Aryzta’s troubled journey from global industry player to fight for survival

Call it a bad karma but the moment former Aryzta boss Owen Killian received the RDS Gold Medal for Industry, the State's top business award, things began to go wrong.

It was November 2014 and Killian was, back then at least, the man with the Midas touch, having transformed an ailing agricultural firm into a global bakery business with a turnover of nearly €5 billion.

Its tentacles were everywhere. It supplied hamburger buns to McDonalds; bread to sandwich chain Subway; and donuts to Tim Hortons, Canada's largest fast-food chain. It owned the supplier of bakery products to German retailers Aldi and Lidl.

It was best known in Ireland for the Cuisine de France brand, though that was only small piece of a very large pie.

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Killian boasted of having created €4 billion in value for shareholders.

But the company’s impressive portfolio of assets was built up through a sequence of acquisitions – 12 in total between 2008 and 2014 – fuelled by a near tripling of the company’s debt, a strategy that was about to unwind in spectacular fashion.

Tracing troubles

In his acceptance speech in the RDS in Dublin, Killian spoke on his favourite theme, staying relevant in business. Not long after, he would be reduced to justifying his own relevance to the company that he was credited with building almost from scratch.

How Aryzta came unstuck is not down to one catalyst but to a series of reversals, some self-inflicted, others part and parcel of the inherently volatile food industry.

Its troubles can be traced back to 2008 when the company, formerly the Irish Agricultural Wholesale Society (Iaws), cleverly engineered a reverse takeover of Swiss food group Hiestand to form Aryzta just as a global recession hit.

Demand from independent convenience stores and smaller food service businesses, a mainstay of Aryzta's distribution business, collapsed. The company had to rely more on the quick-serve sector – businesses such as McDonald's and Subway and the value multiples like Lidl and Aldi – which continued to deliver growth, Fintan Ryan, an analyst with German bank Berenberg, says.

But these businesses were big enough to cut out the middle man or distributor and buy directly from bakeries, Ryan says. To avoid being sidelined, Killian went on a shopping spree, buying up the suppliers of these food businesses.

In 2010, the company spent $900 million (€788.8 million) acquiring Fresh Start Bakeries in the United States, which supplies Subway and McDonald's; and a further $180 million on Walmart's supplier Great Kitchens. In 2013, it bought German bakery Klemme , which supplied Lidl, for €280 million.

In total, it spent €3 billion on acquisitions between 2008 and 2014, with company debt rising from €590 million to €1.7 billion. At a time of global retrenchment, it was an extremely bullish strategy but the markets loved it. Aryzta’s share price shot up by over 300 per cent to trade at close to €78.

Integration problems

Killian had always been a deal junkie. Back in 1997, he had driven the deal that saw Iaws acquire Cuisine de France for £50 million punts (€64 million). The price was considered astronomical at the time, but it allowed Iaws to reinvent itself as a consumer food business.

The post-2008 acquisitions , however, created an integration problem across the group, particularly in the US, where customers were forced to deal with different Aryzta businesses for different products.

The company initiated what it called the “Aryzta Transformation Initiative” to amalgamate its subsidiaries under one integrated management system. The process was messy with lot of one-off restructuring charges which hit the bottom line, Ryan says.

“They always had a reason why organic sales weren’t good, but the earnings growth on their metrics seemed pretty robust,” he says. “Nonetheless, analysts had a hard time stripping out the underlying from the noise.”

A recurring theme was Aryzta’s rather opaque communication with investors, analysts and other stakeholders, something that would worsen as the company’s financial fortunes deteriorated.

The company followed up its amalgamation strategy with a rationalisation programme, essentially streamlining operations and reducing its product range to focus more on higher-margin products. This resulted in the company jettisoning about 10 per cent of sales in North America.

In 2014, it made a fundamental misstep, however, one that would seriously aggravate underlying sales in the US and undermine investor confidence.

It acquired Cloverhill bakery in Chicago, primarily a long-life packaged cakes and pastries business – manufacturer of America's beloved Twinkie – for $530 million. It was a switch in focus from the company's traditional frozen par-baked offering.

This, combined with its Otis Spunkmeyer branded strategy, meant the company was selling directly to the consumers for the first time. But that was diluting its traditional B2B (business to business) focus, and placing it in direct competition with its own customers. They responded by withdrawing contracts.

In the company’s own words, the strategy triggered “co-pack volume losses” resulting “in significant negative operating leverage at the Cloverhill facility”. That was in 2017 after US revenues fell nearly 6 per cent.

The Cloverhill facility was later embroiled in controversy after a raid by federal authorities discovered that a significant portion of its workers did not have the necessary paperwork.

And, in the sort of calamity that only hits you when you’re down, one of the dough machines at the group’s Hazle Township facility in Pennsylvania spat out a suspected heroin packet onto the production line. Further suspect packets as well as “drug paraphernalia” were discovered after the line was shut down. Production was disrupted as state troopers interviewed staff and about 80 cases of dough that had run through the production line were destroyed.

