Orkla ASA (OTCPK:ORKLY) Q3 2022 Earnings Conference Call October 27, 2022 2:00 AM ET
Company Participants
Kari Lindtvedt – SVP, IR
Nils Selte – Group President & Chief Executive Officer
Harald Ullevoldsæter – Chief Financial Officer
Conference Call Participants
Operator
Good morning, and welcome to the presentation of Orkla’s Third Quarter Results. My name is Kari Lindtvedt, I’m Head of Investor Relations. The presenters today will be our President and CEO, Nils Selte, and our CFO, Harald Ullevoldsæter. Nils will start by summarizing the main financials, and then move on to give you an update on the exciting changes that we are implementing here at Orkla. After that, Harald will share the main headlines and details of the financials for the quarter. And then we will move straight to Q&A. And then Nils will give his final remarks at the very end of the session.
During the presentation today, you’re welcome to post questions on the live chat. And we will address the questions together with any questions from the audience here in Oslo in the Q&A session.
But now, let’s begin, Nils the floor is yours.
Nils Selte
Thank you. Kari And good morning, everyone. And thank you for attending our Q3 presentation. I’ve been looking forward to this presentation and opportunity to share with you more details on the transformational workout.
But before I go into the details, let me start with a few words on the Q3 numbers. They reported group EBIT, adjusted growth of close to 30%, mainly driven by solid results for Hydro Power.
The EBITDA adjusted for brand new consumer goods including headquarter was negative by 11%. Adjusted for earnings, adjusted earnings per share increased to NOK 1.58 per share. The current environment that our business are navigating is still challenging and inflation is affecting cost across our businesses. I have initiated cost out projects for all our businesses, and we will revert in our Q4 presentation with the clear and increased ambitions for the future.
During the quarter, we announced on M&A transactions. Our most recent transaction was acquisition of 84% of the shares in the Norway ingredients. This is a significant step for our ingredients business into the US ice cream industry.
The food ingredients business is fragmented, and we see a great potential for further consolidation and growth. Based on these opportunities, we announced that we will initiate the process to find a long term partner for food ingredients to accelerate growth and value creation.
In September, we announced acquisition of 74% of the shares in Da Grasso, a leading pizza franchise chain in Poland. This is one more step on our way to become one of the leading pizza franchise companies in Europe.
So now I want to go into details of the changes we have been working on since I came in early April. I will present our future organization, the new management team and our operating model.
As outlined in our Q2 presentation, we believe there is a potential for improved value creation in Orkla. To achieve this, we have decided to change our operating model. Our ambition is to become a leading brand and brand and consumer oriented investment company with an industrial mindset and a long term view.
As a first step in this transformation, we will change along three main dimension. We have designed a lean and efficient corporate center, focused on active ownership, portfolio management and capital allocation. We are establishing a portfolio or companies that are autonomous and we will maintain important synergies across groups through our business service companies in the areas of procurement, IT and financial services. And just to avoid misunderstanding and to be and to be clear, we have not changed our capital allocation priorities nor our dividend policy.
This is the way we will organize going forward. Orkla is founded on an industrial mindset coupled with deep brand and consumer insight and innovation skills. We will have an investment team that includes both investment professionals and centers of excellence. The center of excellence will as a start includes sales, marketing and innovation and sustainability. The mandate of the corporate function will mainly be to support the ownership role. And on the right side of the slide, you’ll see the three business service companies, Procurement, IT and Financial Services.
Now I want to – I want to introduce you to my new management team effective from mid-December this year. First of all, I’m very proud of this team and I believe it represent a good balance between industrial experience and active ownership skills.
If you start on the upper left corner, I’m really happy that we have ensured valuable or reflects parents in a team through Atle Vidar Nagel Johansen and egg Hege Holter Brekke. New to Orkla three members that will join the investment team, Audun Stensvold with background from different positions, 12 years within Arkit ph and recently CEO of Venus Board ph He takes up his position from November 7.
Maria Syse-Nybraaten with background as investment professional in Fed, she started in Orkla October 1st and last Øyvind Torpp with 23 years with Boston Consulting Group. Last eight years as senior partner he will start November 1st.
