|Shares Out. (in M):||92||P/E||0||0|
|Market Cap (in $M):||3,141||P/FCF||0||0|
|Net Debt (in $M):||2,574||EBIT||0||0|
Aryzta (SIX: ARYN) sells frozen baked goods. It is a classic turnaround situation: a roll-up gets into trouble; old management gets kicked out; new management will focus on improving operations, generating FCF and regaining everyone’s confidence. The turnaround should be neither too simple nor too complicated, which creates an opportunity to build a nice position over a period of time. I’m assuming a 2-year turnaround for the stock to revert to historical valuation levels. Based on my FY2019 projections, this is trading at around 8-9x EBITDA and 11x EBIT. Half of EV is debt and around half of EBIT should be left as free cash flow, so market cap/FCF is similarly attractive and as they repay debt this will increasingly excite the market. Any revenue growth after FY2019 is gravy on top. The company is based in Ireland but their main listing in in Switzerland. All figures in this write-up are in euros.
Aryzta prepares specialty bakery items - a market segment that is growing at above-average rates - and ships them to their customers (mostly in frozen form) who then bake and/or sell them. Sweet baked goods and morning goods represent 50% of sales, 40% is bread and 10% other. Most customers are either retailers with in-store-bakeries, QSRs, or various foodservice companies. There are also smaller shops and convenience stores who buy these items.
The company is the global leader in the frozen B2B baked category so naturally their competitive advantage is in being able to supply larger customers with a certain level of consistency. The geographic mix is about 45% Europe, 45% North America and 10% ROW. The industry is still very fragmented. In North America ARYN has an 11-12% share with the next 7 competitors making up 20%. In Europe it also has 12%, the next competitor has 10%, and the next 9 competitors make up 45%. The other competitors are mostly very small.
Here’s a cross-section of the industry: http://www.specialtyfoodcopackers.com/Bakery.html
Historically Aryzta was in the agricultural services/technology business but in the 1990s it started acquiring food businesses, spinning off the agricultural business into an entity renamed Origin (and keeping a majority stake in that entity). Owen Killian, who was kicked out earlier this year, was CEO since 2003 (and with the company since 1988). During his tenure as CEO he pushed the roll-up strategy quite hard. Specifically, ARYN’s market share grew from 6% in 2008 to 11% in 2015.
In FY2015 they sold Origin and used the proceeds to buy a 49% interest in a specialty premium French food company called Picard. Unlike the rest of ARYN’s B2B food business, Picard is B2C and was thought of as a way to gain a foothold in the B2C market. During that same year, ARYN invested time and money on pushing its Otis Spunkmeyer brand in North America directly in the B2C channel. The foray into B2C angered many customers who now had one of their suppliers as a competitor and some pulled business away. This was only one of the many problems that started in FY2015.
Declines in North America also occurred because of sloppy integration of acquisitions, a lot of which is connected with optimizing capacity and SKUs, deciding what factories and SKUs to keep to make everything as efficient as possible while insuring excess capacity is still available in case of demand surges or increased business. An M&A-focused management obviously typically loses sight of things like that. There was also a small slowdown in Europe.
With all these problems, the stock declined from the 70’s to the 40’s over the year and the company decided to stop acquisitions and use FCF to repay debt.
In FY2016 the same problems pretty much lingered on, combined with just sloppy management in general. Management was always upbeat, everything was spun as temporary and as previously-known (i.e. nothing is a surprise, no panic) and management remained adamant that its strategy of diworsifying into B2C is the right one.
In September 2016 a new chairman was brought in: Gary McGann, former CEO of Smurfit Kappa over 13 years. Since he was someone with a solid CEO background, as soon as he came in he had substantial control and assumed leadership. He is a straight shooter who believes in under-promising and over-delivering and has generally been conservative in his approach.
On January 24 2017, the shares took their second big hit - down another 1/3 on a single day due to a profit warning. Margins took a big hit, especially in North America, due to: (i) increased labor costs (ii) a labor-related ‘incident’ whereby a temp staffing agency that had placed 800 workers at ARYN’s Cloverhill subsidiary was found by the feds to be employing improperly documented workers, who then had to leave. ARYN had to gradually replace them with permanent hires. The incident led to the loss of co-packing business because of inability to deliver (iii) more angry customers who pulled business away because of ARYN competing with them (iv) Operating leverage working in the wrong direction because of all these issues.
There was also more weakness in Europe due to ongoing issues at the company’s German factory, which is the largest frozen bakery plant in the world but was mismanaged. The company had consolidated SKUs into that bakery because there was lots of spare capacity there but didn’t take into account that the facility wasn’t set up very well for those specific SKUs.
