Orkla ASA (ORK) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to Orkla's presentation of First Quarter 2023. My name is Kjetil Sorum, at Investor Relations Head at Orkla. I'm joined here in Oslo today with our President and CEO, Nils Selte, who will summarize the quarter shortly. Before that -- or after that, Harald Ullevoldsæter will take you through the financials for the quarter. After that, Nils will sum up the main messages of today before we move into Q&A. Let me also tell me to tell you that you should be able to post questions at the web during the presentation, and we will address them at the end, together with any questions that might be in from the audience in the room. So with that, I leave the floor to you, Nils.

Thank you, Kjetil, and good morning, and thank you all for joining us. I'm happy to be here today to give you an update on our transformation journey and the financial highlights for the first quarter 2023. Let me start by saying a few words on our ongoing transformation. We went live with our 12 portfolio companies and our new operating model 1st of March this year. I'm happy to observe that organization is adapting rapidly and that the transformation so far has been successfully implemented. We are now an industrial investment company with a brand and consumer-oriented scope. Orkla is [indiscernible] leaner with less than 100 employee s now. We have carved out our business service company and led the ground for continued synergies across the portfolios. The portfolio companies are now operating independently and we have good progress when it comes to finding the right board compositions. I'm therefore proud that we today announced the appointment of Xavier Belison as Chairman of the Board of Orkla Foods Europe in addition to Kjersti Hobøl as a Board member. Also announced today is Thomas Setelic, new Chairman of the Board of Orkla Health, all 3 bringing in extensive experience from comparable businesses. In this quarter, we also announced the new CEO of Orkla Health, Isabelle Dulcellier and soon to announce also new CEO of Orkla Health Care, experienced national leaders bringing fresh perspectives and proven track record of value creation. We are now in the process of preparing bottom-up strategies, strategy plans for the portal companies. We have strong position and solid plans to build from with substantial value creation potential going forward. We have completed our point of departure analysis for our portable company, and this gives a good foundation for building the future strategies. I'm looking forward to presenting these plans on our Capital Markets Day in November this year. And in addition, our new operating model facilities more structural flexibility, enabling us to act fast on opportunities that arise. An example here is the ongoing process of finding a partner to Orkla Food Ingredients. So far, this is going according to plan. Increased flexibility also provides the opportunity to allocate capital to where it brings the best return. We are making good progress building framework for future capital allocation also to be presented at the Capital Markets Day. If we move on to our financial results for first quarter 2023, I'm happy to see that we have both strong top line and bottom line growth. When we look at our group EBITDA adjust, we see a growth of 5%. Further, we see a 13% increase in organic growth in our BCG business, mainly driven by broad-based price increases. Alongside a good performance in the BCG area, we see underlying extraordinary strong performance in both Jotun and Orkla Food Ingredients. Jotun achieved 24% sales growth in the quarter and 81% growth in EBITDA. In Orkla Food Ingredients, we saw an underlying EBIT growth of 26% with strong broad-based organic growth and well-executed revenue management. Another positive is that we currently see an easing in cost inflation in some portfolio companies. Please note that this is a fragmented picture as there are considerable value variation in our company's exposure to different markets, raw materials and also a weaker Norwegian krone. It is worth mentioning the delay in ramping up our new biscuit factory in Latvia. We believe that we have identified the key challenges and are working very hard to get on track. This is temporarily impacting financial results and in some markets, our delivery performance. Let me also update you on our increased cost improvement targets. These are progressing as planned, and we see good initiatives in Orkla Foods Sweden, Orkla Cesko and Svenska and recently announced Orkla is Norway. We have also started initiatives in Orkla Home & Personal Care Norway and expect positive effects from our consolidated biscuit production in Orkla confection snacks when they are fully up and running. In general, we expect to see increased effects towards year-end for our cost initiatives. With that, I leave the floor to Harald to give -- to go through the financials in more details.

