|Shares Out. (in M):||74||P/E||21.2||19.2|
|Market Cap (in $M):||735||P/FCF||14.0||13|
|Net Debt (in $M):||-43||EBIT||36||39|
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Hilton Food Group is a specialist meat sourcing and packing partner for large grocery store chains in Europe, the Netherlands and Australia. The company is now the largest dedicated packer of red meat in Europe and will pack about 300,000 tons of meat (beef, pork and lamb) annually, roughly the equivalent of 2 billion hamburgers.
Food safety and traceability are rising in importance. Hilton’s meat procurement and packaging provides retailers with a secure way to trace product. The company serves the market leader in five of the top ten countries in the world, as measured by grocery spend per capita. In addition to packaging, the company provides value-added services such as i) procurement, ii) distribution center pick & pack, and iii) product category management.
The past few decades has seen a shift by consumers away from butcher shops to shopping at larger, more price competitive grocery stores. This has forced the package meat industry to rationalize into a smaller number of larger international operators that can meet the volume, product and packaging innovation requirements of larger grocery store chains. These larger grocery store chains are electing to work with few, more efficient suppliers (such as Hilton) to guarantee traceability, quality and supply. In summary, as the fresh meat segment of food retail is bifurcating between specialist butcher shops and pre-packed, the essentialness of HFG’s services seem to be increasing, providing structural growth for the company longer-term.
Hilton is debt free and carries 33mm pounds of excess cash. The company generates positive free cash flow annually and also pays out 40-50% of earnings via a dividend. Revenues and profits should grow high single digits to low double digits as the company establishes relationships in new geographies and with new and existing clients. Revenues will also grow as volumes of private label meat consumption grow, which appears to be a secular trend.
Based in the United Kingdom and with 33% still owned by the founders, Hilton Food Group was established in 1994 operating a beef and lamb central packing facility in England. The company’s original mission was to provide low priced, high quality and safe meat products to grocery store operators across the globe. Over the past two decades, HFG has established operations in four additional European countries, one in the Netherlands and a JV agreement in Australia.
Hilton provides these sourcing and packing services in seven different countries for dedicated customers below. The company’s products carry the brand labels of the customer to whom the packed meat is supplied. Core product(s) are steaks, chops, barbecue and minces which are prepared and packaged according to customers specifications (e.g., jalepeno flavored sausages, cilantro flavored hamburger patties).
Value-added lines include ready to cook, marinated meats, and meat cuts accompanied by service sauces. Each of Hilton’s central meat packing plants is operated on a dedicated basis for a specific customer. HFG sources product (meat) from over 40 different suppliers. Most is sourced locally within the EU. Customers include Tesco, Ahold, Albert Heijn, ICA, Rimi and Coop Danmark.
Hilton serves the market leader in five of the top ten countries in the world, as measured by grocery spend per capita. In each of these geographies, it is the retailer’s largest supplier in the category. According to management, Hilton has never lost market share with a customer.
Volume per Customer (k tonnes)
Customer (country) 2004 2015
Tesco (UK) 33 77
Ahold (NL) 28 68
ICA (SE) 3 40
Tesco (IE) 5 18
Coop (DK) 10 (2011) 13
Woolworths (AU) 25 (2013) 40
Ocado (UK) new (2015)
Sonae (PT) new (2016)
Revenue diversification by geography continues to increase as Hilton expands their customer base, but is still most concentrated to the United Kingdom where their largest customer Tesco has significant presence. The geographical diversification creates currency risk seen in revenue, but due to the local meat procurement COGS generally moves in tandem.
Revenue by Country
Supplied volume has grown every year for the past decade. Even with steadily expanding production volumes, revenue has been more volatile primarily due to foreign exchange translation effects to their non-UK revenue stream. In 2014, the revenue decline was attributed to a -4.5% effect from the strengthening Sterling as well as lower raw material meat prices flowing through. In 2015, production volume increased again, however the Sterling strengthening had an effect of -7.4% to revenue. 2016 saw this trend reverse, volumes increased 7.4% while the weakening Sterling helped push revenue up +12.8%.