The company sold its Cloverhill assets earlier this year for reportedly €20 million, crystallising a 97 per cent loss.

The strategic error in Cloverhill was then compounded by a sequence of contract losses, first in North America and then in Europe.

Subway became spooked by its over-reliance on Aryzta, which supplied around 75 per cent of its bread requirements, and scaled back its demand by promoting a rival.

Tim Horton's new owner 3G then sought to squeeze Aryzta on price, which resulted in Aryzta ceasing to supply several product lines to the chain. In Europe, Aryzta also lost out when Lidl in Germany and the Swiss Co-op chain decided to in-source much of their bakery products.

Despite being on the back foot, Aryzta under Killian continued to invest in new capacity. Between 2008 and 2014, it invested €1.4 billion in building new plants and facilities.

“It was, in hindsight, a sort of build it and they will come mentality,” a well-place industry source says. The spare capacity began to undermine earnings and pull negatively on the share price.

Sceptical investors

However, Killian was undeterred. In 2015, Aryzta sold its stake in Dublin-listed Origin Enterprises, which had been spun out of Iaws after it merged with Hiestand, to buy a 49 per cent stake in French frozen food chain Picard for just under €450 million.

This was the most radical shift in direction yet, akin to Aryzta buying a high-end Tesco. It was another pivot towards the consumer and away from its traditional B2B business.

If the strategy was unclear, Aryzta’s justified the acquisition on the grounds that Picard had revenues €1.8 billion and an earnings margin of more than 12 per cent, and was a cash generative business. But Aryzta had paid a massive price for a minority shareholding in a non-core business, and investors were now extremely sceptical of the company’s strategy.

The day the Picard deal was announced, Aryzta’s stock opened up 4 per cent with investors viewing it as good for earnings growth.But by the end of the management call with analysts on the deal, the shares were down between 7 and 8 per cent, as investors digested management’s shaky rationale.

That was probably the single biggest catalyst to Killian’s exit; he never regained the confidence of investors.

By that stage, the shares were tanking. They halved in value in 18 months as the company issued profit warnings and missed earnings targets. Matters weren’t helped when Killian was forced into selling two-thirds of his own stake in 2016, a move which was triggered by a decline in the “collateral value” of his stock.

Later that same year, shareholders parachuted former Smurfit Kappa chief executive Gary McGann onto a board that had for a long time been seen as too beholden to Killian. His arrival triggered another significant profit warning and ultimately the exit of Killian and chief financial officer Patrick McEniff in 2017.

Under McGann almost the entire Aryzta senior team has been replaced with Kevin Toland, the former DAA boss, coming in as chief executive. But it's been a hard slog to turn things around and there has been criticism that the new team have been slow to grasp the full import of the company's financial position.

While the company mulled its options, there was significant shorting of the stock in the expectation of a rights issue. That has done little to raise investor spirits.

Project Renew

In May this year, the company was forced into yet another profit warning, alerting markets that its full-year earnings would be up to 12 per cent lower than previously forecast. Having previously signalled the slide in its fortunes had been halted, the company’s move served only to further depress investor sentiment.

“Last year, we believed we had established a base line for the business and that we were at or close to the bottom of a performance cycle,” McGann told shareholders at the company’s annual general meeting in Zurich on Thursday.

“Clearly we were wrong and we underestimated the challenges facing the business.The reality is that this business needs a significant capital increase to address excessive indebtedness,” he said.

The company’s net debt is still around €1.6 billion – more than five times its earnings before interest, tax, depreciation and amortisation (ebidta). Its €800 million capital raise will reduce this to a ratio of 2.5.

The new team's strategy to return the company to health has centred on a three-year €200 million cost-cutting programme – Project Renew – and the selling off of assets. It is essentially the acquisition spree in reverse. It sold its La Rousse Foods business to Musgrave Group last year and Cloverhill earlier this year.

Ironically it has been dividends from Picard, the company at the top of its list of assets for sale, that have helped strengthen the company’s ailing balance sheet recently. Nonetheless, its disposal remains a top priority.

One of the reasons management has pushed so hard for what is a highly dilutive rights issue is to avoid a fire sale of its Picard stake and to restore customer and investor confidence in the business.

The company has also been overtaken by a number of headwinds including labour and input cost inflation, says Goodbody analyst Jason Molins.

“ Significant freight cost inflation has also been an industry-wide challenge in North America, and Aryzta was one of the first companies to call this out back at the start of 2018.

“Under the new management team, it has been clearly articulated that the strategy would revert to focussing on its B2B bakery business,” he said. “With that in mind, the JV [joint venture] asset Picard [acquired by the previous management team] is no longer deemed core and is part of the group’s ongoing disposal of non-core assets.”

In a recent presentation to investors, the current management team summed up the company’s legacy issues under several headings: unfocused strategy; overexpansion: acquisitions and overinvestment in capacity; disparate group of businesses; talent loss; overleveraged; lack of stakeholder engagement.

It was a damning indictment of the previous era but an honest one, ending a long period of denial. Whether it can successfully extricate itself from its current parlous position remains to be seen.