If we continue on the right hand side with the Corporate Function, we have Harald Ullevoldsæter, who will continue as my trusted CFO. The same goes for Christer Grönberg, as EVP human Resources and you name on this list is EVP Legal and Compliance, Camilla Robstad, General Counsel in [indiscernible] 2018. And finally, Håkon Magelicontinues as EVP Communication and Corporate Affairs. A various solid team I’m proud to partner with going forward.
Let me continue with a few words on what we believe will differentiate or classify investment company going forward. First, we have a industrial mindset and we will take a long term view on our investments. We will support our portfolio companies with commercial experience and take lead on structural opportunities and capital allocation.
This coupled with the new operating model, and synergies across our portfolio, companies will give a competitive advantage. And last or plus standards and code of conduct should serve as a quality stand for our stakeholders.
Areas either portfolio or companies for the future. As a start, we will have 12 companies, sorted here by size from – from top left you see Jotun by definition already a portfolio company and a good example of value creation through long standing partnership.
Well, click here will split into three portfolio companies, Orkla Health focusing on developing or transposition as a leading player in consumer health. Orkla Home and Personal Care will continue to develop our class position as a leading Nordic Player. Health and Sport Nutrition group will continue to strengthen its position in a Nordic online markets. Orkla the left side on hydropower will continue as important financial investments.
Today, we have announced the new top management team and then you design an operating model for Orkla going forward. We expect to give you an update on the progress of the transformation process in our Q4 presentation.
The new portfolio company structure will be operational from 1st of March next year. And we will start reporting on the new structure in the second quarter of 2023. Until then, our financial reporting will follow the same structure as of the one we present today.
We also plan to host a Capital Market Day late 2023 where we will share more details on the potentials, ambitions and plans for our portfolio companies. We will share the timing for the event as soon it has been confirmed.
And with this, I’ll leave the floor to Harald for an update on our financial performance in ‘20 in Q3. Thank you.
Harald Ullevoldsæter
Thank you, Nils. And good morning, everyone. Let’s have a look at the quarter three fund performance. But let me highlight that we have not made any changes to the financial reporting structure in this quarter, but we have split Orkla Foods into Orkla foods Europe and Orkla Foods India. In the following slides, the brand new consumer goods figures thereby includes Orkla food ingredients and consumer investments just as in previous quarters.
So let’s kick off by looking at the group figures for quarter three. Reported revenue growth for Orkla branded consumer goods was 7.5% in the quarter, earnings for branded consumer goods included headquarter decreased by 10.7% in the same period, I will come back to this.
Improvement for industrial and financial investment was mainly driven by significantly higher electricity prices for Hydro Power. This resulted in EBITDA adjusted for Hydro Power of NOK773 million, and this is a new record quarterly EBIT for the Hydro Power business. Later in the presentation, I will revert to the effects of the proposed changes in the Norwegian Hydro Power Tax Legislation.
We had a net non-recurring items of minus NOK101 million in the quarter, the largest element was trademarked writedown of NOK64 million related to the acquisition of Harris in Orkla House Care in 2016.
Profit from associate was NOK238 million, mainly related a strong comeback for Jotun. Net financial items were higher than last year mainly due to higher interest costs but also higher debt level. And the effective tax rate excluding associates was high in the quarter compared to last year. Mostly important driver was increased resource rent tax due to strong profit growth within Hydro Power.
Let me highlight that the tax line does not include the proposed increases in Hydro Power Tax Legislation, as the proposal is subject to approval by the parliament by the suiting [ph] Adjusted earnings per share, as Nils said ended up 50% – up to 15% in the quarter, and 10% year to date.
Let’s then have a look at the cash flow. Cash flow from operation was NOK2.2 billion in the first three quarters. The cash flow from operation in branded consumer goods was significantly lower at the end of quarter three than for the corresponding period in 2021.
Higher net working capital was mainly explained by higher stock values due to higher raw material prices, and increased sales resulting in higher receivables. Current capital was also negatively affected by increased inventory levels due to supply chain issues and contingency stocks.
Next, let me walk you through the net interest bearing debt bridge for the first nine months. Net debt including leases increased by NOK3.7 billion to NOK16.5 billion from year end 2021 to end of September 2022.
