Shares in food manufacturer Premier Foods (LSE: PFD) rose by as much as 23% this morning, after the group’s interim results beat expectations.
Adjusted pre-tax profit rose by 21% to £28.1m, while operating profit from continuing operations swung from a £12.8m loss last year, to a £23.3m profit.
The gains are the result of the first quarterly increase in sales of branded goods for two years. Premier said that branded sales rose by 1.6% during the second quarter, driving an increase in profits.
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This is a bigger achievement than it might sound. Premier Foods has been one of the casualties of falling sales in the big supermarkets. The firm’s branded goods, such as Mr Kipling, Bisto and Sharwood’s, are mainly sold in big supermarkets, not in discounters such as Aldi and Lidl.
To help combat the decline, Premier has introduced new products and adjusted the sizing of certain other projects. Marketing spend is also expected to rise by 10-15% over the year as a whole, with an emphasis on the run-up to Christmas.
Any problems?
At the start of this year, Premier Food’s two biggest problems were its mountain of debt and its large pension deficit.
During the first half, the pension deficit fell from £211.8m to just £32.8m, thanks to a set of accounting tweaks which reduced the firm’s pension liabilities from £4,460m to £4,151m.
Net debt was unchanged at £585m during the first half, but Premier says that this figure should “reduce significantly in H2”. This could be very profitable for shareholders.
A big opportunity
Premier Foods’ shares have been trading on a forecast P/E of about 4.5 for some time now. The reason for this is that the firm’s £585m net debt has overshadowed its market cap, which was around £300m before today.
This level of debt made a conventional P/E valuation (which ignores debt) irrelevant, so the market valued Premier on its enterprise value (market cap plus net debt). On this basis, Premier shares are valued at around 13 times forecast earnings, which is probably about right.
However, if Premier’s net debt falls sharply, the firm’s enterprise value will fall. I’d expect Premier shares to rise to offset this fall, especially if Premier can sustain its improved sales through the key second half of the year.
In my view, Premier shares could reach 60-70p over the next few years. The pace of the gains will depend on how fast the firm can reduce its net debt. However, as debt falls, interest costs should also fall, freeing up more cash to reduce debt.
What’s the risk?
The risk, of course, is that Premier won’t be able to generate a sustained improvement in sales, or that its operating margins will be too slim to generate enough free cash flow to repay debt, rather than just servicing it.
This could happen. Today’s results show that the firm’s 6.8% operating margin generated an operating profit of £23.3m during the first half. Unfortunately, this was eaten up by £24.1m of finance costs, mainly interest payments.
I’m willing to give Premier the benefit of the doubt after today’s results: these shares could be a profitable buy.
