La Doria — Update 31 May 2016

Through the parent company La Doria SpA and its 98.3% holding in Eugea Mediterranea, La Doria Group is a leading private-label (PL) processor and manufacturer of tomatoes, sauces, pulses and fruit-based products. La Doria’s overarching strategic objective is to change the product mix towards higher added-value and hence higher-margin products, and grow its market share in the PL segment. La Doria also owns 57.9% of its UK subsidiary LDH (La Doria) Ltd (LDH), which distributes both its own products and other PL products mainly manufactured by LDH’s minority shareholders.

La Doria was founded in 1954 by the Ferraioli family. The family maintains active management of the company. Antonio Ferraioli is group CEO and with Andrea and Iolanda Ferraioli, the family fills four of the eight board positions and owns 63% of the group’s share capital.

Based on our forecasts, we calculate a fair value based on our DCF model of €15.84, which represents 26% upside. The key sensitivities to our forecasts and valuation are outlined below. However, overall we believe the visibility and outlook are steadily improving. For 2016, pricing for the tomato, vegetable and fruit lines is complete, and costs are fully calculated, as the seasonal campaigns are over and the annual pricing rounds have occurred. In the longer term, the balance of supply and demand for Italian tomatoes has greatly improved through a change in legislation, and sector consolidation, with demand fuelled by the growing consumer preference for PL over branded products, and strong international demand for healthy ingredients of Italian origin.

As further support to our DCF valuation, we look at La Doria’s key metrics versus the peer group. At 10.8x 2016e P/E and 7.7x 2016e EV/EBITDA, it trades at c 40% and c 20% discounts, respectively, to its peers, which we believe to be too conservative.

Consolidated sales of €168.3m were 9% below Q115. This was down to organic growth declining 7.5%, and a currency impact of 1.8%. EBITDA of €14.7m was 11% below last year, with margins down 20bps. Fears of an overabundant crop towards the start of the 2015 tomato campaign caused some panic in the industry and resulted in the acceptance of lower pricing. The fears turned out to be unfounded, although total production was still above 2014 (in line with forecasts); nevertheless the contracts had been agreed and the industry is now bearing the costs of the lower sales prices. Management has worked hard to mitigate the impact on profitability, and indeed industrial efficiencies and lower raw material prices have helped with this. FX movements have further exacerbated the results. We expect Q2 and Q3 to witness similar trends and it will only be in Q4 that the results of the 2016 tomato campaign will start to come through. It is early days (the campaign runs from July to September), but the industry forecast is for production to be 4.8-5.0m tonnes. We note our group forecasts are broadly in line with the company’s targets.

La Doria’s key sensitivities include:

La Doria SpA is the leading Italian producer of tomato-based products – including chopped (53%), peeled (25%), passata (15%) and other (7%) – and processed pulses and vegetables for the domestic Italian and international markets. It is the largest producer of private label ready-made sauces. It is the second-largest producer of fruit juices and beverages in the Italian market. Exhibits 1 and 2 below break down revenues by category and by geography. In FY15, 21% of revenue was domestic Italian and 79% international. Its largest market by far is the UK (c 50% revenues), gained through its subsidiary LDH.

Approximately 90% revenues are for the PL segment, with La Doria serving a wide customer base mostly within the pan-European food retail sector, including Tesco (its largest customer), Sainsbury, Carrefour, Auchan, Selex, Conad and Waitrose. La Doria also has a value-added branded business in the UK under the Cook Italian brand name. Launched in 2011, it still represents a small percentage of group revenue (c 3%), but is fast-growing.

With leading market share positions in its largest markets (the UK and Italy), and some of its other markets (Germany, Japan and Australia), as well as across many of its product categories, La Doria is well positioned to benefit from the increasing consumer preference for high-quality private-label products over branded. In addition, demand for Italian products in some smaller markets is driving revenue growth in these regions well into double digits. Both factors provide a strong structural growth outlook.

The acquisition of Pa.fi.al at the end of 2014 was strategically significant. In line with management’s plan, it further shifted the production mix of the group towards non-seasonal, value-added products. Ready-made sauces have higher operating margins and lower volatility than tinned tomatoes. In addition, the acquisition should help drive growth in countries where La Doria was historically under-represented, providing revenue synergies as well as material cost synergies over the next few years as Pa.fi.al continues to be integrated into the group.

La Doria outlines its financial targets and strategic business plan for a rolling three-year period, usually at the beginning of each financial year. The financial targets outlined in February 2016 were mostly below those set out last year, as shown in Exhibit 3 below.