Cast taxes and financial items totaled NOK1.1 billion. The increasing cast taxes compared to the corresponding period with last year is mainly related to Hydro Power. The main cash outlay during the first nine months was the dividend of three NOK3 per share, paid in – paid out in the beginning of May, and this totaled about NOK3 billion.
Net M&A was approximately NOK1 billion in the first nine months and also related to the acquisition of Healthspan Group and Vesterålen Marine Olje. Additionally, we had an expansion IN CapEx of approximately NOK228 million.
Negative currency effects, translation effects as a result of weaker NOK increased net debt by NOK578 million. So this leaves us with net debt including lease liabilities of NOK16.5 billion at the end of quarter three. The corresponding figure excluding leases was NOK14.7 billion.
Orkla has a strong financial position, and our net debt level at the end of quarter three corresponds to 1.7 times EBITDA, based on the last 12 months when acquired businesses are included in EBITDA. The acquisition of acquisition and Denali, as Nils mentioned are expected to be completed in quarter four. If we were to include these two acquisitions, the net debt figure will be approximately 1.9 times EBITDA.
Let’s have a closer look at performance in branded consumer goods. Let’s start with the top line performance for branded new consumer goods. Reported revenue growth from our branded new consumer goods business in the quarter was 7.5%, as we have already mentioned. Organic growth makes up 9% of the increase, partly offset by negative currency translation effects of 2.7%. Structural changes have a net positive impact of 1.2%.
So, the 9% organic growth is driven by price increases and offset by a volume mix decline of approximately 3%. The volume decline applied particularly to the Norwegian companies and mainly as a result of market contraction of the extra ordinary and growth during the pandemic.
The volume picture is complicated as there are consumer drivers facing between quarters and market contracts and from strong pandemic levels. Overall, going forward we see the increased risk of negative volume effects. Year-to-date organic growth for a branded new consumer good segment was 9.6%.
Let’s look at how the growth is distributed by business areas. All business areas had organic growth in quarter three. The overall picture is that price increases have been implemented throughout the business areas in end markets. The price increases have been taking effect successively during this year, so far with the greatest impact in quarter three.
Higher than normal sales ahead of price increases on the July the 1 in Norway had a negative effect of approximately NOK100 million in the quarter. This effect is mainly ascribable to the business areas, foods, confectionery snacks and Orkla Care.
The potential negative volume effects we mentioned last quarter did to some degree materialize. We estimate that volume mix was minus 3%, as I said in the quarter, adjusted for facing between quarters.
As you will see from the chart on the right hand side, we have split Orkla Foods into Orkla Foods Europe and Orkla India for the first time. The two businesses combined had organic growth of 6%, while Orkla Foods Europe had organic growth of 4.2% and Orkla India 20.1%.
The market contraction in certain segments of the Norwegian grocery market continued following elevated levels due pandemic. This was mainly the case for Orkla Foods Norway, Confectionery& Snacks Norway, as well as Home and Personal Care in Norway. Our painting tools business in consumer investments also continues to experience lower activity in the do it yourself segment.
Before moving on to the profit performance and branded new consumer goods. Let’s have a look at our prioritized growth areas. Our three prioritized growth areas are Consumer Health, our European pizza franchise platform and plant based, all areas experienced progress in the quarter.
Consumer Health grew sales by 28% in the first nine months of 2022 on a reported basis. This was mainly driven by structural growth from acquired businesses to New Trochu ph Vesterålen Marine Olje and Healthspan Group.
Organic growth for consumer health was 3.5%. The digital chair in consumer health reached 45% in the first nine months, compared to 37% in the corresponding period last year, also positively affected by acquisitions.
In September, we announced the acquisition of Da Grasso, which is a leading Polish pizza chain. Orkla has become a major challenger in the European pizza market to a series of transactions since 2018. Within mass investment of Da Grasso, Orkla network will consist of 860 pizza franchise outlets in Finland, Benelux, Germany and Poland. Their portfolio will consist of the leading brands Kotipizza, New York Pizza, and Da Grasso and the acquisition Da Grasso are expected to be completed later in quarter four.
The underlying growth in consumer sales for our existing pizza business was 7% in the first nine months both Kotipizza and New York Pizza show positive growth rates in consumer sales.
