Greencore. Peacock Foods Acquisition. Template Friday,8th December Wednesday, 14th December 2016

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1 Greencore Template Friday,8th December 2016 Peacock Foods Acquisition Wednesday, 14th December 2016 Key Metrics (FYE Sep) 2017e 2018e 2019e Revenue ( m) 2,098 2,395 2,603 EBITDA ( m) Price/Earnings 15.9x 16.7x 13.9x Dividend Yield 2.22% 2.38% 2.59% Share Price Return 1 Mth 3 Mth YTD Greencore -7.1% -14.0% -15.9% Source: Bloomberg Consensus Top 5 Shareholders Ownership Capital Group 6.25% JP Morgan 5.14% Norges Bank 4.12% FMR LLC 3.90% Blackrock 3.22% Source: Bloomberg Greencore 2 year share price Nov/14 May/15 Nov/15 May/16 Nov/16 Greencore Group plc is a leading international manufacturer of convenience foods. It supplies a wide range of chilled, frozen and ambient foods to some of the most successful retail and food service customers in the UK and US. Stephen Hall, CFA Investment Analyst Greencore s shareholders approve acquisition of Peacock Foods At Greencore s EGM on 7 th December, its shareholders approved the acquisition of Peacock Foods, the fast-growing US convenience food manufacturer, for $747.5m. The acquisition was initially announced on the 14 th November and accelerates management s goal to be an international convenience food leader. The deal was done at a reasonably attractive valuation multiple of 10.4x EV/EBITDA, which drops to 10.0x when incorporating the benefit of Peacock s US tax asset worth $65m, and 8.5x when including $15m of proposed annual cost synergies which are expected to be achieved by FY19e. Ultimately, we agree with management s assessment that this deal will add significant scale to the newly combined business. Its portfolio of products are all situated in high growth segments of the food sector and the acquisition will open Greencore s existing US business to new customers, new sales channels, extend its geographic reach, and enhance its operating capacity and expertise. Equity rights issue Management is set to raise 439.4m ( 426.6m post fees) from an equity rights issue in addition to a new $250m debt facility to fund this acquisition. The rights issue will comprise 9 new Greencore shares issued at 153p for every 13 existing Greencore shares. On 8th December, the Nil Paids on Greencore began trading and the final date for the acceptance payment in full, and registration of renunciation of provisional allotment letters is the 21 st December. Dealing in the new Greencore shares, fully paid will commence on the London Stock Exchange on the 22 nd December. The theoretical ex-rights price (TERP) opened at GBp on the 8 th December, and the Nil Paids opened at approximately GBp The rights issue price is GBp153, a 31.2% discount to the TREP. Strategic rationale for Peacock Foods acquisition is compelling The combined business has the potential to transform Greencore s end market and sales channel position in the US and create a strong platform for long term profitable growth. The acquisition could also lead to increased cross-selling opportunities for Greencore s existing US business to sell its fresh and chilled produce to Peacock s core customers which include Tyson Foods, Kraft Heinz, Dole, Kellogg's, General Mills and Apio. Secondly, Peacock s capabilities are within factory automation, project engineering and packaging, and this knowledge can be added to Greencore s existing expertise in fresh food production and food safety. Thirdly, the deal appears attractive from a financial perspective and it should be immediately accretive to earnings, and the targeted return is forecast to be ahead of the cost of capital in year 1. Finally, the financial leverage of the newly combined business will not materially change post the completion of the transaction. The newly combined entity will have a Net Debt/ EBITDA ratio of 2.5x, which is set to decline to 1.2x by FY19e as it is a highly cash generative business which enables it to quickly deleverage its balance sheet. Peacock Foods overview Peacock Foods manufactures convenience food products for large US Consumer Packaged Goods ( CPG ) customers including Tyson Foods, Kraft-Heinz and Dole. This increases the opportunity to cross-sell Greencore s existing fresh and chilled convenience product range. Peacock operates from seven large, well invested facilities with a track record of quality and safety, with expertise in automation, project engineering and packaging. It has an impressive track record of revenue and earnings growth over the past 5 years with a healthy pipeline for organic growth. 1

