Wednesday 22 November 2017

The right ingredient

Finding ways of speeding up growth is the main challenge for the group as the global economy gathers momentum

THIS week's results announcement from Kerry sent the share price of Ireland's premier indigenous food group to an all-time high of over €26. However, with annual sales of almost €5bn chief executive Stan McCarthy is finding it increasingly difficult to grow sales at the Tralee-based company.

In 2010 Kerry recorded a 9.7pc increase in sales to €4.96bn. It was the strongest sales increase McCarthy has delivered during his three years as boss. Trading profits, basically profits before interest and goodwill write-downs, were up 11.3pc to €470m.

Kerry is divided into two separate divisions, ingredients and flavours, and consumer foods. Not alone is the ingredients and flavours division almost twice the size of consumer foods, it is also far more profitable.

In 2010, ingredients and flavours increased its sales by 6.6pc to €3.67bn, while trading profits at the division rose by 12.8pc to €401m. This means that the division's trading margin rose from an already high 10.4pc to 10.9pc.

The performance of the consumer foods division was far less impressive with sales growing by just 1.3pc to €1.76bn, while trading profits advanced by 5.3pc to €132m (the fact that Kerry Group's trading profits are less than the total for the two divisions is due to intra-group sales). The trading margin at consumer foods widened from 7.1pc to 7.5pc.


Ever since McCarthy took over the reins at Kerry from Hugh Friel at the beginning of 2008 the performance of the consumer foods division has lagged behind that of the ingredients and flavours unit. In 2007, the last year before he became chief executive, ingredients and flavours had sales of €3.31bn and trading profits of €310m. In the same year, consumer foods had sales of €1.81bn and trading profits of €119m.

In other words, while the ingredients and flavours division has increased its sale by almost 11pc and its trading profits by 29pc over the past three years, sales at the consumer foods division actually fell by 3pc and trading profits grew by just under 11pc over the same period.

One would have thought that, given the widely divergent performance of their two divisions, that Kerry would concentrate its acquisition activity exclusively in the flavour and ingredients sectors. After all didn't McCarthy promise to double Kerry in size when he became boss just over three years ago?

In practice, that's not quite how things have turned out. In 2009, Kerry paid €140m for Breeo Foods, which brought such iconic Irish brands at Galtee, Dairygold, Calvita and Shaws into the Kerry fold. While it spent €165m on acquisitions last year -- all of which including the €33m purchase of Newmarket Co-Op and its associated cheese plant were made by the ingredients and flavours division -- it's difficult to resist the conclusion that consumer foods is getting more than its fair share of Kerry's acquisition euro.

Why is Kerry so apparently wedded to its no-growth, lower-margin consumer foods division? One possible clue lies in the rapidly increasing proportion of Kerry's trading profits disappearing once intra-group transactions are taken into account.

Trading profits

In 2007, Kerry Group's trading profits were reduced by €28.6m when intra-group transactions were taken into account. This had more than doubled to €63m by 2010.

Could it possibly be that the consumer foods division is providing the ingredients and flavours division with a captive market for at least some of its output?

What is incontestable is that Kerry is nowhere near meeting McCarthy's target of doubling in size within five years. It isn't even close. At a group level, sales have risen by a cumulative 4pc from €4.78bn in 2007 to last year's €4.96bn while trading profits have increased by 17pc from €401m to €470m over the same period. Net debt has only declined marginally, from €1.27bn at the end of 2008 to €1.11bn by the end of 2010.

In fairness it isn't as if McCarthy doesn't have a bullet-proof alibi. Soon after he became chief executive, the world was plunged into the worst economic downturn since the 1930s. As excuses go, that certainly beats the dog-ate-my-homework. At a time when most other Irish quoted companies have delivered sharply lower returns to their shareholders, Kerry has continued to crank out higher profits and dividends with the payout to shareholders rising from 20 cent to 28.8 cent per share over the past three years.

A 44pc increase in the dividend and the share price at an all-time high -- how many bank shareholders must be wishing that their managements had been able to crank out the solid, unspectacular growth that Kerry has achieved under McCarthy's leadership?

The Kerry Group was founded as recently as 1972, which makes it a mere infant in Irish food industry terms. For the first 29 years of its existence it was headed up by Denis Brosnan. When he retired in 2001, it was widely expected that McCarthy, who has been with the group since 1976, would succeed him.

Things didn't quite work out as planned. In late 2001, just as Brosnan was preparing to step down, McCarthy suffered a minor health scare. While he was soon hale and hearty once again, the Kerry board decided to play it safe and gave the top job to Hugh Friel, Brosnan's long-time deputy, instead.

Being passed over at the last minute must have been a bitter disappointment to McCarthy. However, he didn't let it show and knuckled down instead. By the time Friel was ready to retire in 2007, McCarthy was the only credible successor.

A native of Churchill, a few miles from Kerry's Tralee headquarters, McCarthy joined the company straight out of school in 1976. After joining Kerry he initially worked in the finance department and was encouraged to study accountancy by the company.

His big break came in 1984 when, soon after qualifying as an accountant, Kerry transferred him to the United States, where the company had just opened a representative office in Chicago. In 1988, Kerry consummated its first major US acquisition when it purchased Beatreme.

Described by someone who knows him well as "a driven workaholic" the young McCarthy rose quickly through the ranks of Kerry's rapidly expanding North American business. He was appointed vice-president of materials management and purchasing following the Beatreme acquisition. In 1991, he was promoted to vice-president of sales and marketing before being appointed as president of Kerry North America in 1996.

Originally confined to the United States, Kerry's North American operations have now expanded into Canada and Mexico. The company also has operations in South America. By 2007, McCarthy's last year in charge, Kerry's sales in the Americas were €1.3bn.

Until his appointment as Friel's successor McCarthy had been based in the United States for the previous 23 years. His wife is American and they have three young children. Although he will be 54 later this year, the keep-fit enthusiast, who works out regularly, looks many years younger. Having successfully steered Kerry through an economic recession of almost unparalleled severity, where does McCarthy take the company from here?

While the recent strength of the share price demonstrates that investors appreciate the company's defensive qualities, the challenge facing McCarthy will be to find ways of speeding up growth at Kerry as the global economy recovers.

Irish Independent

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