In the weeks following the profit warning, the company announced:
- CEO/CFO and others resign, new regional COOs appointed immediately
- Discontinuation of guidance
- Plans to temporarily have a scrip dividend
- Strategic alternatives for Picard stake + discontinuation of all B2C ambitions
Later in 2017 Kevin Towland was hired as the new CEO (but he only started officially in September). New board members with relevant food experience were brought in as well (though one recently had to resign because of a non-ARYN issue) and the new North America CEO is someone from FTI consulting who had already been helping ARYN as a consultant.
To give a broad idea of how revenue has evolved throughout these 3 subpar years: YoY organic revenue growth has generally come in somewhere between 0% and 4% in Europe and between -7% and -2% in North America, as opposed to their prior trend of 1-3% when business was good.
The turnaround strategy is as follows:
- Delever the balance sheet through improved performance, hopefully selling the Picard stake and refraining from all investments except maintenance cap-ex or cash spent to build a deeper, more valuable relationship with specific customers.
- Communicate with customers to clarify that the company will not compete with them
- Get pricing right, balancing between passing input costs and competitive prices
- Work on efficiency and productivity in North America - basically the Cloverhill facility, the rest is ok
- Over time, see if certain subsidiaries are better off sold to another party
The turnaround is operational in nature, though it is somewhat financial too. The debt is not insignificant but with ongoing debt paydown and increased EBITDA, ratios should improve soon enough. Cloverhill is expected to return to profitability this year although it’s a tough project to get all the lost revenue back and reduce labor costs. The other problems are easier to fix and not really that bad. Germany is pretty much being fixed already as per the recent PR.
Once they bring things back to normal I believe there’s room for more success because:
- It’s still a very fragmented industry where much share can be taken with the right plan
- Good management
- They have a lot of excess capacity so for a while there will be some nice operating leverage. This will please the market. The German plant is at 60-65% of capacity now.
- Not to be overlooked, there is a macro trend globally toward more consumption of these types of foods so basic growth should exceed GDP growth. I think revenues can certainly grow 2-3% in North America and Europe. ROW should be able to do at least 6-7% but possibly way more.
First, to give an idea of what this business can produce, below are Aryzta’s results for recent years
[ excludes revenues from the Origin business] [ fiscal years ending July 31st ]
|EBITDA - maintenance||€244,288.00||€257,735.00||€369,519.00||€418,920.00||€456,710.00||€529,203.00||€557,546.00||€529,636.00||€340,303.00|
I’m assuming it’ll take them 2 years to turn things around and get back to 16% EBITDA margins. I’m modeling revenues as down 5% vs. today assuming they have to get rid of some unprofitable sales. Cap-ex should be around EUR 100m.
The company has net term debt of EUR 2,154m and EUR 770m of perpetual callable step-up bonds which I’m also treating as debt. Assuming over the next 2 years they pay off EUR 400m with the sale of Picard, but nothing more, net debt will be EUR 2,524m.
Projections @ end of FY2019
|EBITDA @ 16%||578m|
|Full cap-ex (maintenance + strategic projects)||100m|
|EV / Cash EBIT||10.8x|
|EV / EBITDA||8.9x|
- Operations gradually improving at Cloverhill
- Sale of Picard
- Debt repayment
- Perhaps sales of certain small divisions that don't fit
- Street regains confidence
|Entry||12/03/2017 09:01 PM|
sorry if I am missing something but why is your MC in the 2019 projections less than the MC in the VIC header...is this EUR vs. USD issue?
|Subject||Re: 2019 projections - VIC|
|Entry||12/03/2017 09:36 PM|
Yup I diligently followed VIC instructions. Market cap and EV need to be in USD.. I'm guessing to properly filter by market cap.
|Subject||Re: Re: 2019 projections - VIC|
|Entry||12/03/2017 11:25 PM|
thank you. What do you think a reasonable multiple will be as they sort out the operational issues.
|Entry||12/04/2017 05:11 AM|
including prefs as debt this is 6x levered net (~2.5bn net debt, ~400mm EBITDA in Jul'18). how much of EBITDA do they lose if they sell the rest of Picard? isn't this a capital raise waiting to happen? what is the 'right' level of leverage for this business to be at (given new management, net priorities, issues last 2 yrs) and so doesn't this remove a ton of the upside from debt -> equity conversion if they are going to issue 20% of the stock at some point anyhow?
|Subject||Re: Re: Re: 2019 projections - VIC|
|Entry||12/04/2017 07:44 AM|
If you mean what multiple do they deserve while turnaround is ongoing, it's hard to tell.. I would say this is a situation where first analysts see some improvement, and then at that point the market starts to price in future continuation of the improvement. So maybe half way to my ultimate target of around 16x-18x EV/EBIT. But the real kicker could be what comes later. If through the turnaround management become experts at optimizing this type of business, they could find ways to reorganize even better and squeeze out more margins, and sell more, and maybe even make acquisitions that actually add per-share value. Then, I imagine they can also take better recipes from one sub and apply them at another sub. All that can lead to further appreciation of the type that I've tended to miss out on too often!
