Orkla ASA (OTCPK:ORKLY) Q2 2022 Earnings Conference Call July 14, 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
Kari Lindtvedt
Good morning, and welcome to the presentation of Orkla’s Second Quarter Results. My name is Kari Lindtvedt, I’m Head of Investor Relations. We start today with President and CEO, Mr. Nils Selte, who will give you the main headlines of the quarter and also share some reflections on his first three months in office.
Then, CFO, Harald Ullevoldsæter will give you the details of the financials, and after that Nils will summarize our main messages today before we move on to Q&A. During the presentation, you are welcome to post questions on the live chat and we will address them together with any questions from the audience here in our floor at the end of the session.
With that, I leave the floor to you Nils.
Nils Selte
Thank you, Kari, and good morning, everyone. Thank you for attending both here in Oslo and on the web. In the second quarter, we delivered Group EBIT adjusted growth of 39%. The main driver behind this was strong result in Hydro Power.
Overall, given the environment we are operating in, I am satisfied that we have implemented our planned price increases during the first half of 2022 and that we now have more visibility on our inbuilt cost for the rest of the year.
[Indiscernible] we have delivered high service level and Orkla Food Ingredients delivered solid results. We had organic growth of 12% in Branded Consumer Goods and positive volume progress. On the other hand, profit conversion was weak mainly due to cost inflation and the lag effect from price increases.
In addition to price mitigation actions, we continue our focus on cost improvements and other revenue management initiatives. Adjusted earnings per share increased by 17% to NOK 1.33 per share in the second quarter.
Before handing over to Harald, I would like to reflect a bit upon my first three months in office. There has been some exciting days with lot of learning, hard work and good initiatives. First of all, we have a great organization, enthusiastic people with drive and pride in what they do. This is vital for the future of Orkla. Our brands and people form the basis for everything we do and we will continue to create value based on these skills and insights.
We are currently navigating a challenging environment not only in terms of cost inflation, but also because consumer trends and habits are changing rapidly. This creates opportunities for us and we need to be in the forefront of the development. As I said during the first quarter presentation the strategic direction and ambitions remains unchanged and in line with what was communicated during our Capital Market Day in November last year.
But to realize untapped potential, I have initiated and analysis in order to evaluate our operating models. I believe there is potential for enhanced value creation by establishing more autonomous businesses and we will also investigate the role of the corporate functions. The purpose of this is to secure efficient processes and more clearly define the ownership role for a level above the operating companies.
This is a transformation process for Orkla that will take time but I am convinced it is the right thing to do. There are several reasons why I believe that establishing more autonomous businesses will accelerate value creation.
One, it will free up energy, encourage entrepreneurship and generate enthusiasm in each unit. Two, this allows and forces the management to really focus on delivery in the respective businesses. Three, we can more easily implement targeted and tailor-made incentive system for each business, and four, we can establish dedicated boards with also external members and this board will have a hands on mandate and continuously evaluate the strategy, the performance of the management and the structural opportunities.
Also a structural standalone autonomous businesses will create more optionality and flexibility for structural moves. They will be better prepared to quickly act on opportunities that arise in a more flexible way than today and also proactively drive and entertain industry shaping moves.
During our Capital Markets Day, we introduced our portfolio management framework. We will apply this method systematically to actively decide whether to invest, hold or divest assets. From my perspective, to hold an asset is also an active and monetization that must be taken. We will continue to build on deep experience, our deep experience with developing leading consumer-oriented brands while also shifting the portfolio towards faster growing consumer segments and markets.
This work has already started with for example the acquisition of Eastern, NutraQ, New York Pizza last year. We will continue this work with responsible and active capital allocations. The new structure will allow for increased information transparity around key assets.
As I said in Q1, we expect to be ready to share more information on our updated financial reporting structure in the second half of this year. Brands and consumer insight is a competitive advantage for Orkla and this is important to maintain – this is important to maintain and build up on going forward. These competers combine to the future operating model, our fundamental to why I think Orkla can deliver competitive return to our shareholders going forward.