Reported growth for plant based was 18% in the first nine months, organic growth is 22%. While organic growth of Orkla branded products amounted to approximately 8% for the year to date periods. The difference here is a manufacturing contract with support scale advantages and capability development.
We are committed to the plant based category and see attractive long term underlying fundamentals for both the category and or class market position. Even with a more short term uncertainties.
Let’s then move on to earnings performance in branded consumer goods. EBIT for branded consumer goods including headquarter decreased by 10.7% in the quarter, reflecting an 8.6% underlying decline and 2.3% negative Forex effect. But offset by structural growth from acquired companies of 0.2%.
The underlying decline in the third quarter was mainly caused by high cost deflation in all business areas, and as we said smaller volume decline. Cost increases should also be seen in connection with a higher activity level in the period, particularly Orkla food ingredients. On the right hand side, you can see the EBIT margin decreased by 1.8%. On a rolling 12 month basis. The underlying performance in the 12 month period was minus 1.7% points.
Let me elaborate a bit more on the cost situation before moving into the business areas. The market imbalances are in the aftermath of the pandemic and bottlenecks from the Ukraine war are still a reality for our businesses.
Commodity prices are still at the very high levels, despite some signs of leveling off in certain categories in recent months. Due to the contract structure of our commodity sourcing to our centralized procurement function, we are still rolling over to contract with higher prices.
At the same time, energy costs continue to rise in the quarter. In addition to our direct energy costs, we also see that rising energy prices have indirect effects as this is a central cost element for producing commodities in many cases. For example, refining of sugar and production of glass for packaging.
For our input cost base, which covers raw materials, packaging, trade goods, energy and freight, we expect to see a 15% to 18% increase this year. Additionally, we see elements SG$A and factory overhead costs increasing. This is mainly due to the general cost inflation, activity levels normalizing post-COVID and the cost of securing our supply chain. To mitigate this, we will implement further price increases going forward. And then, as Nils said, new cost initiatives will be necessitated ph with an ambition to increase the target we have set. At the same time, we will continue to invest in our brands to A&P and product development, as we have year-to-date to maintain the strong position long term.
Let’s then move on to the business areas, starting with Orkla foods Europe. Orkla Foods Europe reported a revenue increase of 0.6% in third quarter of which 4.2% was organic growth. Sales growth was broad based across markets, while volumes declined in several markets due to normalization of markets in the Nordics and consumer pressure in Central Europe and the Baltics.
Food Service and convenience continue to the positive trend from the first half of 2020, while sales growth as was more moderates in someplace negative in the grocery channel. The positive effects from reopening are diminishing, more people spending their vacation abroad also impacted sales figures negatively.
Market shares were stable in the quarter. But we see tendencies of contracting markets in volume in some countries. EBIT declined by 19% largely driven by higher input costs. In addition to higher raw material cost packaging and energy, there was increasing cost pressure of non-input costs.
Before looking at the quarter numbers for Orkla, India for the first time, let me remind you about the strong companies that we have in place in – and the rationale for why we do. All trust history in India dates back to the acquisition of MTR in 2007. MTR has since then had a cumulative average growth rate of 13%.
India is characterized by significant regional differences in taste and culture and there is no global Indian market for our product categories. This is a very good fit. With our class operating model which nurtures local uniqueness and local consumer insights.
Our two companies MTR and Eastern have strong market leading brands in the home states of Kerala and Karnataka, as well as Andhra Pradesh, with a combined population of about 160 million. In addition, export make up 18% of sales, primarily targeting the Indian diaspora around the globe for example, in the Middle East and US.
Growth is supported by strong underlying consumer trends with a shift from un-organized to organize spice mixes and ready meals, increasing purchasing power and more urban lifestyles.
The integration of Eastern is progressing well and Orkla India is delivering on the synergy plan that was implemented in connection with the acquisition. We are very satisfied with our management team in India, the market positions and prospect for our Indian business.
That said let’s look at the performance in quarter three. India had sales growth of 26.4% in the quarter, where organic growth was 20.1%, driven by both pricing and volume. The progress was broad based across categories and most markets.
Sales to grocery were strong. In addition to which the export market was recovering from the pandemic as Indian has expect have returned to work abroad. Both masalas and spice mixes showed stable growth with double digit growth in quarter three.