The lower sales prices for new contracts (negotiated in summer 2015 with validity from 2016) were to blame for the reduction in sales targets. That said, it is testament to management’s commitment to stem the volatility of the business and to reduce the overall dependence on the ‘red line’ that a larger cut to the top line is mitigated throughout the P&L and the net profit targets (pre-minorities) were broadly unchanged. Net profit targets (pre-minorities) benefit from a lower forecast tax rate, and at the group level the main benefit stems from eliminating minority interests. La Doria increased its stake in the UK subsidiary, La Doria Holding (LDH), from 51% to 57.9% in Q315. More importantly, the LDH shareholder agreement was reviewed and updated. This has led to a change in the accounting treatment of the minorities: La Doria now consolidates 100% of its minorities, and treats as debt the value of the put options that exist against it.

We compare our forecasts relative to group guidance in the financials section on page 9.

To help achieve its financial targets, the company sets out the following strategic guidelines:

As illustrated in Exhibit 1, the red line (tomato-based products) contributed 23% of revenues in FY15 and is the single largest contributor to group profits.

Over the past few years, there have been a number of structural changes in the Italian tomato market that have been favourable to the company, as they have shifted the balance of supply and demand back in favour of the processors by stabilising the level of production in the market. These have had the effect of improving the profitability outlook while reducing the volatility of the business, thus increasing the visibility of forecasts. Primarily these factors are:

These factors have resulted in an alignment of interests; all stakeholders in the value chain of the Italian tomato industry now have an interest in avoiding overproduction. In April 2014, a number of stakeholders created the cluster ‘district of the Central and Southern Italian industrial tomato’. This was set up to promote coordination among the different areas and to improve efficiency through better planning. By collaborating as a cohort, the industry should be better placed to match supply with demand, thus avoiding large-scale overproduction.

The issue with the 2015 campaign was down to unfounded fears of overproduction. At the very start of the campaign, record temperatures in southern Italy during the month of July caused an acceleration in the ripening of the tomatoes, hence causing an abundance of crop. This turned out to be a timing issue rather than a sign of an excess crop, but the unfounded fears caused pricing to soften. La Doria, however, has managed to mitigate the impact of lower pricing thanks to lower raw material costs and greater production efficiencies. We note, however, that overall 2015 production did increase on the 2014 level, though the increase was in line with industry expectations.

On the demand side, there have been a number of factors that have improved La Doria’s outlook:

La Doria has a number of internal strategies to enhance profitability and reduce volatility:

The annual tomato campaign runs from the end of July to the start of October. Typically La Doria negotiates annual contracts with its customers, and hence prices, just before or during the processing season. This gives La Doria good visibility over the outlook for its profitability until Q3 of the following year, when the next pricing rounds occur. La Doria establishes both the volume and pricing of the contracts, so by the end of the processing campaign the total cost is broadly known.

As stated above, 2015 production stood at 5.4m tonnes, compared to sector forecasts of 5.3m tonnes. As discussed, the main problem with the 2015 campaign was the intense heat at the start of the season. This brought forward part of the harvest and created concerns regarding overproduction, which ultimately proved to be unfounded. The total cost of the 2015 campaign was down on the prior year due to a reduction in the raw material costs and also a significantly higher industrial yield given the efficiency of the campaign during the first few weeks. Prices for 2016 are down in the region of 10%.

It is still early days for the 2016 campaign but the current forecast is for a 10% decline in total tomato production at national level, to c 4.8-5.0m tonnes. La Doria management expects the cost of tomatoes to be flat, and hence the 2016 campaign should be benign.

As shown in Exhibit 1, the vegetable line (pulses and beans) represented 26% of revenues in FY15. The 2014 season saw a reduction in the cost of raw materials, and hence 2015 pricing for La Doria’s products was slightly down as a result. The 2015 season saw a greater reduction in raw material costs due to an improvement in crop yields, and hence 2016 pricing is expected to be down again. In Italy, the canned vegetable market witnessed 2.5% volume growth during 2015, and 3.8% value growth. The market leader won back a small amount of market share, while the other brands declined. The private label sub-segment, which is where La Doria mainly competes, also declined slightly (source: Iri Infoscan). In the UK, La Doria’s key product in the category is private-label baked beans, where it holds a 48.4% market share, down 420bps vs 2014 (source: LDH management estimates using Kantar Worldpanel data). The decline was caused by one of La Doria’s customers introducing another supplier, but management expects market share to recover during 2016 as its new range of baked beans with inclusion gains traction. In 2015, the overall baked beans market was down in both volume (-2.1%) and value (-0.8%) terms; however private label grew volume by 90bps (source: Kantar Worldpanel).

La Doria management is keen to expand the vegetable line. The division offsets the more commoditised red line products and also has the advantage that production can occur throughout the year, rather than being concentrated within the three summer months of the tomato processing campaign. Expanding the vegetable line therefore would help improve group efficiency.

