Shares in food producers used to be seen as a defensive investment with modest, stable and fairly boring returns. People have to eat, even when the economy slows down. They do not necessarily eat more when incomes increase.
But things have changed. One only needs to look at RCL Foods and its latest results to realise how closely the fortunes of today’s food companies are linked to the economy as a whole.
RCL posted a decrease of 25% in earnings before interest, taxes, depreciation and amortisation (Ebitda) and a decrease of 61% in headline earnings per share in the financial year to end June due to the bad performance of its chicken and sugar businesses. Its branded food businesses, however, achieved excellent performance.
Usually, one would expect the more basic businesses in its portfolio to produce the better results in times of economic hardship when people tend to cut back on the luxury and convenience of processed, branded food products and move back to the basics. Unfortunately, the large chicken and sugar businesses had to contend with unusual circumstances.
“The local sugar and poultry industries are under significant pressure, impacted by oversupply and declining local market demand due to muted consumer spending,” said management in its explanation of the weaker results. “With respect to sugar specifically, the recent implementation of the sugar tax had a big effect.”
Despite an increase of 5% in revenues in the sugar division to R5.7 billion, Ebitda dropped from a profit of R284 million in the previous financial year to a loss of nearly R85 million.
RCL argues that the effect of the sugar tax will lead to a permanent reduction in local demand and that a higher proportion of future sugar production will be exported – with transport costs leading to lower margins.
The proportion of raw sugar exports increased to 51%.
Write-down means less tax payable
The board of directors decided it prudent to write down the value of the sugar interest by R762 million. This impairment at least reduced the tax payable this year by R210 million and reduced the deferred tax liability by R52 million.
Management says the difficult trading environment for chicken has continued unabated due largely to continued imports of frozen chicken at low prices.
Imported chicken dumped at prices lower than production costs locally remain a concern for all local chicken producers. RCL estimates that imported chicken at ‘dumping’ prices has secured 25% of the local market, to the detriment of the SA industry.
Double whammy on the chicken front
It has led to reduced market prices, leaving local producers in the lurch in the face of an 11% increase in feed costs.
RCL’s results and management comments show that the company responded to the challenge by increasing its offering of value-added chicken products, which offer better margins. Translated into plain language: moving towards more expensive branded food.
Expensive foods the way to go
Management reports that the groceries division more than made up for the shortfall in the chicken business. Branded groceries, pies, prime bread and desserts all delivered exceptional performance.
The same trend could be seen in the other divisions, such as the milling and baking division where value-added baking products helped the struggling milling businesses.
Management notes that it will continue to invest in branding and promotional activities to build its brands and drive profitability. RCL is not the only food company thinking this way. Management notes that this particular market is highly competitive.
In contrast, the prospects for the bulk foods categories – chicken, sugar and grains – remains subdued.
The best RCL can do is focus on factors within its control and keep engaging with government about policies which restrict growth.
Headline earnings per share (eps) of 38 cents were at their lowest since 2014 when RCL posted a loss of 43 cents per share. The following year’s headline eps fluctuated between 63 cents and R1.12. RCL reduced its final dividend to 10 cents per share for a total of 25 cents for the year, compared to 40 cents the previous year. The dividend is the lowest since 2014, when RCL paid out 20 cents despite the loss it suffered then.
Healthy PE ratio
The share picked up R1.30 to R11.50 after the announcement of the results. It is still closer to its five-year low of R9.40 rather than its high of R19.50. Nevertheless, investors are giving the Remgro company a vote of confidence and the price represents a price-earnings ratio of a high 30 times, hopefully not only until they receive their dividends.
There are a few encouraging signs that profits might recover somewhat in the new year. Management notes that some operational problems in the milling division have been solved, while several of its leading brands of groceries, pet foods and peanut butter have grown market share and increased margins.
It has also paid all the once-off start-up costs related to a new distribution contract with Pick n Pay, with the benefits starting to flow in the new year.