Aryzta shareholders may be left with crumbs

While only 12 months into the job as chief executive of Aryzta, Kevin Toland could be forgiven for thinking he’s taken on more than he bargained for when he signed up for the task of turning around the embattled bakery giant best known as the former IAWS and owner of the Cuisine de France brand.

His current battle in order to stop the Aryzta ship from sinking further, is to convince shareholders that while his plan to raise €800m through issuing more shares is not simple, it is the only viable one and it will succeed.

Aryzta says this €800m will be used to reduce debt by €500m, working capital needs of €100m and fund a €150m cost-cutting programme called Project Renew.

Resistance

However, there is already resistance to this plan from some elements of Aryzta’s shareholder base as the €800m capital raise will lead to significant dilution of shareholder investments.

Of course the situation that led to this was not of the current management’s making. A series of acquisitions saw Aryzta becoming one of the biggest bakeries in the world, supplying the likes of McDonald’s and Subway.

There are three main issues with Aryzta – it has high debts, tough operational trading conditions with loss of volumes and falling margins along with a tumbling share price. Over the course of Toland’s first 12 months in charge, shares have plunged a further 65% amid continued bad news. Less than four years ago, shares were trading at highs of €73, meaning close to €6bn has been wiped off the value of the company since 2014.

The extent of the challenges facing Aryzta were unveiled last week when the company announced pre-tax losses of €493m for its 2018 financial year. The losses related to writedowns on the sale of some German and US bakeries.

However, even excluding these exceptional charges, Aryzta, a business that made €600m in earnings in the past, is making half that today. Profits (EBITDA) fell 28% in the year to €302m, as margins narrowed from 11.1% in 2017 to 8.8% in 2018. Revenue fell 10% to €3.4bn.

North America, which accounts for 47% of the business, has proved to be persistently problematic for Aryzta, with sales volumes falling 18% over the last four years. Prior to the final quarter of its 2018 financial year, when sales volumes in North America grew by 1.2%, Aryzta’s US business had reported 11 consecutive quarters of declining sales volumes. 2017 was a particularly bad year, with volumes plunging almost 9% in 12 months. Meanwhile, margins have also collapsed from 17% in 2014 to just 6.1% last year.

While the North America business has significantly underperformed, Aryzta says it has no plans to sell it and believes a return to 12% to 14% profit margins is achievable. Holding on to its North American business makes sense for Aryzta given some of its largest customers such as McDonald’s, Burger King and Tim Hortons are US companies. Abandoning the US market would end these customer relationships, which could in turn risk similar contracts in Europe.

In a capital-intensive business such as this, excess capacity adds cost to each unit of production so volumes are critical to driving efficiencies. While it hopes to cut €200m of costs from the business by 2021 the business needs to stabilise volumes. Its customers hold a strong hand in negotiations so capacity and efficiencies need to be maintained in order to win volumes.

In a call with investors last week, Toland was blunt in his assessment of the company, describing Aryzta as “overleveraged” because of the unfocused strategy pursued by previous management.

It’s certainly true to say the company is highly borrowed, with net debts at year end July 2018 of €1.5bn leaving Aryzta with a net debt to earnings (EBITDA) ratio of 3.8 times. Aryzta has been on the lookout for a buyer for its 49% stake in French frozen food company Picard since last year, which it is currently carried at a book value of €500m. However, it is proving difficult to find a buyer for a minority stake in a business and when it does it will likely take a further hit on this investment.

While any rights issue will lead to some form of dilution for existing shareholders (if they do not partake), the problem for the Aryzta plan is that shareholders are effectively being asked to vote in the dark, with no visibility of the issue price range or the number of new shares being issued.

This is because Aryzta is headquartered in Switzerland where the rules of the stock exchange state that public companies do not need to indicate a share price range or the number of shares being issued when undertaking a capital raise such as this. Instead, they merely need to declare the amount of capital they wish to raise (€800m in this case).

Aryzta has some 90m shares in issue today and has a market capitalisation of €860m based on Tuesday’s share price of €9.30. Raising €800m will effectively double the size of the company. However, depending on the issue price, the number of shares in the company could double, triple or even quadruple. In effect, unless existing shareholders invest, they will be diluted and their investment will lose further value.

While there is no indication of what the new share price will be, as with any rights issue it will be at a discount to the current share price.

Although unknown, it could be a three-for-one rights issue where the issue price would then be around €3 which could see almost 300m new shares being issued. In this scenario, after a three-for-one rights issue at €3 per share, for an investor with 1,000 shares at €9.30, this investment of €9,300 could fall to €4,575 if they do not partake in the rights issue. Taking up the offer, in a three-for-one scenario would require a further investment of €9,000.

This means the rights issue could see new shares being issued in the company at a discount of up to 80% of the current share price. On top of this, unless shareholders invest (which could mean doubling their stake) their share of profits will be diluted. This will be a bitter pill to swallow for investors who are already questioning the turnaround plan and have seen significant value destruction since the share price tumbled from peaks of €73.

While the need for a rights issue of such a scale is questionable, management believe the company needs €150m of the capital raise to just cover day-to-day liquidity and survive. Ultimately, getting this across the line with shareholders is the lifebuoy Aryzta badly needs to stay afloat.