Blog

In a pickle - a company should be run for their benefit and not its bank's

06/11/2012

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

Premier Foods, the business behind such big-name brands such as Bisto, Mr Kipling and Oxo, is the largest food producer in the UK and has achieved that position through a number of high-profile mergers and acquisitions, including Campbell’s Soup in 2006 and Hovis-owner RHM the following year. This top-of the market buying spree saw the company take on a lot of debt but, unlike Taylor Wimpey, which we looked at yesterday, the story has yet to have such an upbeat ending.

On 30 October, Premier announced the sale of its ‘sweet pickles and sauces’ division, which includes another household name in the shape of Branston Pickle. While not especially significant in itself, this is just one of a large number of disposals the company has been forced to make over the last couple of years as a way of resolving its debt position to the satisfaction of its bankers.

As a result of its high level of debt and the consequent hold the banks have had over the company, Premier has sold businesses with revenues of about £1bn for proceeds of around £820m since the beginning of 2011, which one might think would have helped de-gear the business to a fairly significant degree. However, high interest payments on the debt burden, cash injections into the company’s pension fund and the regular annual costs of maintaining the business’ assets have absorbed much of the company’s cash flow. By selling businesses the company has also reduced its ability to generate cash flows to pay down debt in future.

As of 2010, Premier had some £1.3bn of net debt and around £360m of earnings before interest, taxes, depreciation and amortisation (EBITDA). By the end of this year, net debt is expected to be about £800m – so just some £500m lower than two years ago despite having made so many disposals. Factor in projected EBITDA after all the disposals of under £200m and the ratio of net debt to EBITDA, a debt ratio that lenders often focus on, hasn’t fallen at all.

This will be of much less concern to the banks than it should be for shareholders. By pushing for these disposals lenders have reduced their total exposure – and hence their potential loss – by £500m. Shareholders however, have seen the business shrink before their eyes and yet the sliver of equity they own is no less leveraged than it was before.

The level of debt Premier had two years ago has meant everything done in the intervening period, including the disposals and consequent use of the proceeds, has essentially been for the benefit of the lenders and the pension fund. We are not saying that this is wrong – these two groups are rightly looking after their own interests - but it certainly hasn’t been a pleasant experience for equity investors.

Premier has become the latest illustration of the potential perils of investing in businesses that have too much debt and which, as a consequence, are run more for the benefit of those providing that debt rather than for those the company would normally be run for – the shareholders.

Author

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.

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