Agenda: Aryzta looking for dough as bakery business falls flat

There’ll likely be no cake to celebrate the 10th birthday this month of Irish-Swiss baker Aryzta. It is probably looking to raise some dough. In the week following July 31st, the end of its financial year, about €200 million was wiped off its value. Its shares, mainly traded in Zurich, plummeted by 23 per cent to 11.12 francs (€9.63).

By the close of business on Thursday, it was worth less than €840 million against €1.1 billion nine days earlier. That’s roughly a quarter of what it was worth just five months ago.

Investors are fleeing the company, which makes Cuisine de France bread and burger buns for McDonald's, because they fear its liabilities are becoming unsustainable and that it will have to issue new shares to shore up its position.

Aryzta owed lenders about €2 billion at the end of January, midway through its financial year, while the net figure was €1.6 billion. Analysts believe net debt is now about €1.65 billion. The company is not due to publish full-year accounts, confirming the actual amount, until October 1st.

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When it does, they are likely to show that, in the 12 months to July 31st, Aryzta’s earnings before interest, tax, depreciation and amortisation (ebidta) – a measure of the actual cash the business generates – were about €300 million, less than one-fifth of its net debt.

Repay its liabilities

That ratio is the crux for stock market analysts as those earnings are a measure of how well able it is to repay its liabilities.

According to results for the six months to the end of January, the group agreed with its banks that net debt would not rise above four times ebitda by the end of its financial year. It now appears to be at risk of breaking this “covenant”.

Aryzta has a number of options. It can renegotiate terms with its banks, sell some of its businesses or raise more cash from its shareholders.

Tapping investors for more money seems the least realistic of these choices, argues Ian Hunter, an analyst in stockbroker Investec's Dublin office. He calculates that the group would need about €335 million. Even allowing for a generous 10 per cent discount on Aryzta's current share price, it could have to issue more than 36 million new shares to raise the necessary funds.

This would leave existing investors, who have seen the value of their holding slashed in a series of profit warnings in recent years – and with more than a quarter wiped off the remaining value of their stake this month alone – with a choice, buy more shares or have their investment diluted by a further 43 per cent.

“I don’t think it’s an option that Aryzta will be looking at,” he observes.

Nevertheless, analysts such as Jörn Iffert at UBS – one of the group's lenders – and Fintan Ryan at Berenberg believe this may be the option Aryzta chooses. Both published notes in recent days indicating that they believed the group would bite the bullet and issue new shares.

Raising capital

Ryan argues that raising capital is necessary to alleviate chronic levels of debt and “allow headroom for Aryzta to complete a necessary restructuring and core re-investment process”. Even at that, the analyst says Berenberg’s “hold” position is based on Aryzta selling its 49 per cent stake in French frozen food chain, Picard, and on no further fall in earnings.

Earnings have been falling. They dropped 30 per cent to €161.3 million in the six months to January 31st from €229 million during the same period the previous year. Some analysts had been expecting them to reach €420 million at year end, but estimates now are generally closer to €300 million.

The widely anticipated Picard sale, thought likely to yield €350-€360 million, has yet to happen. In fact, Aryzta drew fire from ratings agency Fitch because the French group increased its own debt to pay dividends to the baker and the retailer's other owner, private equity group, Lion Capital. Aryzta received €35 million from this, on top of a €53 million payment from Picard earlier this year.

Some observers disagree with Fitch (which assesses companies according to their ability to repay debt). Instead of just waiting to sell its Picard stake, they say, Aryzta is simply getting some value from it up front. However, Ryan agrees that the group could pay later for taking the dividends.

Every euro taken from Picard now could mean one euro less when the stake is sold, he says.

First year at the helm

Aryzta is reaching another anniversary shortly, the end of chief executive Kevin Toland's first year at the helm after he succeeded Owen Killian, the man who built Aryzta, last autumn. Toland left the top job at State airports company, DAA, for his current role. Before that, he worked in senior roles for multinationals such as Coca Cola, and ran the successful US operation of food group Glanbia. In short, he had a lot of the right credentials.

He and chief finance officer, Frédéric Pflanz, replaced Killian and Patrick McEniff. Management changes followed, David Johnson took over as chief executive North America and Gregory Skilkas took the same post Aryzta's European business.

