2023-05-13 01:41:17 ET
Summary
- Orkla recently reported their 1Q23 report. The results were very good in relation to expectations, leading to significant outperformance.
- Some would say the company now deserves a higher target and a "BUY". Me, I become interested in Orkla under 70 NOK. At over 80 NOK, it's starting to look expensive.
- Let's look at why the company outperformed and what can be expected going forward.
Dear readers/subscribers,
Reviewing Orkla (ORKLY) is always a bit of a fun valuation exercise. The company has a relatively narrow trading and valuation range, and I know very clearly when I view it as expensive and cheap, relative to its performance potential. Orkla is a fairly interesting FMCG company - and inflation and other macro has only made it more interesting, as it shifts with volatility.
The company has adopted far more international profiling over the past few years. This is not necessarily a bad thing, though it does add layers of complexity to an already somewhat interesting organization. To that end, the company has actually gone ahead and simplified its reporting structure, a change that has gone live as of March 2023, meaning the new reporting structure is part of the latest quarterly report , which is certainly interesting.
However, what makes Orkla more interesting is the sheer profitability and safety of operations here. The company may best be viewed as a very good "savings account", with the potential for a capital upside - but only at the right price. if you buy it too expensively, it's essentially a savings account with a capital downside.
Not something we really want to go for.
Let's see what Orkla has to offer us after 1Q23.
Orkla after 1Q23 - plenty of interesting news to share
So, as I said - a few new interesting pieces of news from Orkla at this time. The new organization going live in March means we have new numbers and figures to look at and new considerations for reporting. The full reporting structure will be implemented in the second quarter of this year.
The most important news first. Earnings and profitability. Orkla has, as far as FMCGs go, always been one of the more profitable ones in the segment. The company is typically compared to other consumer packaged goods companies, and here is above average in every single profitability KPI. What's more, the company's ROIC net of its WACC is one of the better ones you can find in the entire industry.
No matter what you think of Orkla as a business, those are some impressive overall trends. The company has a very attractive segment structure and sales mix, with 95% of revenues coming from its branded consumer goods, and around 5% coming from its Hydro Power segment. The company has attractive gross margins, around 50%, with operating margins at around 12.6%, and a net profit of around 8.6%. For a company in this segment, that is very good - given that most grocers or sellers of the products net around 3-4%, if that.
The company managed 5% EBIT growth in the first quarter, with branded consumer goods adjusted for HQ growth of 14%. This also brings with it 13% organic revenue growth for the consumer goods segment, both broad-based and price driven.
It also includes impressive EPS growth of 6% in a difficult environment, bringing total adjusted EPS on a diluted basis to 1.32 SEK with a 6.5% growth.
On the other hand, company debt went up several billion NOK due to very negative FX, as the NOK lost ground to most other currencies. The company's debt is now close to 20B NOK, which gives us the following debt picture.
The organic growth was broad-based, with improvements across all business units and geographies, with the best performance from a double-digit 22% YoY growth from Food Ingredients as the segment recovered from low levels. The company continues to target impressive growth from its Consumer health segment - a popular choice not just for Orkla but similar companies, and this segment is growing on par with those 50% growth expectations by 2025E.
Other segments are growing double digits as well, but eyes should be on the company's growth segments. and while I may not be a consumer of plant-based protein or products as such, I can still appreciate revenue growth.
The company's improvements, if we dig deeper, come in part from price increases which the company successfully managed to push, while margins are still being pressured by cost increases. In fact, while the company does have good EBIT, the margins are one area that is still in decline.
The underlying margin on an RTM 1Q22 basis is down 1.7% YoY to an RTM 1Q23 basis. We will have to see where things end up in the end, but in order for the company to get back to double digits, they would have to push pricing even further, and I'm doubting if the company can actually manage that while retaining a semblance of market share that it has today.
Still, improvements are on track - reducing costs and trying to enable value creation. It's just that nothing the company can do can really take away the input costs and general inflation trends across the entire value chain. It's a problem, and it's certainly not going away.