Cost increases across important input factors is a theme also in India and continued in the third quarter. This has led to a need for further price increases. The earnings growth was partly offset by increased investments in AMP to strengthen the brand’s long term. EBIT margin in the quarter was 13.5% at 1.44 percentage points from the corresponding period last year.
Moving on to confectionery and snacks. Orkla confectionery snacks had organic growth of 7.5% in a quarter, the growth was driven by price increases, while volume growth was negative. Part of the negative volume growth was related to facing between quarter two and quarter three. This was however, offset by positive facing from quarter four to quarter three this year due to Christmas sales.
Market performance in grocery was negative, partly explained by high growth the two preceding years. This was particularly the case for the Norwegian market. Growth outside grocery was more positive, EBIT increased by 2.1% in the quarter compared with the corresponding period last year.
Cost increases for input factors was compensated by price increases that took effect earlier in the year and in the quarter. However, costs continue to rise in confectionery snacks cost base also successfully through the third quarter.
Let’s have a look at performance in order Orkla Care. Orkla Care reported top line growth of 7.4% of which 3.7% was organic. Price increases business to business and growth in international markets drove overall organic growth, despite market contraction in several Nordic markets.
This quarter both Orkla Care and Orkla Home and Personal Care in Norway experienced a sales decline, driven by more markets adjusting after high demand during the pandemic. The volume decline in Norwegian entities continued in the quarter as the grocery channel is contracting of the high levels. The margin was negatively affected by high costs and negative mix effects and volume decline in health and home personal care Norway. Earnings declined by 28% in the quarter, the margin contracted 2.4% compared to last year.
Let’s turn to Orkla Food Ingredients. Orkla Food ingredients delivered another quarter with strong organic growth. In quarter three, the organic growth was 20.9%, mainly due to pricing. The growth was broad based across categories and markets, and mainly price driven.
Sales of ingredients to the ice cream and confectionery industry were negatively affected by lower demand and cold weather at the end of quarter three. The EBIT adjusted improvement of 22.9% was driven by sales growth and negatively affected by significant cost increases. There are continuous challenges related to security of supply, in addition to still increasing input prices. High inflation across Europe generates uncertainty regarding purchasing power.
Now let’s have a look at performance in consumer investment. Orkla [ph] consumer investment reported a sales increase of 6.3% with organic growth was 0.7%. Solid growth in chain sales in the pizza franchise business contributed positively supported by price increases.
Orkla home care hazard [ph] sales decline in the quarter driven by negative performance in the UK. As I mentioned, in the third quarter, we took a write down of NOK64 million trademarks related to the acquisition of Harris back in 2016. The reduced demand for painting tools primarily in the UK was the main driver of the 15% EBIT decline.
Increased energy and input costs combined with general inflation continued to put pressure on margin throughout the companies and consumer investments and drove the earnings decline in the quarter.
Let’s then move on to Jotun. High sales volume and increased prices gave strong top line growth for Jotun in quarter three. All four segments had double digit sales growth in the quarter. The strong top line contributed to the EBITDA – EBITA our increase of 75% in quarter three. Margins are still pressured by high raw material prices. But you don’t expect further sales growth going forward. High input cost will continue to be challenging, while there are signs of easing in the commodity markets relevant for Jotun.
Finally then let’s look at Hydro Power. Third quarter volume in Hydro Power was 26% above last year, while proximately 23% below 10 year average production in the quarter. Prices were over three times higher than the level last year. And this was the main driver of the record high EBIT of NOK773 million in quarter three.
Let me elaborate a bit more on our Hydro Power business. It’s a busy slide but I will try to go through it. We got a lot of questions early in the year on our Hydro Power assets. This has been reinforced by the Norwegian government proposal to increase the effective tax rate on the Hydro Power activities in Norway. I would like to take this opportunity to share some more information about the dynamics of our Hydro Power business and how the proposed tax changes impact us.
Let me start by reminding you of some fundamentals. If we use median historical production volumes as our reference, we produce approximately 2.5 terawatts on a yearly basis. Hydro Power consists of our own power plants in [indiscernible] and leased power plants to or plus 85% interest in Safdar [ph]
The power operation in Safdar are a reservoir based and regulated by lease with stock craft ph that runs until the end of 2030. When the lease expires, the power plants will be turned to stock craft in return for financial compensation, equivalent to the estimated residual value, written down for tax purposes of approximately NOK1.1 billion.