But we also need to strengthen our competence in areas such as in expense management and execution of active ownership. This is already work in progress. In making the businesses more autonomous, we will keep it a top priority to maintain our synergies in the most important areas.
With this, I will leave the floor to Harald for more details on the financial in Q2.
Harald Ullevoldsæter
Thank you, Nils, and good morning, everyone. Let’s now have a look at the quarter two performance. For a sake of good order, we have not made any changes to the financial reporting structure this quarter. We will revert later in the second half of the year with more details on this.
In the following slides, the Branded Consumer Goods figures thereby includes Orkla Food Ingredients and consumer investments just for you as the previous quarters. So, let’s – I can take.
Let’s start on. Reported revenue growth for Orkla Branded Consumer Goods was 17% in the quarter acquired companies contributed 5.9%. Earnings for Branded Consumer Goods, including head quarter decreased by 0.5% in the same period, and I will come back to this.
Improvement for industrial and financial investments was mainly driven by high power prices in hydro power. Power prices in quarter two were more than three times the average price in the corresponding period of last year. Volumes in quarter two were lower than average historical levels for a period, but 5% above last year.
This resulted in EBIT for hydro power of NOK 579 million and this is significantly higher than average annual EBIT for hydro power business in the last ten years. We had no net non-recurring items of minus NOK 50 million in the quarter. The difference from last year is largely explained by costs related to an ERP project last year.
Profit from associates was NOK 238 million, mainly related to Jotun. And net financial items were higher than last year due to higher debt levels and slightly higher interest costs. The effective tax rate, excluding associates was higher in the quarter compared to last year and the most important driver was increased natural resource tax due to strong profit growth from hydro power. And as Nils said, adjusted earnings per share ended up 17% in the quarter and 7% in the first half.
Let’s have a look at the cash flow for the first half. Cash flow from operation was NOK 677 million for the first half of the year. The cash flow from operation in Branded Consumer Goods was lower than in 2021. We had higher net working capital, mainly explained by increased sales resulting in higher receivables and higher stock values due to higher raw material prices.
Recurring capital was also negatively affected by increased inventory levels in Orkla Food Ingredients and Orkla Foods. To hold more stock due to supply chain issues and contingency stocks.
Next, let me walk you through the net interest-bearing debt bridge for the quarter. Net debt including leases increased by NOK 4.8 billion to NOK 17.6 billion from year end 2021 today in the first half year 2022.
Cash taxes and financial items totaled NOK 940 million and the main cash outlay during the first half was a dividend of NOK 3 per share paid out in the beginning of May. This totaled about NOK 3 billion.
Net M&A was approximately NOK 1.1 billion for the first half related to the acquisition of Healthspan Group and Vesterålen Marine Olje. Additionally, we had expansion CapEx of approximately NOK 150 million. Negative currency translation effects as a result of a weaker NOK increased net debt level by NOK 318 million.
This leaves us with net debt including leasing liabilities of NOK 17.6 billion by end of quarter two and the corresponding figure excluding leasing was NOK 15.8 billion. Orkla has a strong financial position and our net debt level at the end of quarter two corresponds to two times EBITDA on the last twelve months, when acquired companies are included in EBITDA.
Let’s then have a closer look at the performance in branded consumer goods. Let’s start with the top line performance for Branded Consumer Goods. Reported revenue growth from our Branded Consumer Goods business was 17.3%. As we have already mentioned, this was mainly driven by organic growth of 12.1%.
Structural changes had a net positive impact of 5.9%, why? There was a negative ForEx translation effect of minus 0.7% mainly from a stronger NOK versus euro and SEK. Year-to-date organic growth for the Branded Consumer Goods segment was 9.9%.
Let’s then have a look at the total growth distributed between the business areas. All business areas had significant organic growth in quarter two, apart from consumer investments. The overall organic growth was both price and volume-driven where price accounted for approximately two-thirds, remaining one-third is volume mix of – much of is explained by recovery in Out-of-Home channel.
Despite no signs of negative volume effects in the figures for the second quarter, we kind of threw out some degree of negative volume effects going forward. We saw higher than normal sales ahead of our price increases in July the 1st. We estimate that this element have a positive effect just below NOK 100 million in the quarter.