2 The company s newly combined set of capabilities and scale should create significant opportunities to bring new products to existing customers and develop new channels and customers. Peacock also provides a range of services to customers alongside its core manufacturing offering, including processing and packaging, ingredient sourcing and materials management, project engineering and commercialisation, warehousing, and distribution. This deal should add significant scale to Greencore s US operations and if the business successfully wins new contracts and reduces excess capacity, it should improve the overall operational leverage of the business and support margins. The chart below show Greencore s expanded national reach in the US once the Peacock Foods transaction is completed by the end of December Greencore s existing operations in the US Greencore s existing US business supplies a range of convenience food products (sandwiches, wraps) to its two primary US customers, Starbucks and 7-Eleven. The business recently reported a small operating profit in H2/16. However, new contract wins and reduced start up costs are necessary to support operating margins growth towards the 6%-7% level seen in the UK. There is significant excess capacity in Greencore s manufacturing sites in the US. Peacock s facilities are approximately 70% utilised; however Greencore s Rhode Island site is just 35% utilised, therefore it can add meaningful new volume without significant capex investment, which materially improves the operating leverage of the US business. Growth opportunities in the US The organic growth prospects for Peacock s business remains very attractive, as it operates within several high growth segments of the food sector. It anticipates 6% organic revenue growth in its frozen breakfast sandwiches division, 6% in its kid s snack meals and salad kits, and 8% in pre-packaged Food-To-Go (FTG) division per annum. This acquisition now cements Greencore as the no. 1 convenience food manufacturer in the US, which is still a highly fragmented market. Given the highly cash generative nature of the combined business and the quick deleveraging profile of Greencore which sees its Net Debt/ EBITDA ratio drop from 2.5x at September 2016 dropping to 1.2x by September 2019; we anticipate further consolidation by Greencore in the future once it deleverages its balance sheet further. Peacock has the opportunity to deepen and grow long standing relationship with its existing customer base and has extended the length of contracts in recent years similar to Greencore. Peacock is set to bolster its relationship with Kraft Heinz in early FY17e, which is set to add $100m revenue per annum to the business. 2

3 This acquisition broadens Greencore s geographic footprint in the US, and opens up California as a potential new region to deepen its relationships with Starbucks and 7-Eleven through Peacock s manufacturing site in Anaheim, California. Favourable trends Greencore s management sees the recent trend of increased levels of outsourced manufacturing continuing in the US for many years to come, which should lead to large ticket contract renewals with its existing customer base. Peacock is primarily focused on fast growing segments such as breakfast sandwiches, chilled meal kits and salad kits which are set to grow at high mid-single digits on the near term horizon, as consumers trends shift towards healthier, more convenient, on-the-go snacks and meals. The penetration rates of outsourced private label manufactured convenience goods are still relatively immature in the US compared to the UK. We anticipate penetration levels improving over time in the US, leading to significant organic growth. Greencore s UK operations Greencore s UK business is well placed for further organic growth as it lengthens and deepens relationships with its biggest customers, M&S, Sainsburys and the Co-Op. It has grown its market share in the Food-To-Go (FTG) sub-segment of the food market in the UK substantially in recent years, from 35% 5 years ago, to 60% in 2016; and is set to capture further market share in 2017 due to contract extensions and new product offerings. The vast majority of the Greencore s UK facilities operate in a chilled supply chain environment, albeit certain facilities operate in ambient and frozen environments. Management s goal is to replicate the success of its UK business in the US. Peer valuation snapshot The table below compares Greencore s key financial metrics to listed Irish food peers, large cap food producers and ingredients companies. Greencore trades at an EV/ EBITDA ratio of 7.4x, a significant discount to all three groups of food stocks below. Its dividend yield is above the basket of publicly traded Irish stocks, inline with ingredient companies, but below the large cap food producers. It has the 2 nd greatest upside potential to its consensus target price at GBp 300, offering investors 22.6% potential upside if achieved. P/E EV/ EBITDA EV/ Sales Revenue CAGR EBITDA CAGR Div Yield Consensus Target Potential Upside Price FY17 FY17 FY FY17 Price % Greencore x 7.4x 0.8x 28.4% 27.7% 2.2% % Listed Irish Food Peers Aryzta x 8.9x 1.4x 1.0% -1.9% 1.3% % Kerry Group x 13.0x 2.1x 4.6% 6.8% 0.9% % Glanbia x 13.1x 1.8x 4.8% 7.1% 0.9% % Fyffes x 10.9x 0.7x 4.6% 9.4% 1.3% % Average 15.9x 11.5x 1.5x 3.8% 5.4% 1.1% 12.7% Large Cap Food Producers Danone x 10.7x 2.0x 8.6% 9.7% 2.9% % Nestle x 12.7x 2.6x 4.3% 5.7% 3.4% % Kraft Heinz x 14.3x 4.9x 1.3% 8.4% 2.9% % Average 19.8x 12.6x 3.2x 4.7% 7.9% 3.1% 14.3% Ingredients Companies ABF x 11.5x 1.4x 9.8% 9.9% 1.5% % Tate & Lyle x 9.0x 1.3x 8.7% 14.7% 4.1% % Symrise x 12.6x 3.0x 5.1% 7.6% 1.7% % Suedzucker x 7.2x 0.9x 4.0% 23.3% 1.8% % Naturex x 11.3x 2.1x 5.4% 14.2% 0.1% % Givaudan x 14.0x 3.5x 5.6% 4.3% 3.4% % Average 22.0x 10.9x 2.0x 6.4% 12.3% 2.1% 10.5% 3