Thank you, Nils, and good morning, everyone. I will now take you through this update on our financial performance for quarter 1. And let me highlight that this will be the last quarter on the existing reporting structure. As from quarter 2, the business areas will be replaced by portfolio companies in addition to an increased level of detail per reporting unit. So let's kick off by looking at the group figures. Reported revenue growth for Orkla Branded Consumer Goods was 23.2% in the quarter. Earnings for Branded Consumer Goods, including headquarter, increased by 14.3% in the same period. Let me revert to this later. The decline in for industrial and financial investment was mainly driven by 21% lower electricity prices for hydropower on close to flat volumes. This resulted in EBIT for hydropower of NOK 255 million, which is down from the corresponding quarter of last year and quarter 4 but still at a historically high level. We had net other income and expenses of minus NOK 52 million in the quarter. The largest elements were M&A costs, restructuring costs, project costs and reorganization of Orkla ASA. Profit from associates was NOK 422 million, mainly related to a strong comeback in Jotun, as Nils mentioned, and I will come back to this. Net financial items were higher than last year, mainly due to higher interest costs but also higher debt level. Average interest rate in the quarter was 4.4%. Reported tax expenses were on par with last year at NOK 410 million. The tax rate, excluding associated companies was slightly lower in the quarter compared to last quarter -- last year. And this is mainly driven by lower resource and tax related to hydropower. The underlying tax rate adjusted for nondeductible costs was basically unchanged. Adjusted earnings per share ended up 6.5% in the quarter. Let's have a look at the cash flow for quarter 1. Cash flow from operation was NOK 740 billion in the first 3 months of 2023. The cash flow from operations in branded consumer goods was higher than in 2022. This was mainly driven by improved earnings and less negative change in net working capital. We will have high focus on current capital going forward and our ambition is to reduce the current capital to a more normalized level. The larger projects and the net replacement investments was the construction of the new biscuit factory in Latvia. Replacement investments also include other factory projects. Let me then walk you through the net interest-bearing debt bridge for quarter 1. Net debt, including leases increased by NOK 2.4 billion to NOK 19.6 billion from year-end 2022. Cash taxes and financial items in quarter 1 totaled NOK 834 million, which is higher than in the corresponding period last year and driven by higher hydropower profit in 2022, that is being paid for in 2023. Net M&A was NOK 852 million. We had expansion CapEx of NOK 79 million in quarter 1 compared to NOK 51 million in quarter 1 2022. Negative currency translation effects as a result of a weaker NOK increased the net debt by NOK 1.4 billion. Orkla has a strong financial position, and our net debt level at the end of quarter 1 corresponds to 2x EBITDA based on the last 12 months when organic growth makes up 13.4% of the increase. This was supported by significant currency translation effects of 7.5%, and structural changes had a net positive impact of 2.4%. We're experiencing strong growth in out-of-home sales channels, while volume performance in the grocery channel was weak, especially in food categories. The timing of Easter had a positive effect in the Scandinavian countries, particularly in Norway. So let me share some more insights on the growth. All business areas had organic growth in the quarter. The 13.4% organic growth was price driven. Volume mix was slightly negative, but with a large variation between the business areas. Most markets experienced a decline in volumes to the grocery channel compared to the corresponding period last year. The volume decline was most evident in Orkla Foods Europe and consumer investments. And the risk of contracting volumes is still present going forward. High overall economic inflation is reducing the purchasing power of consumers in most markets where Orkla is present. Orkla Food Ingredients experienced positive volume growth in the quarter. The overall market shares in the grocery channel were slightly negative in the quarter. Orkla is experiencing increased competition from private label. This is broad-based across Food Europe, confectioner & Snacks and care. An important driver is the discount stores that are gaining shares. We communicated in quarter 4 that this was particularly relevant for Denmark and in the Czech Republic. In quarter 1, this trend has continued, and we see the same development also in Sweden. This has a negative effect on Orkla due to lower market shares in hard discounts. Before moving on to profit performance, let's have a look at our prioritized growth areas. Consumer Health grew sales by 