Finsbury Food Group - A Continuing Transformation

Finsbury Food Group Logo

Following the removal of companies like Communisis (LSE:CMS) and Quixant (LSE:QXT) from the site portfolio, I have sought to introduce a couple of revenue generating and profitable companies to replace them. The first of those introductions was consultancy company, Driver Group (LSE:DRV). The second is baking company, Finsbury Food Group (LSE:FIF), one of the smaller LSE listed food companies. The company is a leading UK manufacturer of cake, bread and bakery goods. The shares have performed well over the past year as they have continued to recover from the financial crisis. However, I reckon the shares should still offer investors appreciable upside. Finsbury is currently trading at a mid price of 59p. With 65.6m shares in issue, the company is being valued by the market  at £38.7m - this follows a retrace in the share price that gives the perfect opportunity for buyers who 'purchase the price dips' of fundamentally sound companies.

The chart above shows the current share price scenario. The share price has broken out of a steady uptrend and has broken below the 200 day moving average. At 59p, it is comfortably below the recent high of around 78p. Ordinarily this is a bearish scenario, but there a number of reasons to believe that this is merely an oversold period, that will soon be corrected. Not only do the RSI and MACD indicators show it to be oversold, but the dip has taken place during December. This is a period of the year when institutions tend to be less active within the markets (partly due to the proximity to Christmas). Therefore, there is less institutional 'support' on the buy side, and any downward movements tend to be exaggerated. Any bounce will probably take the share price back above the 200 day moving average, and if sustained, it can be confirmed as a false sentiment change. I fully expect the underlying upward trend to be maintained, either in a shallower, or steeper manner. The only bearish scenario would be if the share price were to re-visit 50p, but I deem that extremely unlikely. I am not concerned by the recent price drop, and would deem it an opportunity.

There are a number of share transactions to note. In June, executive director Crawford Currie purchased £23,000 worth of shares at 56p, whilst in July, the Chairman sold £3.5m worth of shares at an average just shy of 54p. Once again, this would usually be a bad sign, but the sale was fully taken up by institutions, who didn't demand a discount. Therefore, the sale could well have been to both improve market liquidity and improve the institutional backing of the company. Chairman Martin Lightbody retained a significant holding. I don't consider this to be particularly negative. Ruffer Investments and their discretionary clients have been building a stake over a number of months. That stake currently stands at 13%.

The final point to note that links in with the technical analysis, is that Crawford Currie (who was also the Finance Director of Lightbody, a company that Finsbury acquired) resigned in late November. The departure announcement did not state a reason, but it could well be that Currie had the chance of a better job opportunity elsewhere. That conclusion is aided by the fact that
Currie has been working for Finsbury/Lightbody for 15 years. This announcement could realistically have fuelled the downward swing with investors taking this relatively immaterial announcement as a sign to take profits.

Chances are that if you live in the UK and shop at large UK food retailers such as Sainsbury's, you have been in close proximity to Finsbury's products. In fact, you may have even bought them yourself. As a cake, bread and other goods manufacturer, one of the key streams of revenue is through supplying these stores. Finsbury is in fact the second largest manufacturer of 'Ambient Packaged Caked' (pre-packed cakes and in-store bakeries) in the UK. That market alone has been valued at £901m in June 2013.

The company's products are premium quality, with Finsbury voted 'Supplier of the Year' in the 2013 Bakery Awards. Their bakery operations are split into several sections:
- Lightbody (of Hamilton): A celebration cake supplier employing 1100 staff.
- Memory Lane: A cake business based in Cardiff employing 700 staff
- Nicholas & Harris: Salisbury based baking company that employs 500 staff. Manufactures specialist breads, rolls, hot cross buns and teacakes. Products are sold direct to UK retailers. Manufacturing facilities were recently expanded here. Finsbury acquired a lease on the neighbouring building which allowed for an extra 25,000 sq ft in space

However, only 59% of Finsbury's total sales volume are from entirely own-brand goods. Finsbury also licenses brands. These include WeightWatchers (for which it manufacturers low fat cakes), Thorntons (LSE:THT), Nestle Confectionary and Disney (primarily the manufacture of celebration cakes). Specialty breads brands are also licensed. Circa 87% of the total group revenue is generated in the UK, with the remaining classed as overseas. That overseas revenue is predominantly from Europe, so exchange rates do have some influence on their results. The European sales are completed through Lightbody Stretz (a business 50% owned by Finsbury). In terms of client revenue, 5 customers (large UK food retailers) account for 80% of the revenue. A point that needs to be emphasised is that there is not an undue amount of risk. Normally such revenue concentration means that the company would run a high amount of risk - if any major customer ceased selling the product, the financials would be significantly impacted. The reality is that the risk is not existent, due to the size of the clients.

