Belfield Capital Investment Case-Ebro Foods Yusuf Samad 20th July 2020 Price €18.56 Executive Summary Ebro Foods is a steady business in a dominant market position and a strong balance sheet. Historically strong return on capital is suppressed by a three-year capex program to enhance productivity leading to EBITDA growth from 2021. Management has a credible long-term track record in allocating capital and is well aligned with a large stake. Meanwhile, the business has been uplifted by Covid 19; the stock yields 4% that could be significantly enhanced with a special dividend from disposals. Investment Thesis • Dominant market position in the essential food sector. EBRO Foods is a Spanish food producer. It is the global leader in production and distribution of rice, rice-based products and complementary food products and the second largest pasta manufacturer. • Steady business with a strong balance sheet-a Survivor As a producer of staple products with several well-known brands like Tilda rice, Ebro has defensive characteristics like other food sector players such as Nestle and Unilever. It has had steady low single digit revenue growth (4.6% p.a. from 2016 to 2019). The balance sheet has grown to finance acquisitions, capex and higher working capital but is robust with Net Debt to EBITDA of 2.9 times. The leverage should decline as capex peaks in 2020 and debt is reduced with large disposals. • Boost from COVID 19 COVID 19 has boosted sales and profits in 1H driven by stockpiling and cooking at home offset by the loss of food service operations such as corporate canteens and restaurants. We expect full year sales and EBITDA to grow 14% even though the exceptional sales growth in the first half will taper off in the second half of the year. Full year Adjusted EBITDA projected at €400m up from €343m. • Potential for margin improvement Over last three years, Ebro has spent €408m on capex and made the key acquisitions of Tilda in 2019, a premium rice brand and Bertagni, a filled pasta and fresh pasta specialist in Italy in 2018. The capex has been directed towards the overhaul of its instant rice and fresh pasta productive capacity and a significant effort to expand the market for its frozen cereal and rice products. A major expenditure is to move from the current factory that is now part of urban Seville to La Rincondada, located 30 miles away. The new plant, to be ready in 2021 will produce microwave and convenience products. It will enhance cost efficiency. It will not be ready till 2H 2021. • Founder owned business with skin in the game The sell side is somewhat sceptical of the capex programme especially since the results in terms of EBITDA margin improvements have not been visible while debt has risen and the Return on Capital Employed has declined. However, management believes in investing for the long-term and has done so successfully under the leadership of Anthonio Hernandez Callejas, the current Chairman and CEO since 2005. The track record of allocating capital such as timely exits from the sugar business, divestment of the dairy business and purchase of Tilda is impressive. It is helpful for shareholders that management is strongly aligned with a family stake of ~16%. Another 34% of the company is held by three established Spanish families. • Paid to wait Given the family owned nature of the business, Ebro has a consistent dividend policy. It is currently trading at a yield of 3.04%%. The proceeds of any disposals are also likely to be paid out partially as dividends. Ebro has announced the sale of its US pasta business and six parties are believed to be pursuing it. We estimate the sale proceeds to be €340m that would allow reduction in debt and payment of a dividend ~€1 per share. Risks and Mitigants • Productivity improvements fail to materialise despite the capex The pay-off from the capex program is expected in 2H 2021 when the new factory starts operations. This should reflect in higher EBITDA margins, towards 14% as it boosts production of faster growing and higher margin products. The key mitigant is that the management team is very experienced in the rice and pasta production business with a good track record. • Increase in raw material prices for rice or durum wheat that cannot be passed on. For 2020, Ebro has built up inventories of raw materials before prices increased. Also, with strong brands and for premium products, it is able to pass on the costs albeit with a lag. • Strength of Euro vs. USD Profits generated in US Dollar are exposed to the risk of euro appreciation. • Competition from private label Market share in the US pasta business has been hurt by competition from