The fruit line accounted for 12% of revenues in FY15 (Exhibit 1). The profitability of the segment, however, is below that of the others, as it has suffered through several years of underperformance during the recent period of economic difficulties. As for the other divisions, 2015 pricing was mainly driven by the 2014 crop. Lower raw material costs resulted in decreasing prices. The 2015 fruit crop, however, witnessed a decline in volumes and hence raw material pricing was up sharply. This increase in raw material costs caused a stabilisation in both juices and concentrates pricing. In 2015, the Italian market was stable both in volume and value terms (source: IRI Infoscan). This is a marked improvement following years of significant volume and value decline. Private label continued to gain volume share of the total fruit juice market (c 50bps, according to Symphony IRI), though La Doria itself had a slight decline in share (c 90bps, according to company data based on Symphony IRI).

This segment was carved out following the acquisition of Pa.fi.al. It combined the acquired business with La Doria’s existing ambient ready-made sauces. The segment accounted for 11% of revenues in FY15 (Exhibit 1). During 2015 the domestic Italian market witnessed strong growth in terms of both value and volume. Tomato-based sauces were up 4.7% in volume terms and 5% in value terms, while pesto sauces were up 10% in both volume and value terms (source: Symphony IRI). Private label also grew and market share was up within the tomato-based segment. In the UK the ambient ready-made sauces market witnessed fairly stable volumes (+0.5%) but sharply lower value (-6%) (source: Kantar Worldpanel). Private label share expanded at the expense of the brands. Within the pesto subcategory, the UK market was up an impressive 12.3% in volume terms, with private label share expanding significantly (over 400bps in volume terms).

La Doria owns 58.0% of its subsidiary LDH. The LDH shareholder agreement was reviewed and updated following La Doria’s purchase of an additional 7.0% stake during 2015. This has led to a change in the accounting treatment of the minorities: La Doria now consolidates 100% of its minorities, and treats as debt the value of the put options that exist against it. LDH is the leader in the British market for private-label tomato-based products, pulses, dry pasta and canned tuna. The ‘other’ category is mainly composed of LDH’s sales and accounted for 28% of group sales in FY15.

The remaining 42.1% stake in LDH is owned by a combination of Thai Union Group, Di Martino and management. LDH’s three major shareholders – La Doria, Thai Union Group and Di Martino – together supply the majority of its ranges across tomatoes, pulses, tuna and pasta.

During FY15 the ‘other’ line witnessed stable volumes and a slight reduction in pricing.

La Doria’s recent share price performance has been positive. It has recovered significantly in the last three months, and it has outperformed relative to the FTSE MIB on a three-month, six-month and 12-month basis. Despite this, on 2016 estimates La Doria trades at 10.8x P/E and 7.7x EV/EBITDA, with a 2.1% dividend yield. This is at a discount of c 40% on P/E and c 20% on EV/EBITDA to the average of our peer group of private-label and small-cap food manufacturers, which we believe is unwarranted.

Our primary valuation methodology is DCF analysis, and we calculate a fair value of €15.84, or 26% upside from the current level. This is based on our assumptions of a 1.0% terminal growth rate and an 9.0% terminal EBITDA margin. Our WACC of 6.0% is predicated on an equity risk premium of 4%, a borrowing spread of 5% and beta of 0.8. Below, we show a sensitivity analysis to these assumptions and note that the current share price is discounting a terminal EBITDA margin of 8% (which compares to La Doria’s already reported EBITDA margin of 10.4% in 2015) and a terminal growth rate of c -0.5%.

La Doria’s key sensitivities include:

On 12 May, La Doria reported Q1 results in line with expectations. Consolidated revenue for the quarter of €168.3m was down 9.3% versus the prior year. The main culprit for the sales decline was a contraction in selling price, but currency movements also contributed to the reduction in sales. FX alone was responsible for a 1.8% decline in sales. International markets were down 12% in Q1, reversing a long period of revenue growth. Again, this was down to the combination of lower sales prices and adverse currency movements. The domestic market, however, was up 1.6% in revenue terms. The decline in organic growth in Q1 was mainly down to a reduction in selling prices, with volumes broadly stable.

Tomato-based product volumes were flat during the quarter, though pricing was substantially lower as a result of the 2015 tomato campaign. The vegetable line also witnessed a contraction in pricing caused by lower prices of many raw materials. Margins, however, held up well. Volumes were also somewhat lower. La Doria continued to extend its product range in the UK by launching baked beans enriched with a range of ingredients. The fruit line had a better quarter, with stable volumes and lower prices, both in the UK and in the domestic Italian market. The sauces line also witnessed stable volumes and lower prices. Growth in ‘other lines’ was again negative, driven by lower selling prices by LDH of dried pasta, canned salmon and corn.

By geography, domestic sales were up 1.6%, which is encouraging given the backdrop of the challenging 2015 tomato campaign. International sales were down 12%, also exacerbated by FX effects. International markets now represent 78% of sales.

We make no material changes to our forecasts, and we illustrate below our forecasts versus La Doria’s own targets for a range of metrics. Our forecasts are broadly in line with current targets. With current and forecast net debt/EBITDA comfortably below 2x, the balance sheet remains conservative.