The company does not hedge their foreign exchange risk. This adds a degree of volatility to reported revenue numbers. However, it is important to focus on the fact that margins have been consistent across their history due to the nature of their contracts, and that net income has increased every year.
The fresh meat segment of food retail is bifurcating between specialist butcher shops and pre-packed, providing structural growth for Hilton. In existing countries, cost pressures on the traditional supermarket model are shifting volumes to pre-packed products. The past few decades has seen a shift by consumers away from butcher shops to shopping at larger, more price competitive grocery stores. This has forced the package meat industry to rationalize into a smaller number of larger international operators that can meet the volume, product and packaging innovation requirements of larger grocery store chains.
Due to food safety requirements, meat packaging requires state of the art facilities dedicated solely to meat products. Hilton uses automation and robotics so there is minimal human intervention which reduces contamination risk. These larger grocery store chains are electing to work with few, more efficient suppliers (such as Hilton) to guarantee traceability, quality and supply.
Hilton competes with 3-4 large private companies but relationships appear to be very sticky given the business disruption that can occur upon switching to a different packaging partner. The low operating margins of the industry serve as an impediment to switching as well. Hilton also reportedly has the most automated plants in the industry.
Trust is supplier relationships and quality is very important, as Tesco terminated a supplier relationship named Silvercrest in January 2013 after learnings that the company was supplying hamburger meat using horses from Poland. This episode was a huge public relations issue for Tesco.
This shift towards increased use of centralized meat packing solutions is still continuing. Europe is seeing an increase in the number of “click and collect” facilities (internet based ordering). These developments appear structural (not cyclical) and should further reinforce the trend towards retail packed meat, as this is the meat offering for internet based offerings.
The Business Model
Hilton’s processing facilities are generally built in very close proximity to customer’s distribution centers to reduce transportation cost, further strengthen the partnership bond, and effectively manage the meat category for the grocer. The company has long-term supply agreements in place with its major customers with pricing either cost-plus or agreed packing rate basis. Income can be increased or decreased subject to achievement of certain pre-defined performance measures and targets.
Hilton gets paid either cost-plus or a fixed dollar profit per ton of volume packaged. Gross and operating margins have been very steady for the past decade. Sales are driven by volume changes, share gains (at the retailer level), new relationships and geographies, and FX changes.
Management follows a differentiated strategy to partner with and service the market leader, with whom its value-add can be the largest, and then pull through higher volume over time. This contrasts with the industry norm push strategy, where competitors try to build brands and serve multiple retailers in geographies to avoid pricing pressure and customer concentration risk. Competitors follow their strategy for various historical reasons which can’t be changed. Many competitors (e.g. Danish Crown) are organized as farmer cooperatives that cannot risk losing cattle volume.
Hilton, in contrast, owns no abattoirs (slaughterhouse) and can thereby make choices to maximize return on capital in the processing segment of the value chain. Hilton’s strategy presents greater operational risk for Hilton and its customer. But management believes that once a relationship is established, it produces better results for both parties and is, in turn, a more durable business model.
HFG is focused on four main areas:
Building volumes and extending product ranges with existing customers
Partnering with existing customers in new geographies
Gaining new customers in new geographies
Maintaining high rankings for quality, product development, innovation and efficiencies.
Hilton’s largest risk is customer concentration risk. Tesco and Ahold comprise 47% and 26% of revenue. This results in significant buyer power for these two customers. An offset to this is that after the horsemeat scandal in the UK in 2013, Tesco extended and expanded its relationship with HFG by signing a new 5-year supply agreement spanning 2014-2018. Note that in August of 2017, Tesco, their largest customer renewed their contract for another five years further solidifying their revenue and profit stream.
Hilton also has food scare risk. While HFG is not the grower/breeder of the meat, and thus not liable for contamination, a major food scare would likely cause sales and/or profits to fall. HFG ensures full traceability from source to packed product across all suppliers.
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