Under Toland's charge, the group refinanced its debt and agreed new facilities with Bank of America, Merrill Lynch, HSBC, Rabobank and UBS. He also announced a €200 million cost saving plan in March and extracted those €88 million in dividends from Picard.

The new executive team says it has identified and is addressing the challenges facing Aryzta. “We have rebuilt our management team and are committed to our core frozen business-to-business bakery business,” they say, adding that they are committed to maximising cash flow, have cut jobs and are working on reducing costs.

Nevertheless, Aryzta has issued three profit warnings over the last year, the most recent in May, when Toland told the markets that earnings would be 9 per cent to 12 per cent less than expected.

Ryan says the new CEO and his colleagues have so far done much of what should have been done. “The current management team seem to be getting to grips with a lot of the problems that they have inherited,” he says. “They have not been able to solve problems in areas outside their control.”

Hunter believes the banks may be willing to give the recently-arrived executives some breathing space. “What I am thinking is that Aryzta will try to negotiate its covenants with its banking syndicate,” he says. “The reason I am saying that is because the bankers will be looking to support the new management and give them a while to sort everything out.”

Aryzta’s covenants require it to get its net debt-earnings ratio from 4.5 times last January to four times at its year end and 3.5 by next January. Renegotiating this would ease pressure on Toland and his colleagues, not to mention the share price, leave time for the cost-cutting programme to have an impact and for a final decision on the 49 per cent Picard stake.

Analysts agree that the management team has inherited most of the problems with which they are now wrestling. Through the first part of its history, Aryzta was mostly successful. It was born in 2008 from the merger of Ireland's IAWS and Swiss group Heistand. The newly-created business took its name from the Latin "arista" which means the apex of a grain of wheat.

If nothing else, this pointed clearly at what the company did: it baked things. Its brands included Cuisine and Delice de France in Europe, and La Brea Bakery, Tim Hortons and Otis Spunkmeyer in Canada and the US. The company made, "artisan" bread, cashing in on a trend in middle-class taste, and cakes, doughnuts and so on, that people like having with coffee.

Burger buns

Those McDonald burger buns though, illustrate a key part of its operations, baking and freezing products that it sells other businesses which sell them under their own brand or as part of products of their own. It has businesses producing and selling these goods in Europe, the Americas and Asia.

Everything went well initially. About the time of its first year end in 2009, the entire business was worth €1.5 billion; three years later, at the beginning of February 2011, it had almost doubled to €2.7 billion. In February 2014, it was €5 billion and by the following year was around €6 billion. In November 2014, Killian was awarded the prestigious RDS Gold Medal for Industry.

But the ingredients for its fall from grace had been gathered before the peak. In 2014, it bought a company called Cloverhill in Chicago and Pineridge Bakery in Canada for a combined €730 million. While it was not initially reflected in the share price, many in the market struggled to see the logic for buying Cloverhill, which specialised in making products for vending machines. It was far removed from Aryzta's core business giving it little scope for savings or efficiencies.

Aryzta was never able to come up with a convincing reason for buying it, Investec’s Hunter says, and in the end, the company sold Cloverhill in January. It received a reported €20 million for an operation it was originally said to have paid more than €500 million for.

It also offloaded “high-end” products specialists, La Rousse and Signature Foods. In April, the group said that it hoped to raise €450 million from selling non-core businesses by the end of July, a figure that included the disposal of its Picard stake.

Damaged its business

Straying outside its area of core expertise as well as a clumsy move into areas where it competed directly with its own customers damaged its business. But that is not the extent of its structural problems, analysts say.

In 2013, the group paid €280 million for a large bakery in Klemme in Germany that is not yet operating at full capacity. And now it is facing price rises in raw materials, butter and wheat, in part due to this summer's heatwave that has reduced crop yields.

Aside from tapping shareholders or hammering out a new accord with its banks, there is one other, nuclear option, for Aryzta: a sale. One commentator suggests that it is feasible that private equity players or trade buyers are running the rule over the group. Analysts concede that, like everything else, shareholders would agree to sell once they thought the price was right.

A sale could ultimately mean the breaking up of Aryzta, with a buyer selling some of the constituent parts and ending up with a more streamlined and manageable operation.

However, observers say that could pose its own problems. Aryzta’s scale means there are likely to be overlapping customers and suppliers, making it difficult to disentangle the constituent parts of the group.

Whatever the next step, if there is a tenth birthday party, shareholders won’t feel there is much to celebrate, however nice the cake.