Ask Bakkavor what the proposed combination of J Sainsbury and Asda would have meant for its business of supplying fresh food to both supermarkets and it replies that the effect would have been negligible. The truth is surely that it would have been bad news.
When two of the UK’s Big Four supermarkets detailed their plan to merge last year, they made no secret of their expectation that their combined buying power would mean they could extract better terms from their suppliers.
For a company such as Bakkavor, which counts Sainsbury’s among its four central customers, dealing with an enlarged operator may well have increased the level and regularity of its orders, but it would almost certainly have eaten into its margins.
So now that the £12 billion merger has been blocked by the competition regulator, should Bakkavor’s investors be relieved and expect the margin pressure on their company to be lifted? Probably not.
Bakkavor was set up in 1986 by the Icelandic Gudmundson brothers, Agust, 54, and Lydur, 51, and listed on the stock market in November 2017 at 180p a share. It supplies pre-prepared meals, salads, breads and pizzas and desserts, mainly in the UK but also in the US and China.
While it serves substantially all of Britain’s supermarkets, including Wm Morrison, the Co-operative Group, Aldi and Lidl, its four main customers are Sainsbury’s, Marks & Spencer, Tesco and Waitrose.
The group is a constituent of the FTSE 250 with a market value of just under £700 million and in its most recent financial year it made a pre-tax profit of £77.9 million on revenues of £1.86 billion, indicating an adjusted profit margin before special items of a mere 8.3 per cent.
Bakkavor’s shares are problematic for the prospective investor. First, the shares are tightly held. The brothers hold just over 50 per cent between them and just under 25 per cent is owned by Baupost, a US private equity investor. With the free float as a result just above 25 per cent, it can make for sharp price fluctuations.
Second, the shares have been in the doldrums. Having peaked at 212½p in the months after the listing, they have since been in gradual decline, trading below the issue price since September and off a further ¾p, or 0.7 per cent, at 118¾p yesterday.
What worries the stock market is pressure on Bakkavor’s future revenues and margins. It is firmly embedded with its main four customers, working closely with them to control changes in their ordering patterns, which can be rapid — if, say, a warm spell suddenly arrives and they expect customers to eat more salads. The company also works alongside the supermarkets developing product ranges so it is unlikely that any of them would suddenly fall away. Between them, these four grocers have an 86 per cent share of the market for freshly prepared food.
However, the cost of ingredients, initially of milk and subsequently fruit and vegetables, have been on the up, adding to the pressure.
The additional worry is higher prices of the high-quality and more expensive fresh produce that Bakkavor delivers mean they will be struck off the shopping list early by consumers looking to control their spending as the UK heads into almost certain economic downturn.
The big expansion opportunities lie in the US and China, currently accounting for just under 11 per cent of revenues. Growing in the two countries will take time and money. Bakkavor is not overly leveraged, but nor is it cash-rich.
The shares trade for an undemanding 11.5 times Peel Hunt’s forecast earnings for a prospective yield of about 3.4 per cent. There seems little in the way of a catalyst to propel them higher.
ADVICE Avoid
WHY Leader in its field, but margins under pressure and little momentum in the shares
Moneysupermarket
The critics may be divided about its “You’re so Moneysupermarket” ad campaign, but investors in the price comparison website have been much more certain about the shares.
The stock price has gained more than 31 per cent since the beginning of the year amid increasing signs its investment in reinventing itself as a more diverse and digitally led group is beginning to pay off.
That the government lifted its energy price cap by £117 barely a month after imposing it in January also played its part, prompting as it did unprecedented levels of switching and fuelling a 19 per cent surge in its revenues to £104.9 million during the first quarter.
Moneysupermarket was founded as a mortgage listings business in 1993 and enables consumers to compare prices on financial products, energy costs, holiday deals, and broadband and mobile charges.
Moneysupermarket spends heavily on marketing, but it has also been investing millions in developing new products and making its comparison facility easier to use on tablets and mobiles. Consumers’ increasing use of portable devices to access Moneysupermarket means they tend to take longer to switch, increasing its cost of acquiring new business. That process is gradually depressing the company’s profit margin, 36 per cent last year, at an annual rate of about 1 per cent.
It aims to lift its profitability by finding ways to retain its customers and get them to switch more products by, for example, reminding them of renewal dates or emailing them if suitable deals emerge.
Moneysupermarket was careful to tell investors that the record energy switching it experienced in the first quarter was unlikely to be repeated, underscoring how much trading can be affected by external factors, more in fact than any qualitative improvements it might introduce.
However, the longer-term trend among consumers to pursue flexibility and better deals seems to work in the company’s favour.
The shares, down 2½p to 354½p, have gained nearly 29 per cent since this column recommended holding them in October. They trade at 19.9 times UBS’s forecast earnings for a yield of 3.1 per cent. Keep them.
ADVICE Hold
WHY Benefit of reinvention coming through but with more to come