20% on a reported basis in quarter 1. This was mainly driven by structural growth from acquired business through Healthspan Group. Organic growth for Consumer Health was 6.5%. Orkla has become a major challenger in the European pizza market through a series of transactions since 2018. And the latest acquisition of DaGrasso in Poland was completed in December and was consolidated from January 1. Orkla's network consists of 852 pizza franchise outlets in Finland, Benelux, Germany and Poland. The portfolio consists of leading brands like Kotipizza, Neo Pizza and Agraso. The underlying growth in consumer sales for our existing pizza business was 5.6% in quarter 1. All markets, except Germany, had solid growth in the quarter, positively impacted by increased consumer prices. The German market is challenging with high cost and wage inflation in addition to which consumer spending is under pressure. Our network restructuring is ongoing, where underperforming stores are being closed to ensure a robust base going forward. Reported growth for plant-based was 35%. Organic growth was 25%, while organic growth for Orkla's branded products amounted to 1% in the quarter. So let's move on to earnings performance for Branded Consumer Goods. EBIT for Branded Consumer Goods included headquarter increased by 14.3% in the quarter, reflecting a 5% underlying increase, 7.5% positive ForEx effect and structural growth from acquired company of 1.8%. The Norwegian krone had a weak development during quarter 1. We experienced a positive translation effect in converting EBIT from our foreign businesses into NOK in quarter 1, while the total transaction effects were negative. The total effect was negative. A weak NOK will be negative in the short term, but our long-term competitiveness will improve as our main competitors have a larger part of their cost base outside Norway. The underlying EBIT increase in the first quarter was mainly caused by revenue growth. Cost of inputs were on a high level but were compensated by price increases. Spot prices for raw materials essential to Orkla showed a flat and partly declining curve over the last 2 quarters, but at a high level compared with the same quarter previous year. We still have a lower than historic average purchasing contract duration, now about 3 to 9 months. And if the market trend continues, we should see some positive effects during the second half of this year, while we experienced a temporary negative currency effect if exchange rates stays at the current level. Let me add that the exposure varies a lot between the business areas, as Nils mentioned. The cost increase in Orkla Food Europe is significantly higher than for the other business areas. Due to the mix of raw materials and the average contract duration are also somewhat longer. Easter was 1 week earlier than last year, and we estimate this positive effect mainly related to Orkla Foods Europe and Confectionery & Snacks to account for about half of the underlying EBIT improvement compared to last year. Profitability in Confectionery & Snacks was negatively impacted by temporary higher costs related to the ramp-up of the new biscuit factory in Latvia and lower sales due to a very low service level. The increase in non input costs like SG&A and factory overhead weighed negatively on the results. The pace of increases is similar to previous quarters and it's something we take seriously as this is expected to be demanding also going forward. We announced a NOK 1 billion cost avoidance initiatives last quarter to mitigate the adverse cost performance. Factory composition and categories with low profitability will be continuously evaluated, including organizational optimization, a larger reorganization in the Czech Republic impacted quarter 1 positively. While projects in Norway and Sweden for Orkla Foods Europe are expected to have a positive effect from quarter 3. On the right-hand side, you can see that the underlying EBIT margin decreased by 1.7% on a rolling 12-month basis. Much of this is caused by the dilutive effect on inflating sales and costs. Compared with the 12 months level in quarter 4, the EBIT margin show signs of flattening. Let me then move on to the business areas. And let's have a look at Orkla Foods Europe. Orkla Foods Europe reported a revenue increase of 15.7% in the first quarter, of which 10.3% was organic growth. The growth was broad-based and price driven in the grocery channel, while volumes declined across most markets. Foodservice and convenience continued the positive trend from 2022. Market shares in grocery progressed negatively in most markets, particularly the Czech Republic, Sweden and Denmark. This can, to a large extent, be attributed to changes in consumers' behavior where hard discount stores are gaining shares and campaigns are used to drive customer traffic. There is still a challenge with high cost of raw material, packaging and energy, enforced by a weakening NOK and SEK. Despite this, EBIT increased