2023-12-29 09:01:15 ET
Summary
- Orkla has performed well with strong profitability and growth potential, outperforming expectations in the FMCG sector.
- The company's 3Q results showed growth in key segments, but a decline in the Hydro Power segment impacted overall performance.
- Orkla's valuation is important, with a recommended buy price below 70 NOK and caution advised when the price exceeds 75-80 NOK.
Dear readers/followers,
I've been very clear insofar as to where you should "BUY" and where you should "HOLD" Orkla ( ORKLF ). It's my stance that I have a fairly good view of where this company, in its current configuration and trading patterns, should be bought and when it should be held. Here are my recommendations insofar as they go for 2023, and how they have performed.
The position that I have is doing very well, with a significant upside thanks to investing at a very good price. I'm currently nowhere near where I would divest or rotate what I hold, but I'm also not in a position where I would buy more. The closest we came was the dip you can just sort of make out if you look at that small chart.
The latest set of results I reviewed were the 2Q ones. In this article, I 'll review 3Q , give you my picture for full-year results, and show you where I expect 2024E to go for this company.
Orkla has done quite well for itself over the past year. Many operational improvements and fundamental advantages have been perceivable, and the company has seen less impact from inflation and cost increases than I expected.
Let's look at what we have here.
Orkla's Upside at a good valuation and the 3Q23 results
Orkla is, if you follow my work on the sector, an international FMCG company with the potential for significant growth but also heightened risk compared to other FMCG companies. The company has strong profitability, growth potential, and valuation, scoring high in these areas, but has a very narrow avenue of what I view as an investable valuation.
The fact is that very few FMCGs like Orkla offer the company's double-digit margins on an EBIT level - 11.5%, and a net margin of over 8%. This is compared to FMCG/Grocer margins of usually below 4%, or around 4% here in Scandinavia. So Orkla, selling food and doing so profitably, is doing extremely well here in the context of the larger picture.
The company's 3Q came out close to November - and many of the results were good, though they were unable to make up for a solid decline in Hydro Power. The overall company group adjusted EBIT fell by 14%, despite improved operational cash flow and underlying EBIT growth in eight out of twelve portfolio companies. Jotun, the paint company with a 42.7% stake continued impressive growth with a 50% EBIT increase, and the core segment of Orkla Foods Europe grew by 5%. The smaller segments, growth segments, grew often in triple digits, such as Orkla HPC, HSNG, and the Pierre Robert Group.
Company EPS also grew , 2% on an adjusted basis to 1.61 NOK/share with strong continued profit improvement from Orkla India, one of the company's main growth vectors.
I can admit that I was skeptical of this vector at first, given the complexity of doing business in India, but I am growing less and less skeptical overall here.
Fundamentally speaking, Orkla remains a very conservatively managed company. With just south of 20B NOK worth of debt after dividends and buybacks, the company is just at the 2x Net debt/EBITDA here - which remains conservative.
I believe it is warranted here to lift some of the portfolio companies as examples here for company performance in 3Q.
What we see here is I believe indicative for the broader sector in terms of industrial and cyclical recovery. The company's food segment has held up remarkably well, with consumers accepting the higher prices for premium products.
I should know, because I am one of the consumers who buy the company's product and accept exactly this premium for the business's products.
We can see similar trends in the confectionary & snacks segment as well, with solid profit growth, although weighed down by the company's new biscuit factory. The improvements here, like with the foods segment, are based on price-driven top-line growth. The company is gaining few new customers, instead of keeping the customers they have and having them pay more for the product.
Personal care and home are growing as well - and here we actually see some volume growth in terms of organic growth, not just pricing. The European pizza segment is growing as well, with good consumer sales growth, and every main market except Germany is seeing good organic growth, due to better prices for customers.
Germany was down because the company had to close 40 stores YTD - but performance overall remained healthy in most markets.
Here are the smaller pushes and segments...
However, as mentioned early on, nothing could take away from the lower power prices from the Hydro segment. To give you a comparison, the prices last year during 3Q were between 289-352 öre/kWh, and are now 19-66 öre/kWh. That means that the EBIT on an adjusted basis fell by more than 70% from 773M NOK to less than 155M NOK - and the volume also dropped by more than half.