4 Greencore s valuations & shareholder distributions We have seen a modest valuation re-rating over the past week, however valuations still look attractive. It currently trades at 15.9x FY17e earnings, dropping to 13.9x by FY19e if its earnings growth trajectory is achieved. This still represents a 19% discount to the broader Euro Stoxx 600 Food and Beverage Index at 19.6x. Greencore also offers investors a dividend yield of 2.2%, which is better than the ISEQ Index at 1.4%, but behind the wider Euro Stoxx 600 Food and Beverage sector at 2.9%. Greencore s management remains committed to a progressive dividend policy with a pay-out ratio target of 30-40% of earnings. The newly combined Greencore This transaction will see revenue originated in the US jump from 15% in FY16 to c. 45% in FY17 with the remaining 55% generated in the UK and Ireland. Post completion, its US sales and manufacturing footprint will both increase 5 fold. The acquisition will also diversify its product range, adding breakfast sandwiches, snack meals and salad kits to Greencore s existing portfolio of products, which includes sandwiches, wraps, sushi, ready made meals, soups, cooking sauces, table sauces, Yorkshire puddings, cakes and deserts. It also diversifies Greencore s customer base away from its two biggest clients, Starbucks and 7-Eleven, and opens new sales channels through grocery retail channels. Conclusions Ultimately, we agree with management s assessment that this acquisition will add significant scale to the newly combined business. Its portfolio of products are all situated in high growth segments of the food sector and the acquisition will open the business to new customers, new sales channels, extend its geographic reach and enhance its operating capacity. In our daily note on the 8th December we advised clients to use the recent weakness to pick the stock up. Despite the recent 10% rally since, we remain happy to pick up Greencore at current market prices. Potential upside catalysts We list 5 potential near term catalysts to support earnings growth and factors which could potentially lead to a valuation re-rating in Greencore s share price. i) Annual cost synergies greater than $15m per annum and if they are fully realised ahead of FY19. ii) Announcement of new contract wins in the US, which reduces excess capacity and improves operating margins. iii) Announcement of new long term contract renewals in the UK with its customers/ partners, which increases earnings visibility. iv) Lower levels of capex, leading to higher free cash flow generation and accelerated debt repayments. v) Investors take advantage of Greencore s valuation discount relative to the Euro Stoxx 600 Food and Beverage Index. Risks i) A weakening pound leads to cost price inflation of raw materials imported from the European Union. ii) Continuation of price wars between UK retailers makes price increases more challenging. iii) Increases in minimum wages in the UK pressuring operating margins. iv) A fall in consumer sentiment in the UK post Brexit, however management recently said it has not seen any decline in demand since the referendum. v) Loss of large contract due to a drop in food safety standards, which is unlikely in our view. 4

5 Wednesday, 14th December 2016 Regulatory Information Issuer Descriptions: (Source: Bloomberg) Greencore: Greencore Group plc manufactures and distributes a diverse range of primary foods and related products, food ingredients and prepared foods to the consumer and industrial sectors. Historical Record of recommendation Greencore: We have upgraded our recommendation for Greencore, to Outperform from Not Rated, as of 25/11/2015. None of the above recommendations have been disclosed to the relevant issuer prior to dissemination of this Research. Date of distribution The first date of distribution is the same date as this report unless otherwise specified. All regulatory disclosures pertaining to valuation methodologies and historical records of the above recommendations can be found on the Cantor Fitzgerald Ireland website here: This material is approved for distribution in Ireland by Cantor Fitzgerald Ireland Ltd. 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