by 8.7%, largely driven by sales growth, positive currency consolidation effects and positive effects of prioritization of Easter. Weighted exposure for different purchasing categories makes the cost increases more negative for Food Europe than other business area, as I mentioned. Meat, dairy, sugar, tomato paste and rice are examples of raw materials with significant increases. In addition, glass and metals are large packaging categories with strong price increases. Moving on to Orkla India. Orkla India had sales growth of 22.2% in the quarter, of which organic growth was 17.6%, mainly price-driven. The growth particularly within spices and dairy. Additional price increases for 2023 will be necessary. Correspondingly, advertising and promotion expenses have been increased to strengthen core brands long term. The EBIT margin in the quarter was 11%, down 0.3 percentage points from the corresponding paid last year. Moving on to Confectionery & Snacks. Orkla Confectionery & Snacks had organic growth of 13.6% in the quarter. Market volumes were fairly flat after a period of negative market growth in the second half of 2022. Early Easter than last year had a positive impact on sales growth. Higher costs than expected related to the start-up of the new biscuit factory in Latvia, are impacting earnings negatively. The main problem is related to 2 new packaging machines. The ramp-up cost approximately $30 million in extra costs in the quarter. In addition, a very low service level is having temporary negative effect. We expect continued ramp-up costs and low service level also in quarter 2. Market shares were negatively affected by the low service level in biscuit. EBIT decreased by 2.1% in the first quarter compared with last year. Raw materials were significantly higher than previous quarter. Then let's move to Orkla Care. Orkla Care reported a growth of 18.2% of which 8.5% was organic. The organic growth was driven by our online retailer, HSNG, Nutra Q and international sales and both price and volume. Growth in international sales was related to the Oral Care and sunscreen. The category's detergents, personal care and dietary supplements, saw volumes and market shares decline in Norway and Denmark. Earnings increased by 14.5% in the quarter. Results are still negatively impacted by broad-based cost increases. While less extraordinary costs related to freight and logistics were incurred as in the corresponding quarter last year. Price increases also impacted positively. The margin contracted 0.4% year-over-year. Let's turn to Orkla Food Ingredients. Orkla Food Ingredients delivered another quarter with strong organic growth. In quarter 1, it was 22%, primarily driven by price increases. Volumes were also positive, mainly driven by plant-based drinkables and margarine. The growth was broad-based across categories and geographies. Let me remind you that we anticipate that some of the demand for margarine is for a more temporary nature that could reverse when we enter the second half of the year. The EBIT improvement was 17% driven by acquisition, positive translation effects and price increases, but offset by higher cost of raw materials, transportation and energy. The Denali Ingredients, which was acquired in quarter 4 last year, completed its first full quarter with revenue and EBIT growth in line with plan. Let's have a look at performance in consumer investments Orkla Consumer Investments reported organic sales growth of 9%. There was still good growth in consumer sales for the pizza business, driven by price increases. The German market is an exception, as already mentioned. The sales decline in House Care continued, particularly due to lower demand in the Nordics. Lilleborg and our textile business, Pierre Robert Group also contributed positively to the revenue growth in the quarter. There was an underlying EBIT decline in consumer investments mainly due to lack of price increases to cover significant cost increases in Lilleborg. Let's have a look at our associates Jotun. Strong sales growth continued for Jotun in the first quarter. Reported sales growth was 24%. The underlying sales growth was 18%. Sales performance was driven by price increases and moderate volume growth. Sales growth was particularly strong in Decorative, Marine Coatings and Protective, while underlying performance was more modest in powder. Operating profit increased by 81% in the first quarter, driven by improved gross margin, volume growth and good cost control. Jotun expects sales growth and margin improvement in the upcoming quarter. Finally, let me say a few words about hydropower. Volumes in quarter 1 were slightly lower than for the same period last year and the 10-year average. However, electricity prices were 21% lower year-over-year. Operational expenses were somewhat higher mainly due to the windfall tax of NOK 34 million that was introduced in the second half of 2022. And with that, I give the floor back to Nils for his concluding remarks.

