Pioneer Foods: profits strained by fine in H1/2010

Paarl / ZA. (pfg) Fines, falling prices and low sales plague South Africa´s Pioneer Foods in the first half 2010. In the six months ended 31 March, the group´s revenue fell by more than 400 million South African Rand (ZAR) or five percent to 7,9 billion ZAR. Pioneer, which produces Sasko bread, Weetbix and Liquifruit, said in a statement that headline earnings a share fell to 81,7 cents from 166,4 cents the previous year. Salient features in the company´s first half 2010:
Revenue 8,0 billion ZAR down five percent
Operating profit (before items of a capital nature) 427 million ZAR down 22 percent
Headline earnings 144 million ZAR down 51 percent
No interim dividend

Adjusted for administrative penalties provided:
Adjusted operating profit (before items of a c.n.) 777 million ZAR up 42 percent
Adjusted headline earnings 494 million ZAR up 66 percent

Group MD André Hanekom: «We achieved this satisfactory set of results in difficult trading conditions with all operations making a positive contribution. We focused on containing costs and improving efficiencies to stabilise our margin in an environment where selling prices mostly declined or remained constant. Our cost base benefited from lower grain commodity prices, but rising electricity, fuel and payroll costs have placed additional pressure on margins. We are investing in growth in key market segments and we believe we can extract further value from improving cost management and efficiency enhancements. The defensive nature of the Group´s product basket remains well positioned to cater for the needs of the consumer in the constrained spending environment».

Group revenue declined by five percent to 8,0 billion ZAR as a result of deflationary pressures on sales prices, virtually across the product range. An overall sound volume base was maintained, which to an extent buffered the effect on revenue of final product price declines.

The company raised a provision in March 2010 for potential administrative penalties of 350 million ZAR following the ruling of the Competition Tribunal on the bread matter and the receipt of the referrals for the wheaten flour and white maize flour investigations by the Competition Commission.

This resulted in operating profit declining by 22 percent to 427 million ZAR. Excluding the provision for administrative penalties, adjusted operating profit increased by 42 percent to 777 million ZAR with a determined focus on the management of operating costs and improving efficiencies in the challenging macro environment.

This improved operational performance is largely a continuation of the results reported in the second half of the 2009 financial year and resulted in the adjusted operating profit margin for the Group improving to 9,8 percent (2009: 6,6 percent) for the six month period under review.

Headline earnings declined by 51 percent to 144 million ZAR (81,7 cents per share) from the comparative reporting period. Excluding the provision for potential administrative penalties, adjusted headline earnings increased by 66 percent to 494 million ZAR or 280 cents per share.

Working capital increased by 531 million ZAR as a result of a seasonal build up in inventories and an increase in trade and other receivables, inflated by late payments received after the half-year close.

Increased capital spend contributed to net interest bearing debt rising by 218 million ZAR to 878 million ZAR from 30 September 2009 or 18,9 percent of equity.

Sasko

Revenue declined by seven percent to 4’150 million ZAR, while operating profit, adjusted for the provision for administrative penalties, increased by 42 percent to 517 million ZAR due to improved production efficiencies and an improved margin of 12,5 percent (2009: 8,2 percent).

The Sasko Grain business posted an improved performance based on a marginally better volume base, effective selling price strategies and rigorous cost management. Price deflation is evident across the range of products with the wheat and rice categories posting double digit price declines.

Prices as well as volumes declined in the Sasko Bakeries business. Excluding the cost of wheat, sustained upward pressure persisted in most costs, including salaries, wages, fuel and electricity. The Sasko Pasta business achieved improved and satisfactory results.

Agri Business

The Agri Business division achieved much improved results with better on-farm performance, although revenue declined by eight percent to 1’239 million ZAR. Operating profit increased by 79 percent to 73 million ZAR as the margin improved to 5,9 percent (2009: 3,0 percent).

Selling prices decreased in the broiler business with slightly higher sales volumes. In the egg business sales volumes were lower, though better price realisation was achieved.

The combination of lower raw material prices, improved efficiencies at the production facilities in the egg and broiler businesses and increased sales volumes in the animal feeds business, contributed to this much improved operating performance.

Bokomo Foods

Revenue declined by one percent to 1’323 million ZAR and operating profit declined by four percent to 121 million ZAR for a slightly lower operating profit margin of 9,2 percent (2009: 9,5 percent). The main contributor is the breakfast cereals business which posted an improved performance with strong volume recovery in especially Weet-Bix, indicating a prompt utilisation of the recently installed capacity.

However, a substantially lower raisin crop in 2009 along with a stronger rand had a negative impact on raisin and other dried fruit product exports, resulting in a weaker performance from this segment as a whole. Rebuilding of the fire damaged raisin facility in Upington was completed in time to be fully operational to receive the 2010 raisin crop. Insurance cover limited any material effect on the financial performance for the period under review and the insurance claim is expected to be concluded in the current financial year.