private labels. This business is now being sold. Ebro can protect itself also by innovating new formats and products. Also, it is helpful to have recognised brands as consumers start to purchase directly on-line. Business EBRO Foods is a Spanish food producer. It is the global leader in production and distribution of rice, rice-based products and complementary food products and the second largest pasta manufacturer. EBRO’s origins are in the sugar business operating as Azucarera Ebro Agricoles. In 1989 it had acquired 60% of Herba Rice Mills In 2000, it merged with local dairy group, Puleva that had been in public ownership in Franco’s time and was privatised. The foundations of the rice and pasta business were laid with the acquisition of a 100% of Herba Rice in 2001, Panzani, the French leader in pasta and to sauces in 2005. In 2008, EBRO anticipating a change in regulation sold its sugar business, Azucarera. In 2010, the dairy business, Puleva was sold to the French company, Lactalis due to the challenges of expanding the business geographically. Ebro had made the dairy business more profitable, modelling it after the sugar business. It focused on achieving higher EBITDA margins and ROCE and achieved greater efficiencies in the back office, consolidating manufacturing operations in five locations into two factories. In selling the dairy business, Ebro recognised that dairy prospered better in Northern European countries and less so in Southern Europe where temperatures are higher. As in Italy and other Southern European countries a tradition of cooking had developed based on use of olive oil. The business model is now oriented towards this tradition. Ebro has been shaped into the current model since 2005 by Antonio Hernandes Callejas who is currently the Chairman and the CEO. Antonio began his career in 1979 in Arrocerias Herba, a rice producer founded by the Hernandez family. In 2002, he was appointed Director, Vice-Chairman and member of the Executive Committee of Ebro Foods, S.A. and since then he has been a key figure in the transformation and international expansion. In 2004 he was appointed CEO of the Company and in 2005 he became Executive Chairman of the Ebro Group. While listed, Ebro has the characteristics of a family owned business. Three established Spanish families hold nearly 50% of the stock alongside the Callejas family. The Alba family, also owner of Banca Marche, own 14%, the Damm family owns 11.7%, Callejas family owns 7.96% and has an associated interest in another 7.96%. The Spanish sovereign wealth fund SEPI owns 10.4%. The free float is 45% and includes ownership by Artemis Investment Management. EBRO group had revenues of €2.8bn in 2019 and Operating Profit of €212m. The two main business segments are Rice and Pasta contributing 56% and 44% of revenues respectively and an equal share of operating profits. A small proportion of revenue (0.5%) is derived from other business activities., mainly from investment properties. As shown below, only 6.3% of revenue is generated from customers in Spain. The rest of Europe accounts for 50% and France represents nearly half of these revenues. The Americas represent 34% of revenue, most of which is from the US (28.4%). Ebro Foods Spain Europe Americas RoW Total US France Segment Revenue €000 164,502 1,254,599 933,091 261,785 2,613,947 791,742 702,185 Segment Revenue 2018 % 6.3% 48.0% 35.7% 10.0% 100.0% 30.3% 26.9% Segment Revenue 2019 €000 181,295 1,412,700 955,702 263,601 2,813,298 798,684 690,528 Segment Revenue 2019 % 6.4% 50.2% 34.0% 9.4% 100.0% 28.4% 24.5% Growth 2018/19 % 10.2% 12.6% 2.4% 0.7% 7.6% 0.9% -1.7% Business segments A. Rice businesses (56% of revenue and 63% of Operating Profit) 2018 Sales- Europe 41.4%, NA 37.5%, Spain 10%; EBITDA-NA 45.1%, , Spain 19.1% Europe 29.5% a. Herba Group The Ebro Group is the leading European player in rice retailing, the food service segment and in the supply of rice, rice derivatives and ingredients for industrial purposes. It follows a multi-brand strategy with several high profile brands including: SOS, La Fallera, La Cigala, Saludades, Rix fis, Lassie and Risella. It is the market share leader in Spain, Portugal and the Netherlands and second in Belgium. In parallel, it supplies rice to Europe’s leading food sector players: • Beverage Industries • Industrial rice companies • Baby Food: cereals, baby food, etc. • Pre-cooked dishes: non-refrigerated, dehydrated, frozen, etc. • Animal and pet food. b. Tilda Group Acquired in August 2019 for €292m. The Tilda brands specialising in basmati rice has global brand recognition. Tilda manufactures in the UK that also accounts for 60% of sales.