Premier Foods faces six key challenges – including: managing consumer demand uncertainties, reducing its borrowing and grappling with its pension deficit – according to City analyst Investec.
Commodity concern: Premier Foods remained vulnerable to rising wheat prices, said Investec
In a note, entitled ‘Fighting on’, Investec analyst Martin Deboo also listed: retailer relationships, commodity cost fluctuations and taxation as key risks to the firm achieving Investec’s target price of 95p for Britain’s biggest food manufacturing firm.
While noting the firm’s full-year results for 2012 reported last month revealed “the first year of meaningful profit growth since 2009”, Deboo highlighted the challenges ahead.
Consumer demand uncertainties topped the list of risk factors, as the firm was “entirely exposed to the austerity-weary UK consumer”. This would be offset by the fact that Premier’s products are “larder staples sold at middling price points”, said Deboo. Investec’s forecasts assume organic sales growth – excluding milling – of just over 1% in the financial year 2013.
Retailer relationships could also derail progress towards achieving the target price. The firm depends on its relationships with the UK big four retailers and suffered extensive de-listings in Tesco in 2011 following a dispute, said Deboo. But since then, “the entire senior management team responsible for the dispute has been replaced”, he added.
Vulnerable to wheat prices
Commodity cost fluctuations remain a significant threat as raw materials and packaging account for about half of the firm’s turnover. The firm is particularly vulnerable to rising wheat prices – with the contribution from its bread division falling by 48% to pound 26.9M in its latest results. The firm blamed the performance on “an adverse customer mix, wheat quality affecting manufacturing efficiencies and higher costs to serve”. Deboo said: “Our best view of Premier’s commodity basket is that it is likely to flatline in the financial year 2013.”
High leverage remained a key challenge for Premier as the firm struggled with 5x net debt : earnings before interest, tax, depreciation and amortisation estimated as at end of financial year 2013. “We foresee a risk of covenant breach at the end of financial year 2014 as the interest charge rises and the covenant tests tighten,” warned Deboo. But further refinancing could not be ruled out – particularly as the banks had proved supportive in the past. The key achievement would be to build “credibility to support a de-leveraging equity raise in 12–24 months’ time”.
Pension deficit
The pension deficit would continue to dominate attention at Premier. Deboo said Premier had agreed with the trustees of its two pension schemes to defer deficit contributions to their schemes in the financial year 2013. The trustees had also agreed to cap the level of deficit contributions up to 2016. The firm had an accounting pension deficit per IAS19 (employee benefits) of pound 352M net of deferred taxes as at December 31 2012, he said. Aggregate liabilities were pound 3.7bn.
Taxation was the final critical factor listed by Investec as influencing the achievement of its target price. Earnings are sensitive to UK corporation tax rates and the guided rate of 23/25% is in line with the current UK corporation tax rate, said Deboo. “Premier pay little or no cash tax in the near term due to the utilisation of advantageous tax losses,” he added.
Deboo predicted Premier Foods faced “a fight … in a still tough environment with limited marketing investment”. Investec retained its 'hold' advice on Premier stock with a target price of 95p.