Site proposing power operation or run of the river based on the water fall rights are not subject to reversion of any kind. Orkla Hydro Power operation produce and supply electricity to the Nordic power market at spot market prices. But about 1.1 terawatts is sold at a fixed delivery commitment with a net effect of zero and profit, provided that productions exceeds the delivery commitments. Please note that the Hydro Power is only subject to resource rent tax on approximately 60% of its total production volume. This is a bit complicated I know.
What makes this lesson straightforward is that part of the fixed contract and fixed price contract volumes are taxed based on the spot price when calculating the resource rent tax. However, this is subject to clarification with the tax authorities. And regarding the proposed changes to the tax legislation, the proposed effective resource rent tax will increase from 37% to 45%, with effect from the 1st of January this year, and the resource rent tax is paid in addition to normal corporate tax of 22%. Additionally, a windfall tax of 23% will be introduced on prices above 70 [ph] kilowatt hour and will be effective from the 28th of September 2022. If approved, this is an excise duty not eligible for any form of tax deduction and will affect a bit and not the tax line.
If the new tax legislation is approved, the performance effective tax rate year to date in quarter three would be 55%, of which NOK85 million or 5 percentage point of which will be due to the proposed increase in resource rent tax, NOK85 million so far this year.
The estimated effective tax rate under the new tax regime exclusive of windfall tax for full year 2022 is approximately 54% of reported earnings before tax. That’s in my presentation, I think we will move on to Q&A.
Question-and-Answer Session
Operator
Okay, we have a few questions from the web. All three of them for now coming from [indiscernible] I’ll take them one at a time.
Unidentified Analyst
Firstly, assuming that current raw material and energy prices stay at the current levels, when should we expect margin recovery?
Nils Selte
I fully understand the question, and I think it’s very, extremely difficult to be very precise on it. We can’t go into those details, because it’s still quite uncertain, the environment we are operating in, but it will take more time than we thought before. So, yeah.
Unidentified Analyst
Okay, and then question number two, how should we think of your overall previous strategic targets under the new operating model?
Harald Ullevoldsæter
I think there will be basically no changes we will still continue to invest in health, we will continue to invest in Out-of-Home and we will continue to work on alternative protein sources. So that there will be basically no changes on that. And if there will be changes. I think we will come back to that at a later stage. But currently we are focusing on the same as before.
Nils Selte
So I think if I could add, I think we – we will probably make new targets for each portfolio companies going forward if we look for a long period of time after we have computed on the new strategy for the each of the companies. And so I guess when we have capital markets next time, we will have more, more targets at the company level then on the group level.
Unidentified Analyst
Thank you. And, third and last question from all my team. How did your market share perform in Q3? Are you losing share to private label?
Nils Selte
We don’t see any signs today, helpful losing share to private label. So the overall comment is that our market shares are approximately same level as, as before, of course with the difference of sense small bouncing in all our markets and all over categories. But of course, we are – we are worried about if private label will take market shares going forward, as we have seen in other countries.
Unidentified Analyst
Thank you. And then we have a question from Mike Hughes [ph] Can you please elaborate on the minus 9% underlying EBIT decline in branded consumer goods? Is it volume, or cost the main driver?
Nils Selte
I think both volume and costs are important in understanding this tip as a 10% decline. I think the cost part is a bit higher. But the volume part is, of course, also significant.
Unidentified Analyst
Thank you. That seems to be the final question on the web. Before we ran off today, I believe you have some final comments, Nils that you would like to share.
Yeah, absolutely. Thank you. Kari and Harald. I should be do this short. But what I really want you to remember from this presentation is that we actually see solid growth in the EBIT, adjusted growth. And that was mainly driven by Hydro Power. And also that we are seeing that environment or businesses that we are navigating is challenging.
I wanted to remember that we are changing or into an industrial investment company. And I think this is a bold move. and that step changing our value creation going forward. And lastly, I’m proud of the new management team. With me I have a WS [ph] on dedicated team of strong individuals and great team players ready to transform or club. Thank you very much.
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