Stockwatch: Beware this food zombie

Joining the dots of news items for Premier Foods hardly gives a positive image for shareholder value. The company has previously tapped its suppliers for "investment capital" - a year ago it charged smaller firms £5,000 to stay on its supplier list.

As ever in business, once a firm gets away with something then next time it ratchets up the attempt - and it has only taken one supplier to go public with accusations of blackmail to create public furore. The chief executive (since early 2013) should have known the risks with this approach but opted to take them; so what does it imply about Premier's health?

A pattern of decline after excess acquisitions and debt

At 33p the FTSE Small-cap shares are down 99% on levels around £33 (pre-consolidation) the stock reached in 2005 to 2007. Very few such shares, genuinely recover: essentially it depends whether the mix of debt, costs and sales can work beneficially. With interims to end-June showing a 6.1% drop in sales, management anticipated the second-half year would see an improvement, but third-quarter results revealed a 5.1% fall in sales of "power brands" to £119.5 million while "support brands" slipped 0.9% to £40.4 million.

Non-branded sales dropped 10.3% to £17.1 million such that total sales fell 4.7% to £177 million. This has come despite a re-organisation, mainly to cope with group liabilities, but also to focus on perceived best prospects. Management blames "increasingly demanding market conditions" which implies pressure from shoppers migrating to supermarket own-brands. Longstanding brands can sound attractive, but their high-margins mean scope to under-cut.

In fairness, the re-launch of Mr Kipling cakes has been encouraging and it has recently grown sales - enjoying a circa 20% share of the UK cake market. Since this is now Premier's most significant brand - with Cadbury cake as a support brand - the British public needs to retain its sweet tooth and obese habits than respect regular advice against sugar and trans-fats.

Ambrosia is said also to be building steadily on its strong UK market share, likewise Homepride. Yet cooking sauces and accompaniments "continue highly competitive"as anyone can see from inspecting supermarket shelves. Not to doubt the ongoing brands in Premier's portfolio have commercial value when effectively managed; e.g. Bisto and Oxo should continue to achieve sales as staples; but if a foods group was being created to capitalise on trends in eating, would it really focus on these?

The crux for Premier's risk/reward profile is whether sustainable sales growth can be achieved in what looks like a three-year grace period now debts have been restructured. There appears little prospect of creditors pulling the rug, but it's a tough future considering the state of the grocery trade.

Balance sheet remains a disturbing sight

Despite a placing and 8 for 5 rights issue at 50p raising £353 million also £500 million in loan notes, last spring, liabilities remain heavy. Long-term debt has been cut by £218 million to £600.7 million and short-term debt by £128.8 million to £40.3 million, reducing net debt to £571.9 million or 181% of £320 million net assets. Mind how there is £713.9 million goodwill and £552.6 million other intangible assets, most of which accrued from acquisitions (made above book value). Intangible brand value is fine in principal but worthless in a falling sales scenario.

An interim operating loss of £10 million became a £55 million pre-tax loss largely as a result of a £45 million net interest charge; it will be interesting to see how the second half-year compares after the spring refinancing. The cash flow statement showed operational cash flow down from £14.4 million to £5.8 million, like-for-like. This group also has £536 million pension fund liabilities, if down from £603 million.

Premier is therefore quite the classic "zombie company": if a market economy was functioning effectively then shareholders would have lost everything years ago and creditors taken haircuts; but such is "the new normal" of super-accommodative monetary policy, the zombie staggers on. Management has done well to stabilise a very difficult situation and it is not surprising how further radical measures are being taken, e.g. with suppliers.

Has Premier's restructuring created a long-term viable entity?

News releases involve jargon such as strategic business units, power brands and support brands; however, the question is whether this mainly cakes-to-condiments group can define a net present value of future cash flows - and reduce its liabilities. Several key insiders believe it can, e.g. on 13 November the chairman bought 30,000 shares at 38.5p to own 304,881.

This followed a senior manager buying 83,976 shares at 29.5p on 24 October, to own 312,127; and another buying 100,000 at 42.75p on 6 August to own 115,500 shares. Senior managers don’t indulge "PR" buying to prop up credibility. But Premier has yet to show evidence it has genuinely turned a corner for sales. The market consensus forecast for £80-90 million pre-tax annual profit appears to need a pinch or two of salt.

"Highly speculative" is the appropriate tag

The rebellion by some suppliers, speaking to the media, may be more relevant in terms of whether the best ones decide not to increase their financial exposure to a still high-risk entity. Possibly the press coverage could hurt product sales in the short term, but a merciless grocery trade is the main ongoing factor. No way is this stock an "investment", it is long/short trading material: looking premature as a recovery buy, while short-sellers may prefer to wait until nearer the maturity of the group’s main bond.

For more information see premierfoods.co.uk.