This effect is mainly ascribable to the business areas Food, Confectionery & Snacks and Care and will have the opposite effects in quarter three. The facing of Easter sales had also a positive effect on second quarter as mentioned in quarter one. Adjusted for these effects, organic growth is reduced from approximately 12.1% to approximately 11%.
Certain segments of the Norwegian grocery markets saw a market contraction in the quarter following elevated levels through the pandemic. This was mainly the case for Confectionery & Snacks in Norway, as well as Home & Personal Care in Norway.
Similarly, our painting tools business in the consumer investments experienced lower activity in the Do It Yourself segment.
Before moving on to profit performance in Branded Consumer Goods, let’s have a look at our prioritized growth areas. Our three prioritized growth areas are consumer health, European pizza franchise and plant-based. All areas experienced progress in the quarter.
Consumer health grew sales by 41% in the first half of 2022 on a reported basis. This was mainly driven by structural growth from acquired business to NutraQ, Vesterålen Marine Olje, and Healthspan Group. The organic growth for consumer health was approximately 6%. The digital share in consumers health reached 44% of sales in the first half of 2022, compared to 32% in the corresponding last year, also positively affected by acquisitions.
We have grown our Out-of-Home pizza business significantly over the past twelve months through the acquisition of New York Pizza and three smaller chains in Germany. The underlying growth in consumer sales was 8% in the first half and both Kotipizza and New York Pizza showed positive growth rates in consumer sales.
At quarter end, our chains had 666 restaurants in our network. Reported growth for plant-based was 15% in this first six months. The organic growth was 18% while the organic growth for Orkla branded products amounted to 6% in the first half of the year. The difference here is a manufacturing contract, which supports scale advantages.
Let’s look at the earnings performance in Branded Consumer Goods. EBIT for Branded Consumer Goods, including head quarter, decreased by 0.5% in the quarter, reflecting a 6.4% underlying decline and 0.4% negative ForEx effect, but offset by structural growth from acquired companies of 6.4%. The underlying decline in the second quarter was mainly caused by increased input costs of raw materials, packaging, and energy.
Additionally, we see cost elements like salaries become more negatively impacted by an inflationary environment. On the other hand, the underlying EBIT development in quarter two was positively affected as I mentioned by extraordinary high sales in Norway in front of the price increases of 1st of July and the facing of the Easter compared to last year.
On the right hand side, you can see that EBIT adjusted margin decreased by 1.4% on a rolling three months basis. The underlying performance in the 12 months period was minus 1.5%. Orkla implemented several price increases during the second quarter and at the start of the third quarter to compensate for the adverse cost increases.
The price adjustment will have increasing effects into the second half of the year. At the same time, Orkla’s sourcing and procurement structure implies higher cost in the second half of the year due to the lag effects described earlier.
Let’s move on to the business areas starting with Orkla Foods. Orkla Foods reported a revenue increase of 11% in the second quarter, of which 11.6% was organic growth. Sales growth was broad based across markets and channels and consists of both price and volume growth. The growth was particularly good in food service, and convenience, which were positively affected by reopening effects, after the pandemic. Growth in the grocery channel was also positive in quarter two.
Orkla India showed good progress in both sales and earnings compared however to a weak figure last year impacted by the pandemic. EBIT declined by 7.2%, largely driven by higher input cost. The trend of steep cost increases across categories of raw materials, packaging, transport energy and salary costs continued in quarter two. Significant price increases have been implemented in all markets.
Moving on to our Confectionery & Snacks. Orkla Confectionery & Snacks had organic growth of 8.8% in the quarter. Some areas within grocery experienced market contraction after strong growth during the pandemic. This was particularly the case for the Norwegian markets. This was outweighed by good growth outside grocery.
Earnings declined by 15.7% in the quarter. Input cost, transport and packaging continued to increase in the quarter. Price increases will take effect successfully through 2022.
Let’s have a look at Orkla Care. Orkla Care reported top-line growth of 31%, of which 8.3% was organic growth. The international markets for Orkla Home & Personal Care, Orkla Wound Care and business-to-business had good sales in the quarter.