|Subject||Re: leverage - Picard results are not consolidated|
|Entry||12/04/2017 07:51 AM|
Sorry for the confusion. Picard is 49% owned and not consolidated. It is booked as a JV and revenue numbers don't include Picard. So the projected EBITDA is post-Picard-sale.
|Subject||Re: Re: leverage - Picard results are not consolidated|
|Entry||12/04/2017 10:43 AM|
ok thanks - but even so if they sell that for what say 400mm, they are still going to be >5x net levered...so why wouldnt they delever further through a capital increase? has mgmt guided to sustainable/target leverage for the business and if not what gives you confidence you dont get diluted?
|Subject||Re: Re: Re: leverage - Picard results are not consolidated|
|Entry||12/04/2017 10:53 PM|
|Entry||12/05/2017 05:37 AM|
Picard as a whole has ~€239m net assets, ~€1.4B sales, ~€200 EBITDA and ~€1.6B net debt (non -recourse debt to ARYZTA). Selling its 49% stake for ~€400m would mean ~€800m equity value and ~€2.4B EV. That would be 3.3x book or 12x EBITDA, which seem to be high multiples given ARYZTA’s circumstances.
Can you elaborate on the relationship between the JV’s 51% owner Lion Capital and Aryzta? Please try to be as trsnaparent on this as you can. No need to state “Lion cares aout partnerships and long term relations” if you think otherwise.
Why did not ARYZTA get the support from Lion Capital on the BoD for a sale on last september? Did Lion think they could get more or on the other hand Lion did not think that participating in a transaction with that valuation in mind made sense because it was very unlikely to find interested buyers especially given they know ARYZTA’s urgent needs?
Are there any drag along clauses that might force Aryzta to sell for the price Lion Capital wants? I guess the Lion has different financial constraints vs. Aryzta. So you think : i) and even if a buyer pays a lower multiple Lion might sell or ii) Lion just thinks the business is worth even more than 12x and are willing to wait more time to sell it. I guess 12x is a high valuation for such a business and given Aryzta’s balance sheet shape.
Thnks and all the best.
|Entry||12/06/2017 09:51 PM|
Lion bought Picard in 2010 and sold the 49% to ARYN at a pretty full multiple. Looking at Lion's plans for the other 51%, it's always tough to know how badly someone wants to sell and what multiple would accept under which circumstances. Maybe today Lion thinks they can fetch 11-12x if they wait but if there's a bear market in credit and/or equities they'll accept less, sooner. I think the one thing we can assume is that *today* a sale is more urgent for ARYN than it is for Lion. So I think Lion simply said no in order to squeeze ARYN as their first negotiating move regardless of anything. They themselves may not be sure what they want for Picard. They couldn't care less about ARYN and ARYN brings no value to them. My guess is that Lion wouldn't mind buying back the 49% if the discount is nice, make an arbitrage profit + keep ownership of a good business. Maybe it's already been offered to ARYN.
And actually.. this may sound crazy but if there's a bear market over the next 2 years while ARYN does a successful turnaround, it's *even* possible that Lion actually becomes more of a motivated seller than ARYN because after all Lion's involvement here is as a PE shop whereas for ARYN, once Picard becomes irrelevant in terms of capital structure, it become a free and clear asset sitting on their balance sheet. Remember: ARYN originally bought the Picard stake using proceeds from their Origin stake, not new debt.
|Subject||Re: Re: Picard|
|Entry||12/07/2017 10:55 AM|
Thank you carbone for your thoughts. Very valid points. Sure, mostly about how the turnaround works out and the other is a plus on the balance sheet in such a scenario. If the turnaround does not work out, it will not make a massive difference. Things would be ugly.
In a market/credit downturn, as Lion has that drag along clause, they would probably push Aryzta to accept a lower bid. I agree that in a downturn Lion might become the more motivated seller. Anyways, not that much to worry about if restructuring goes well.
|Entry||01/25/2018 04:43 AM|
carbone - clearly a bit of a surprise this morning. do you have any thoughts on the extent of the miss and where this should re-base? a lot of your thesis was based around new management having more credibility and acumen than old management; this happened clearly under the watch of new management and speaks, perhaps, to more structural challenges (cost inflation).
personally, i can't see how the common doesnt get diluted in 1H to avoid covenant breaches, but would be happy to hear your updated thoughts. thanks
|Subject||Re: updated view?|
|Entry||01/25/2018 08:07 AM|
Yup, so as you can see I have quite an updated view..