HKFoods Q3'24: Efficiency measures are working well

Translation: Original published in Finnish on 11/6/2024 at 8:23 pm EET

The company's improved profitability accelerates the strengthening of the balance sheet and supports the efforts to repay the hybrid loan and return to dividend payments. The valuation still does not seem favorable considering the risk level of the stock. Earnings development is reflected in the stock value with strong leverage due to high indebtedness. We reiterate our Reduce recommendation but raise our target price to EUR 0.85 (was EUR 0.70).

Growth, good sales mix and improved production efficiency supported profitability

Revenue grew significantly by 9% y/y in Q3, which was below our 12% forecast. We estimate that some 2/3 of the growth was generated by growth in the external revenue of the Polish bacon business, which can be regarded as an accounting change. Organic growth was thus more moderate, although clearly positive. According to the company, growth was generated thanks to commercial successes and a comprehensive product portfolio. The structure of domestic sales strengthened with the growth of retail trade and foodservice channels. The gross margin improved to 8.9% (Q3’23: 7.4%) and  adjusted EBIT grew to 11.6 MEUR (Q3'23: 6.6 MEUR) exceeding our forecast of 9.1 MEUR. The strong profitability is driven by investments in efficiency improvement and savings made by the company. The company said that the automation investment in the Rauma poultry cutting plant completed in Q2 has already exceeded the targets set for efficiency. Consumer behavior also seems to have developed toward a more normal state due to the easing of inflation, and according to the company, the foodservice market is also growing again.

There are prerequisites for further earnings growth if the risks in the operating environment do not materialize

The company reiterated its earnings guidance it had updated in September. The 2024 adjusted EBIT is estimated to be 22-25 MEUR, which requires Q4’s result to grow to 4.6-7.6 MEUR (Q4’23: 3 MEUR). We believe significant leaps have been made in profitability with the efficiency measures and we expect earnings growth to continue at a moderate pace in 2025-26 (EBIT 25-26 MEUR, we raised our forecasts by 6%). Some of the efficiency gains achieved are not yet fully reflected in 2024 figures and we estimate that there is still room for improvement in administration after the divestment in Denmark was completed at the end of October. Investments in ready meals and ready-to-eat products will provide growth from mid-2025 onwards. The pork import restrictions threatened by China or possible changes in the cost environment create uncertainty surrounding earnings development.

Expected return is not yet sufficient

The higher-than-expected earnings level improves the prospects of strengthening HKFoods' balance sheet. Our forecasts still assume that the company will not redeem its hybrid loan until September 2026, but with the improved earnings level, an earlier redemption could become possible if the company is able to accumulate higher safety margins on the covenants related to the balance sheet debt. In our forecasts, the net debt/EBITDA ratio is 2.7x at the end of 2024, as the 37 MEUR from the divestment in Denmark was used for debt repayment in Q4. In our view, the current valuation of the stock is quite close to fair value. The EV/EBIT ratio is slightly above 10x based on our forecasts for the current year. If the current earnings level proves sustainable and the moderate earnings growth we forecast materializes, EV/EBIT will already be close to 9x in 2025. However, we do not find this valuation level attractive without a dividend yield, as the company's indebtedness and the historical volatility of the earnings level increase the risk of the investment. On the other hand, if the earnings level were to improve sustainably, the value of the stock would increase significantly due to the company's high debt leverage.