On the other hand, Home & Personal Care in Norway experienced a demanding market situation in the grocery market with strong sales last year driven by the pandemic.
Earnings grew by 6.6% due to acquisitions, and increased input cost for logistic and raw materials had an adverse impact on the remaining businesses which combined saw an earnings decline. The margin contracted 2.4% compared to last year.
Let’s turn to Orkla Food Ingredients. Orkla Food Ingredients delivered organic growth of 22% in the quarter. Growth was supported by price increases to compensate for higher input costs in addition to positive volume growth. The Bakery segment which is Orkla Food Ingredients’ largest segment was the main driver of the progress and is now above pre-COVID effect level.
The EBIT margin was positively impacted by higher volume, although still hampered by cost inflation and challenging supply chain in certain areas.
Let’s have a look at performance in Consumer Investments. Orkla Consumer Investments reported a sales increase of 20.6%, while organic growth was minus 4.4%. The main driver for organic sales decline was a drop in demand for painting tools. This was somewhat offset by continued growth in the pizza franchise business.
EBIT declined by 11% in the quarter, mostly driven by the revenue drop and margin pressure for painting tools. The UK market for painting tool is particularly weak as soaring inflation on energy prices put pressure on consumers discretionary spending.
High transport and raw material costs continued to impact several business units, where price mitigating actions have only partly offset this so far.
Finally, let’s have a look at our associated company Jotun. Jotun had double-digit sales growth in all segments so far this year compared to last year. The strong sales growth was primarily driven by price increases, while higher volumes also contributed to the overall growth. Sales increased in all regions, apart from Scandinavia where a general demand for paints declined after a period of substantial growth in 2020 and 2021.
Increased marine newbuilding activity in Northeast Asia contributed to solid sales growth in the Marine segment. Operating profit increased by 6% in quarter two compared to last year despite strong increase in sales in the first half of 2022, the operating profit is lower so far to this year, compared to same period last year and the decline is primarily driven by lower gross margin as a result of higher input costs.
Higher raw material prices will continue to be a short-term challenge, while price adjustments increasingly will compensate for higher input costs. I will now hand back to you Nils for the final comments before we move on to Q&A.
Nils Selte
Thank you, Harald. Q2 was yet another quarter, heavily impacted by cost inflation and high energy prices. I am pleased that we delivered good organic growth driven by both prices and volume and then now seem to have more visibility on the input cost for the rest of the year.
Going forward, priority number one is to still manage and mitigate the cost inflation. An important element in this work alongside price increases is volume action and continuous improvement in the cost base. In parallel, we will continue to – continue our initiatives to adjust Orkla’s operating model. The aim is to get more out of our strong organization and asset base to increased shares return.
I look forward to share further updates with you in the second half of the year, until then, I wish you all a great summer and we will now open for Q&A.
Question-And-Answer Session
Q – Kari Lindtvedt
Let’s start with some questions from the audience here in Oslo. Are there any questions? We have a couple on the web then. First one from Markus Heiberg, Kepler Cheuvreux. When do you expect pricing to offset costs on a year-on-year basis? Should we expect positive underlying EBIT growth going forward?
Harald Ullevoldsæter
First, we don’t do any guiding, but I can say, as we have said, we have increased significantly price increases during both quarter one, but also significantly into quarter two and by the start of quarter three. And as Nils said, we have more visibility on our material costs for 2022. So, I guess, that could answer somewhat this question.
Kari Lindtvedt
Sure. And then a second question from Markus. Can you give some flavor on volume growth in your main categories? Any signs of changing behavior? Do you see regional differences in light of this point also in light of very different inflationary rates across markets?
Harald Ullevoldsæter
I think we have quite broad based volume growth in all our business area, but of course a big part of it is related to out-of-home, which is of course kind of recovery from last year. But you also see good growth in other areas. But as I said, we also have some challenges in, particularly in Confectionery & Snacks Norway category and also the Home & Personality – Personal Care and Home Care products in Norway where last year it was very, very infected by COVID and this is some 10% decline in the total market – grocery market in Norway for those categories.