There is/was nothing that the company could do about this, just as with any macro development. Orkla keeps the eyes on the ball, or balls in this case, with the company's growth projects. The leverage is actually up quite a bit from a bottom level of 0.9x during 2020, but at 2x is still not at any level I would consider worrying here, due to fairly well-staggered maturities not materializing until 2025-2027, and the company still has plenty of sources left to pull if and when it is needed.
The company's current dividend means we're seeing a yield of around 3.86%, which is not the greatest, but is it low enough that it would make the company uninteresting as an investment based on the share price and dividend alone.
However, valuation remains the single most important thing here. While Orkla is a fundamentally good company, the price at which you'll want to buy isn't currently being met, and I'll show you why.
Let's look at the risks and upsides to the company.
Risks & Upside to Orkla
The risks to the company are easily understood in the price-driven nature of its premium segment and the volatility of its power/hydro segment. Given the relatively static nature of this company's share price development for more than years (the company has delivered less than 2% annual returns if you invested in mid-2017), this shows you well the necessity of investing at a conservative valuation for this company.
Given the market-leading nature of its FMCG brands, I don't see any underlying major risk to the company here - the brands, especially in home markets, are well-established enough that they're not going anywhere. It all comes down to the fact that Orkla has a tendency to perform much less ideally than expected, with a 50% miss ratio even with a high margin for error, and the fact that the company usually trades at a premium to its growth estimates.
Also, in an atypical trend for an FMCG, the company has a few years and well-established trends of negative growth in its recent past, with double-digit drops during several years, which we really shouldn't be seeing often in terms of EPS from this sort of company.
The upside to Orkla comes in investing in the company at a good price - and that's what I'm going to guide you in doing here.
Let's look at company valuation.
Orkla's Valuation
As I've made crystal clear in my previous articles, the right price for this company, and when it becomes a must-buy, is below 70 NOK. It's close to 65 NOK, if I have my way, at which point we're seeing a 4%+ yield with a very good upside. At any time it trades above 75 NOK or close to 80 NOK, this is a time when you should be avoiding Orkla, as I see it.
The reason is simple.
The company has a very strong history of high premiumization, calling for the business to trade between 80-100 NOK/share. While I will admit that Orkla has been growing, and there comes a point at which my 60-70 NOK price targets will no longer hold water, I do not believe that time is it, for the company has failed for a very long time to make the "trip" upward to anything above 80 NOK/share consistently.
At times it's unclear to me what exactly is holding the company back - but looking closely, I would venture a guess that it's a mix between consistently underperforming (50% or above of the time) estimates, the cyclical nature of its power/hydro segment, it's exposures to geographies that even kindly can only be described as "risky", and the near-unchanging nature of its dividend, which only started climbing from 2.6 NOK back in 2021.
I view the de-premiumization of Orkla as necessary. The company has moved from 18-20x P/E to 13-15x over the last few years, despite managing an EPS growth here. Many investors would call the company a "BUY" here - but I am not one of them yet.
What would need to change in order for me to change my stance here and allow a higher multiple is clearer recoveries in the power segment, along with operational stability in the company's growth segments (higher than we're seeing today at least).
That being said, I will clearly state that there will come a time when this company will move upward to a 14-16x P/E, which at that time would be around 95-100 NOK. If you're of a very long-term mindset, and don't mind a potential medium-term underperformance with a sub-par yield compared to what is available on the market today, then this is actually an investment you could make.
I believe that we're in for a trip down south below 70 NOK again, and that's when I'll load to my position in Orkla again.
With that in mind, I give you the following thesis for the company here.
Thesis
- Orkla is a class-leading Scandinavian portfolio manager of attractive foods, a large paint company, and enhanced with some hydropower operations. It's a 350-year-old Norwegian giant that's family-owned, and with very motivated owners that also include an attractive, 2-4% dividend.
- At the right price, this company is a "must-BUY" to me, and that price is close to 60-65 NOK,
- I consider Orkla to be a "HOLD" here, due to the company trading close to 80 NOK, combined with the lack of clarity from the investment/allocation strategy. I see no reason to change this approach as of August of 2023.
- I'll revisit the company in 3-4 months and give you my view of the next 3-5 years at the time.
Remember, I'm all about:
- Buying undervalued - even if that undervaluation is slight and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
- If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
- If the company doesn't go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
- I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them (italicized).
- This company is overall qualitative.
- This company is fundamentally safe/conservative and well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.
The company is a "Hold" here - it doesn't have an attractive upside any longer.
This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
For further details see:
Orkla: Keeping An Eye On Attractive Entry