Thank you, Harald. To sum up, I would like to highlight the transformation of Orkla is proceeding as planned, including operationalization of the portfolio companies and their Boards. Exciting profiles will be entering the companies in the coming months with relevant experience and strong track records. These changes, among others, are really bringing Energy & Spirit into the organizations. We see satisfactory performance this quarter with 5% growth in group EBITDA adjusted. In overall, BCG made a positive contribution, but let me again pinpoint the extraordinary performance in Jotun and Orkla Food Ingredients. As mentioned, there is still uncertainty in volume outlook due to the macro environment and consumer purchasing power. Our strategy work is progressing well, and we are looking forward to presenting the results at our Capital Markets Day in November. And as a final remark, our overall ambition stays firm. We will continue to create value, substantial value through active ownership of brands and consumer companies. Thank you all for listening. And with that, we open up for Q&A.

Okay. Let me start by asking if there are any questions from the audience. Please state your name and company. If not, we'll move on to questions from the web. So I have 4 questions from Ole Martin Westgaard in DNB. I suggest we take them one by one. Thank you. What was the mix on organic growth for BCG? Can you give any color on the volume development and price effects between the different segments?

I think we have commented on what we want to comment during the presentation. As we said, we have a growth in volume on totality for the out-of-home markets, while the grocery markets are facing more or less declining volumes. But a big variation between our business areas. I guess the food categories are the most hurt volume-wise during the quarter. And we have increased prices in every business area.

Next question. You highlight the threat from private labels on volumes. How much volumes have you lost to private label and which areas are most impacted?

I think this is -- we are facing private labels in most of our business areas. We haven't quantified the actual volume drop due to private label, but we have lost some market shares, especially due to the change of hard discounters taking market share, especially in Sweden, also now in Sweden but also in Denmark and in the check as we said in quarter 4, but also now in Sweden, where we have lower market shares in those stores. But you also -- so we see private labels in every part of our business. And we have said it before, private label is our main competitor.

How much of the NOK 1 billion cost program has been realized so far? What to expect for Q2?

I think you have to be aware of this, approximately SEK 700 million of this is a kind of continuous improvement program that we always have in Orkla. And then Nils said, we are going to increase our ambition to by 40% to NOK 1 billion. So the increase from previous year is approximately NOK 300 million. And we are having new activities net that makes us pretty sure that we will reach these targets during the year, but most of the effects will come by the second half of this year.

I think most of the increased ambition will come to the second part of this year.

So we have cost programs in the check. We have it in our biggest company in Sweden or a Orkla Food Sweden. We have it in Orkla Foods Norway, the biggest company in Norway, and we also have it in the Home and Personal Care company in Norway. And we are looking for more opportunities, of course.

Perfect. Last question from Martin. Are the biscuit factory issues in Orkla confection snacks now solved? Will there be a Q2 impact?

There is still ongoing issues in the factory. I think we have a good view on what's the problem, how to solve the problem, but there is a packaging machine that is -- we are troubling with, but we are slowly getting on track and back to truck, as I said in my presentation, and we expect to come for during this quarter.

But let me add, I think we are very glad and happy that this is not a production problem. It's more a packaging machine. We are delivering products as they should taste with the correct texture and everything. But we will have some extra cost in quarter 2, as I said in my presentation, and we will have a lower service level also in quarter 2. We expect this to be increased by the end of quarter 2 and into the quarter 3, but it's still ongoing work.

Moving on to 2 questions from Bruno Monteyne in Bernstein. I also take them one by one. At what point can margins go up year-over-year. You suggest a visible impact from cost initiatives by year-end. Is that when we should expect year-over-year margins to turn?

I don't think we will guide on the -- our turning point of the margin, as we have said before. But as I said in my presentation, if the trend continues with the decline in prices and our short contract duration, we should see some positive impacts by the second half of this year, profit-wise. But of course, there are lots of uncertainties, as always, especially the volumes will continue to be very low or lower. That all will be an important part of this equation as well.

And how many quarters do you think it will take to rebuild profitability to the levels seen 2 years ago?

That's also an extremely difficult question to be very precise. But what I can say that is we are very determined to get back on our profitability levels needs.

And what we have said earlier is that, first of all, we want to compensate NOK-for-NOK and then we, hopefully, over time, we'll kind of regain margin levels. But we don't guide on when that will be.

Then we have a question from Kate Rusanova at UBS. Could you please quantify the volume performance for Orkla ECG in Q1? How did it compare to the minus 3% volume decrease in Q4? Also, can you please quantify the impact of Easter on Q1 BCG organic sales growth?