Kari Lindtvedt
Thank you. Then we have four questions from Ole Martin Westgaard, DNB. First one, can you comment upon the mix between price and volume in the quarter? How was your market share development in the quarter?
Harald Ullevoldsæter
As we have said, we had the volume effect of approximately one-third of the organic growth of 12.1%. Approximately the same mix between price and volume as we saw in quarter one. And I think we said in quarter one also that we weren’t quite happy on our market share development, but it’s just very short period and I think that remains still the truth. We are quite happy, but it’s a very short period. We have to look at this on a longer term perspective fairly concluded.
Kari Lindtvedt
Sure. How should we think about the impact of cost inflation in HQ versus the first half of the year on gross margin?
Harald Ullevoldsæter
The cost inflation in HQ, I am not sure.
Kari Lindtvedt
In second half. We have said that we have like on the cost to draw contracts. So I guess he is asking will you see continued increase in the cost base through Q2, half – second half.
Harald Ullevoldsæter
Yes, we – I think we also said that we will have cost increases during the second half compared to last year due to our contract structure.
Kari Lindtvedt
Yes. And then a question on India. What was the contribution from MTR on Eastern on organic growth in foods in the quarter?
Harald Ullevoldsæter
They are still performing very good I can say. So, they have a good path and they have a good growth compared – much in line with the total growth in the market.
Kari Lindtvedt
And have you noticed any change in consumer behavior on the back of the weaker macro outlook?
Harald Ullevoldsæter
So far, we haven’t seen any volume decline or any volume – negative volume impacts in our figures, but of course, it’s early days. We have increased our prices significantly. So, it remains to be seen if we see any trading down or anything. But I think our biggest exposure will be in the Central Europe and perhaps also in the Baltic where purchasing power a bit lower.
Kari Lindtvedt
Good. And then we have a question from Bruno Monteyne in Bernstein. You mentioned higher prices from July, but also higher commodity prices in the second half. Are price increases bigger or smaller than the expected commodity cost increase? In other words, have you reached the bottom of the margin?
Harald Ullevoldsæter
I don’t think we are going to answer the exact guiding, but I think I have said already, most of our volumes and prices are now fixed for 2022 much more uncertainty into 2023 and 2024 of course. And we have implemented the price increases according to our plans, that’s important to say.
Kari Lindtvedt
Yes. Thank you. Then a question from Kate Rusanova, UBS. Would you please be able to quantify the pre-buying you saw in June ahead of price increases in July? And which markets and business units were most impacted and do you expect some volume unwinding in Q3?
Harald Ullevoldsæter
Yes. I think we said that in our presentation, it is just below NOK 100 million and it’s related to Orkla Foods Confectionery & Snacks and Orkla Care, especially in the Norwegian part of the businesses.
Kari Lindtvedt
Thank you. John Ennis, Goldman Sachs has two questions. You mentioned that you have greater visibility on raw materials now. Can you give us fourth – of the four cost inflation you are expecting for 2022 and 20223 based on what you are seeing and how hedging – how hedged are you in these periods?
Harald Ullevoldsæter
I think I have to repeat a couple of things again. We – most of the volumes and prices are now fixed for materials – specified materials for 2022 with more opening into 2023 and of course 2024. And the first part of the questioning, Kari?
Kari Lindtvedt
That was regarding the forecast inflation you are expecting for 2022?
Harald Ullevoldsæter
Yes, we haven’t given any details on our what kind of inflation is hitting us. But it’s – I can say, it’s double-digit, double-digit growth, yeah.
Kari Lindtvedt
Yeah, yeah. And then the last question from John Linnis, can you give us a stair on your expectations for the hydro power business for the year or for Q3? Do you believe performance will be similar to Q2?
Harald Ullevoldsæter
The short answer, no we cannot. We have very good results of course for hydro power this quarter and so far this year, but we cannot give any estimate for the rest of the year.
Kari Lindtvedt
No. Good. That seems to the final questions on the web. Are there any other questions from the audience here? There seems not to be. And that concludes the questions. Thank you, Nils and thank you, Harald. We will be back with our third quarter results on the 27th of October. And until then, we will wish you very happy summer holidays and thank you for joining today.
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