Tuesday 26 September 2017

Why is Aryzta struggling?

Its shares are down almost a third since March, so what's happening at one of Ireland's biggest success stories? Gavin McLoughlin investigates

Pastries in Paris
Pastries in Paris

Just what is going on at Aryzta? The Swiss-Irish frozen bakery company, one of the Irish food sector's most successful entities, has seen its share price plummet by nearly a third in the last three months.

In March, the Cuisine de France owner's shares hit €73. Now they're scraping around €50. Close to €1.5bn in shareholder value has been vaporised. Investors are selling out as fears rise that Aryzta's highly-regarded chief executive, Owen Killian, has made a strategic misstep, by moving away from the core business of niche food production into the highly competitive French retail market.

Aryzta was born in 2008 when the Irish Agricultural Wholesale Society (IAWS) group merged with Swiss-based Hiestand. The IAWS boss - Roscommon man Owen Killian - became the chief executive of the new entity, and remains in charge today.

He is one of Ireland's highest-paid company bosses, earning €5.84m in 2014 based on Thursday's exchange rates. There's also a huge bonus scheme, which could be worth close to €66m to Killian and his management team - subject to growing the company and boosting profits significantly. That looks like a big ask at the moment.

Since 2009, the share price has had a more or less untrammelled upward journey as the company continued to expand through acquisitions. But now things aren't so positive, with the company facing the most sustained share price drop in its history. Could Killian be losing his touch?

Picard

Analysts have questioned the company's recent decision to plough €446.6m into a 49pc stake in high-end French frozen retailer Picard. The deal, which is still awaiting regulatory approval, followed on from Aryzta cutting its stake in agri-services group Origin Enterprises, a legacy asset from the IAWS days that doesn't fit with Aryzta's core bakery business - which involves freezing baked goods such as croissants, which are then finished in a retail outlet. But getting involved in retail per se doesn't appear to fit with the core business either.

Investec equity analyst Ian Hunter told the Sunday Independent that the Picard decision is what caused the initial drop in Aryzta's share price.

"It was a niche 'frozen for bake-off' company, with clients in North America and across Europe - so it had a very focused business with a slightly higher margin than your standard bakery," Hunter said. "It then surprised the market by proposing to buy a 49pc stake in Picard in France.

"That was a move away from what everyone would have seen as its core competence. And the question there was: 'Why did they decide to do that?'

"Picard is a company that's the upmarket version of Iceland in the UK, with a chain of stores across France, but a completely different business to Aryzta's.

"It is also a business that is highly indebted. The deal was such that they'd have a non-controlling 49pc stake from which it doesn't seem as if they are going to get a dividend for their investment of €446.6m. So no returns coming back for the foreseeable future because Picard will be paying down debt is a change in strategic logic which management hasn't addressed".

Europe

But the main reason for the fall is probably the dip in the company's trading performance. Its third-quarter trading update was a full-blown profits warning, with weak demand in Switzerland and France weighing heavily on the business.

On Thursday, Goodbody stockbrokers' Liam Igoe circulated a note slashing 2016 earnings forecasts by 12pc, and the price target for the next 12 months to €60 from €75.

In Switzerland, Aryzta has been hit by the huge rise in the Swiss franc after the Swiss National Bank abandoned the cap against the euro earlier this year.

Hunter explains: "All companies who have got an exposure to the Swiss franc and are doing business in Switzerland have reported FX headwinds. This is across the board, so it's no criticism of Aryzta at all. For example, people in Geneva are just driving across the border and buying stuff in France. That's well recorded and that would have been expected.

"But what the company did say in its trading statement is that there was weakness in France. They said it was because of security issues.

"We would see that maybe there would be difficulties in France just because of general economic conditions, consumer confidence, that type of thing. They didn't really fully explain why security issues had hit numbers.

"We looked into it just to see whether we had missed that security issues had stopped the French eating croissants and pastries in cafes because people were more concerned, but we could find nothing obvious at all. Management's remarks have therefore put a question mark on what is happening in the French business."

An Aryzta spokesman told the Sunday Independent that the French arm suffered from a significant drop in demand in the weeks following the Charlie Hebdo shootings, because of a negative impact on tourism and increased security on the streets. However, consumer demand has now begun to recover, he said.

As for Picard, the spokesman insisted the move made sense: "Picard is a food business, which is adjacent and has complementary aspects to our French business.

"We believe at some point in the future it will consolidate the French business. We believe it does make sense, it's a repositioning of the investment in Origin into a related sector.

"The price drop has been largely due to two things. The first is the selling down of Origin, which caused a significant reduction in its earnings contribution.

"The Picard transaction has yet to receive regulatory approval, and that's unlikely to come on board until quarter one of next year, so there's a temporary loss due to the disposal.

"The second thing was the trading performance, which accounted for the rest of the earnings reduction."

Igoe predicts the shares to continue to trade around their current level until Aryzta brings its next update to the markets.

"We believe the potential downside from here is small and the current share price should represent a floor for the share price," he said.

"In the near term, we expect the stock to trade close to our floor price range until forthcoming quarterly updates shed more light on progress in North America."

There lies the final piece of the puzzle.

North America

Management has embarked on a drive to improve manufacturing efficiency. The company took lower-volume items off the manufacturing line in order to free up room to make more products for big customers, without having to build new capacity.

The plan meant Aryzta's US revenue growth suffered in the second quarter, but the company expects growth to return to the previous level in the coming quarter.

Outlook

Igoe predicts that positive news will come from North America at the beginning of Aryzta's next fiscal year, as the rationalisation process moves past its disruptive initial phase.

In Europe, he predicts profits to remain squeezed in Switzerland for the next two years because of the currency effect.

In France, the company says demand is beginning to recover after Charlie Hebdo, but the Picard transaction won't contribute to earnings for a while yet.

It looks like it will be a long time before Aryzta shares tip €73 again.

Sunday Indo Business

Also in Business