The Ceres Beverage Company

The Ceres Beverages business segment achieved satisfying results. Revenue decreased slightly by one percent to 1’346 million ZAR with a mixed performance from the various product categories.

Improved production and distribution: efficiencies, lower input costs and the largely sustained sales volume base, resulted in a 34 percent increase in operating profit to 109 million ZAR and an operating profit margin of 8,1 percent (2009: 6,0 percent).

Fruit juice and fruit concentrate mixture products recorded a decline in sales volumes whilst export sales volumes improved. Sales volumes from the Pepsi range of products increased and delivered a satisfactory performance given the difficult market conditions.

During November 2009, the shelving for finished products at the Ceres factory collapsed, resulting in a finished product write-off of 20 million ZAR. It is expected that the insurance cover will limit any material effect on the business´s results for the full year.

Competition Commission Issues

In this regard shareholders are referred to previous SENS and cautionary announcements.

In February 2010 the Competition Tribunal issued its finding on the bread matter following the hearing in the 2009 financial year. The order was the payment of an administrative penalty of 196 million ZAR, based on affected revenue from the bakery business for the 2006 financial year.

The Commission appealed against the finding by the Competition Tribunal to the Competition Appeal Court with regard to the criteria used to determine the revenue on which the penalty was based, which, if successful, may have the effect of the penalty being increased.

Pioneer Foods has opposed the appeal by the Commission and lodged a cross appeal against certain elements of the finding by the Competition Tribunal, which, if successful, may have the effect of the penalty being reduced.

A hearing date has been set for 21 September 2010.

In March 2010 the Commission issued referrals, as anticipated, for its investigation into the wheat and white maize milling markets for adjudication by the Competition Tribunal.

In both referrals the Commission recommended an administrative penalty of 1,6 billion ZAR, being ten percent of the 2009 Group annual revenue, despite the alleged anti-competitive conduct being committed up to and including the 2007 financial year.

A provision of 350 million ZAR was raised for potential penalties in the reporting period. This represents 196 million ZAR for the penalty as ordered by the Competition Tribunal in the bread matter and 154 million ZAR for the referrals in the wheat and white maize milling matters. In determining the provision, approximately the same approach as applied by the Competition Tribunal in the bread matter was followed.

The 196 million ZAR has been paid in April 2010, pending the outcome of the appeal hearing.

Pioneer Foods is committed to resolve the outstanding matters through co-operation with the Commission in a swift and amicable way, and if possible, without recourse to proceedings currently before the Competition Tribunal and has already met with the Commission in this regard.

The penalties sought by the Commission may be adjusted lower, depending on the outcome of the continuing negotiation with the Commission.

Education and training programmes throughout the Group promotes the ongoing compliance with the provisions of the Competition Act and is being monitored with the assistance of independent agencies. Disciplinary action is being taken against employees implicated in anti-competitive behaviour.

Prospects

The defensive nature of the Group´s product basket remains well positioned to cater for the needs of the consumer in the constrained spending environment.

Given the solid operational performance for the reporting period, an improved operational performance for the full year is likely although at a lower growth rate than in the first half of the year.

Headline earnings, however, is expected to decline due to the provision for the potential administrative penalties.

Continuing efforts to manage volume and margin will be key. All the businesses in the Group will be challenged by increasing production costs, that include:

1. Substantial electricity price hikes throughout the value chain,
2. constant upward trend in the oil price,
3. above inflation wage and salary increases and
4. the uncertain direction of the rand relative to other currencies.

These cost factors and the recently introduced wheat import tariff have the potential to place slight upward pressure on selling prices.

Shareholders are hereby advised that as far as the prospects commentary is construed as a general profit forecast as contemplated in terms of the Listings Requirements of the JSE, it has not been reviewed and reported on by the auditors of the Company.

Board Changes

During the six months under review, the following members retired or resigned from the Board: WA Agenbach, AW Bester, HE Blanckenberg, AE Jacobs, JA Louw, AC Singleton, Dr FA Sonn, MT Swanepoel and JH van Niekerk. The following new members joined the Board: ZL Combi, MM du Toit and Prof ASM Karaan.

Interim Dividend

Against the background that the Competition Tribunal issued an order for the payment of an administrative penalty of 196 million ZAR as well as potential further or increased penalties depending upon the outcome of investigations and negotiations regarding alleged transgressions of the Competitions Act, the Board deemed it prudent not to declare an interim dividend.

The Board also needs to act responsible in ensuring that the prescribed covenant in terms of the syndicated loan facility of the Group which governs dividend payments, is not put at risk of being breached by declaring a dividend under the uncertain circumstances.

Once there is more certainty on the monetary effect of potential penalties, dividend payments will be reconsidered. The interim dividend for 2009 was 36,0 cents per ordinary share and 10,8 cents per class A ordinary share.