There were bright spots in the reporting where the margin did not decline as much as this. India is a good example. We saw double-digit growth in revenues and EBIT both, and a nearly flat EBIT margin at 0.3% negative on a YoY basis. The company actually delivered margin growth, but this was then impacted by increased A&P in order to strengthen the overall brands that are being sold in India.
Orkla care was another bright spot. Near double-digit or double-digit revenue and EBIT growth, and only slight margin declines of less than negative 0.5%. This segment did not see as severe input cost challenges, and it shows through to the bottom line.
As you might expect from above, there is one segment that didn't just see top- and bottom-line growth, it also delivered solid margin increases of nearly a full percent despite the ongoing inflation.
We also can't forget that Orkla owns 42.7% of the attractive pain company Jotun - which had a strong start including strong sales growth driven both by price increases and sales growth. Paint and coating margins somewhat recovered on the gross side by price increases, and raw material prices did not increase as high as before, combined with operating profit improvements due to strong sales growth, recoveries, and good cost control. However, while Jotun did excellently, the main profit driver/increase from the past few quarters, namely the company's Hydropower segment, saw a combination of lower power prices and new taxes, dragging things down.
As I review the quarter, I find that Orkla did very solidly - also reflected in the company share price post this quarter, and the transformation of the company is very much going according to plan. The company will create sustainable value and profit from this new structure - at least that is what I see.
Based on the new structure and current trends, as well as Orkla's overall brand strength, I expect the company to manage to keep its market share intact. While margins on the net side may drop 1-2% and stay there, this is not unique to Orkla - costs are going up for everyone in the sector, and there is little that can be done.
My current forecasts, including the positive results for 1Q23, calls for Orkla to manage EPS of around 5.5 NOK for the year, being somewhat along the idea of 0.4 NOK above 2022A. The difference is that I'm expecting this to grow step by step going forward as many of the company's margin improvement and structural plans come into play. I don't expect a significant improvement in operating margin - instead expecting most of the EPS improvements to come from volume/mix as opposed to margin. While I do expect we'll see 8-9% net margins again, I don't expect we'll see double digits for several years again - not unless something drastically changes.
This dictates that my thesis for Orkla overall can only change so much, and we look at company valuation.
Orkla valuation - things are looking somewhat fairly valued
While this company at times may reach levels of 85-100 NOK/share, and stay there for a while, history has shown us that such trends are non-recurring or fleeting. This company did at one time trade at a significant set of premiums for over 8-10 years. However, at the time, is mix was somewhat different and the growth was higher as well. Going forward, growth is slowing down. Previously, the company could grow 20-30% EPS in a year, and not just one year, but years in a row. Once it stopped doing that in 20/212, the company dropped from 19-22x P/E premiums, and it hasn't recovered since then.
Now Orkla is at around 15x, and I would forecast it at 15x - no higher.
Based on a 15x P/E on a forward basis, this company could, with a 3-4% annual growth rate on the EPS side, which I believe to be fair here, return around 6-7% per year, to a total of 19% until 2025E.
Are you starting to see why I want a below-70 NOK share price for the company? At current levels, we're seeing around mid double-digit upsides at a conservative PT - at 60-70 NOK, that goes up to double digits quite easily, and coupled with a 4%+ yield, which currently is at 3.7%.
Orkla is a company I know pretty well. It has a solid market cap, and has comparatively low debt at 23% debt/cap, and its foundations are absolutely solid.
However, if you buy it too expensively, you're buying an anemic company. And given that this company only pays dividends once a year and capital appreciation tends to come in starts, you may be sitting on unproductive returns for some time if you're not careful.
So, let's be careful.
As I've said previously - based on my current estimates, the most you'd want to pay for Orkla comes to no more than 70 SEK. At 60-65 NOK, this is an easy "BUY" for me, but once the first digit in the share price is an "8", that's when I know we're down to single-digit RoR, and that's when I stop buying.
A simple thesis - and for now, this thesis dictates a "HOLD".
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 solid "BUY" here, but not for a longer term, but as a "SELL" in the case of it going above 77 NOK. I see no reason to change this approach as of May 2023.
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.
For further details see:
Orkla Outperformed In Early 2023 - But It's Time To Be Cautious