller add-ons, but excluding any big M&As in the period.

[Operator]

The next question is from Preben Rasch-Olsen from Carnegie.

[Preben Rasch-Olsen]

Just two or three questions from my side. Can you be a bit more specific about what's going on in the Foods Norway? Is this just the warm weather effect or do you see there change in consumer behavior? And also when we hit quarter, profits came in much lower, is this some new trend? Should we expect lower cost going forward?

[Peter Arne Ruzicka, CEO, President & Member of Group Executive Board]

The sound on your question, Preben, was very, very bad and low. It was actually difficult to hear all details of the question. Could you please repeat it?

[Preben Rasch-Olsen]

Oh, sorry. Can you hear me better now?

[Peter Arne Ruzicka, CEO, President & Member of Group Executive Board]

A little bit better.

[Preben Rasch-Olsen]

Okay. I'll try. Norway, do you have some change in the consumer behavior? Or is it just the more of a weather effect?

[Peter Arne Ruzicka, CEO, President & Member of Group Executive Board]

Okay. I would not say it's about consumer behavior. It's several things that are hampering top line growth. One is, of course, the warm weather has had a negative impact, no doubt about that. But we also see that prices on a lot of our, I would say, bestsellers have increased substantially in the retail. A lot of our products are -- have been used in price -- price wars and price campaigns among the Norwegian retailers, especially last year in 2017, actually also in '16, and that drove high volume. What you've now seen is that these price wars have shifted to other categories and other products, and prices of our products have increased substantially. And in several cases and also on some really big SKUs, which is that retail prices have increased from 20%, 30% and even up to 70% to 80% increase, and that's, of course, at least, short-term hampers volume. But also -- and also, of course, the weather has impacted -- extremely warm weather has impacted consumer behavior during the summer. That is a temporary -- temporarily effect, of course.And then what's the second question around the run rate for HQ cost going forward, Preben?

[Preben Rasch-Olsen]

Yes.

[Jens Bjørn Staff]

Yes, well, this quarter, as I said, was influenced by some one-offs. So -- and we will not have -- make room for the LTI for the long-term incentive cost in Q4 neither, but the run rate that we have communicated earlier is around NOK 90 million per quarter, and you should expect that going forward. So when it comes to this, this call it long-term incentive adjustment to this year, it's a one-off. And then as I said going forward, this cost will gradually be accrued over the entitlement period, which is now for three years. So it will be a four-year effect of the same cost that we reversed this year.

[Operator]

[Operator Instructions] There are currently no further questions registered. So I'll hand the call back to speakers. Please go ahead.

[Peter Arne Ruzicka, CEO, President & Member of Group Executive Board]

Okay. Thank you, everyone, for participating on this early morning conference call. I'll hope to see as many as possible in London next week on our Capital Markets Day. And for those of you who are not able to participate, you can follow our presentations on our webcast on orkla.com. Thank you very much.

[Operator]

This now concludes the conference call. Thank you all for attending. You may now disconnect your lines.