Profits dip at Kerry

By Paul Mooney

KERRY Group suffered a fall of €5.7 million in pre-tax profits in the first half of 2006, despite turnover rising by €148 million. The company was hit by higher energy costs across its operations, falling food prices in the UK, and a number of other difficulties.

Pre-tax profit for the period was €125.2 million on turnover of €2,265 million compared with €130.9 on turnover of €2,117 million in the first half of 2005.

Trading margin fell to 7.2%, down from the 7.6% of the previous period.

The outcome had been well signalled at the annual general meeting of Kerry Co-op in Tralee in May, the company's first ever profit warning and a move that saw its share price take a tumble.

Kerry enjoyed an improved outcome in its all-important US ingredients division, helped by improved demand for specialist ingredients. Rising prices for dairy proteins in the US cancelled out weakness of the US dollar. Growth was slower in the company's EU and Asian ingredient businesses.

But the real pain was in its consumer foods division - which is centred on these islands - and in particular the pain was in the UK. The woes there are the very same ones that have been punishing Kerry for some 18 months now, a turndown in frozen foods, slower growth in chilled foods and ferocious cutting of food prices by big UK multiples.

More defensive approach

The dip in profits and margins led to a more defensive presentation by chief executive, Hugh Friel, and his team this week. He zoned in repeatedly on Kerry's ongoing "cost recovery programmes'', something that would not have been emphasised in previous years, he said.

The firm plans to close 10 of its least profitable factories (out of the current total of 153) over the next year or two, which is expected to cut €250 million off turnover but add 0.25% to trading margins.

Friel admitted he felt a need to defend the firm's traditional approach of different business and geographic units operating autonomously under their own chief executives and management, as against a more centralised approach. "It's not the cheapest way of running things but it's the most effective,'' he claimed.

Individual management teams have more "ownership'' of their businesses. "We couldn't get the same results in a centralised operation.''

The chief executive was also at pains to stress that the company had full confidence in the "Kerry Model'', its focus on nutritional advances, emerging 'wellness' trends in food and on convenience. It continue to "leverage' its different divisions off each other to multiply benefits, transfer skills, etc.

The firm's spend on research and development and on product development would be fully maintained, he said.

Friel tempered expectations regarding emerging markets such as China. "'There are no quick solutions. It takes time and patience. The time factor needs to be understood,'' he said. Much of this growth is of a greenfield nature, i.e. slow. "The acquisition possibilities are nowhere near as good as in established markets.''

Ingredients lift in US

Turnover in ingredients rose by 6.5% to €1,54 million. Like for like growth - from existing businesses - was strong at 5%.

Trading profit rose by 4% to €123 million giving a trading margin of 7.9% - down from the 8.1% of 12 months ago. Margin is largely being hit by higher energy costs.

As Kerry had hoped and forecast, markets and margins for speciality ingredients recovered in the US market. The recovery in the EU ingredients - a marginally bigger division - was less strong as there continues to be strong competition resulting in margin pressure.

Big drop in food margins

THE UK consumer food market is a difficult place to be in 2006. Kerry is a big company - but is still dwarfed by the likes of Tesco or Wall Mart (Asda). Food prices fell in the reporting period. Turnover in Kerry's existing consumer food businesses grew by only 0.2%. When acquisitions made in the period are included, turnover in consumer foods rose by 6.6% to €875m. Trading profit fell by some $3m to €52m, a decline of 4.6%. Trading margin was 5.9% - respectable in this sector in 2006 but way down from last year's 7.6%.

Kerry has now abandoned hope that the UK frozen meal market will return to worthwhile growth in the short-term. It contracted by 14% in 2005 and continued to contract in 2006. "Frozen meals continue under pressure and it doesn't look like recovering the ground lost last year,'' Hugh Friel said this week. Clearly, margins in this sector continue to be under pressure. Kerry's frozen meal interests are centred in the former Golden Vale plant at Carrickmacross in which Kerry has made significant investments

According to Hugh Friel, the premium end of the chilled meal sector returned to growth towards the middle of 2006. Kerry has interest in poultry meat production in the Republic and in the UK and this sector, too, has seen prices and markets decline.

Kerry has the clout to force price increases on its branded foods on UK shelves. The problem is that the customer will walk the few feet further down the aisle and pick up the lower priced own label product. Another problem for Kerry is a big proportion of its UK food business is own label. "With the kind of customer we have you can't be continuously going in there looking for price increases.''

Squeeze continues in 2006

KERRY'S heavy emphasis on cost cutting including factory closures and disposals indicate that it expects the squeeze between rising costs and market competition to continue.

Higher energy bills impact on both of Kerry's divisions more or less equally and in all locations. But they also impact on competitors. Hugh Friel's view on higher energy costs is that Kerry can live with them because in time it will get the price increases to compensate, as will competitors.

His problem is that the rapidity of the oil price increases and the time lag in forcing price increases is, in the meantime, cutting Kerry margins and profits.

Oil prices rose by 32% in the first half of 2006 after rising by 42% in 2005, the company said.

Kerry's energy bill rose by €40 million in the first half of 2006 compared to the first half of 2005, which itself was significantly up on the previous year.

The firm recovered €30 million of the increase by a combination of price increases for products and efficiencies, leaving a shortfall of €10 million in the period.

Its energy bill in the second half of 2006 is expected to be up by €40 million, too, and the company is again aiming to recover a similar portion of this by price increases and savings.

Kerry has increased its interim dividend by 10% to 5.5 cent per share. The company carried out a share buy back in June of 2006. It bought back 1.5% or 2.8 million of its issued shares. The company signalled it might do so again.