One of the most important changes to the company occurred in February 2013. Finsbury disposed of their 'Free From' business to Genius Foods for a total sum of £21m. £18m of that is up front with a deferred consideration of £3m due in 2015. The sale was important in that it allowed Finsbury to dramatically reduce its debt pile, thus also reducing future interest payments. That has transformed the balance sheet. The company said, "Although the sale reduces the overall size of the business, the board viewed the disposal as a small step back that would allow us to take a much bigger step forward."

The Company released its final results in September, and that is what makes the company particularly interesting. The latest set of numbers came in slightly ahead of market expectations. These are the important figures and relate to continuing operations:

- Revenues at £176.6m vs £178.9m (decline partly down to currency fluctuations between EUR and GBP)
- Adjusted pre-tax profits of £5.5m vs £4.6m
- Adjusted diluted EPS of 5.9p vs 5.0p equates to a modest PE ratio of 10. The diluted figures have been used due to the large number of outstanding share options that have exercise prices close to 20p, hence will be exercised
- Total debt down 78% to £7.4m from £33.9m. This was achieved through the 'Free From' sale proceeds and a fully subscribed £3.8m equity placing from November 2012. That was completed at 38p. At the time, the money was due to be re-invested in order to 'deliver an annualised £2m/year benefit'
- Dividend re-instated for the first time since 2008. Total dividend of 0.75p/share equating to a small 1.27% yield
- Gross margin at 26.3%, which was aided by slightly lower commodity prices
- £6m set aside for new capital investment projects in the core cake business

Breaking down  the numbers, the company experienced 17% sales growth in bread products, driven by the growth of licensed prices (Vogel's, Cranks and Village Bakery), although the UK cake business had flat revenues. The bread improvement was helped by good sales at Sainsbury's and Waitrose. The company noted that the focus on specialty products helped the company as demand is less income elastic. Despite this, the UK performance does remain driven by consumer consumption trends so any improvement in consumer spending is likely to translate through to increased revenues. A key issue though, is the debt pile. I tend to steer clear of companies with large amounts of debts, but delving into the details unearths that it isn't much of a problem. £3.92m of debt is current (1 year), but Finsbury currently has over £23m of bank facilities undrawn, so if that debt needs to be repaid, it can simply be rolled over using other debt facilities. That is less of an issue as the company has robust operating cash flows, which totalled £8.25m for the year. Net payables of £7.7m exist on the balance sheet, although that figure drops down to £3.3m after accounting for inventories.

On a side note, it's probably prudent to point out that companies will start to benefit from the next drop in UK corporation tax to 21% (if they qualify) in April 2014. That should help the post-tax profits of businesses, and that will be further boosted as the corporation tax is set to drop to 20% in April 2015. A small point, but one that will be welcomed by companies.

Commenting on the results, John Duffy, Chief Executive of Finsbury Food Group plc, said: "These results signal the Group's shift from a transitionary period, to a new period of financial stability. Whilst a strategic disposal has driven this change, the Company is trading maturely, paying down debt and generating cash. Growth remains our priority. Driving organic growth is one of our key focus areas whilst evaluating bolt-on acquisition opportunities. We will ensure that we maintain our operational excellence and product innovation as this will continue to underpin our future growth. Following the reinstatement of the dividend, we are also pleased to announce the proposed total dividend at 0.75p. The Group now looks forward to directing this new stage of development and implementing our growth with the ultimate goal of creating value for our shareholders."

A quick comparison of key financials between Finsbury and other similar 'LSE Food Producers' is shown below. It shows that Finsbury's valuation still has room to the upside, should it be valued at a similar level to its peers. Of course, there are more factors to consider.

At the most basic level, the average PE ratio of Cranswick, Hilton, Dairy Crest, Greencore and Produce Investments, is 16.4. Were Finsbury to be trading on that metric, its share price would be around 96.8p/share. Also from the above, Finsbury's debt pile is better than Real Good Food's and Produce Investments. However, one thing that has to be accepted is that Finsbury's revenues are fairly stable and the business is not currently growing (although it may return to a growth phase as the economic climate continues to improve). For that reason, perhaps the outlined M&A activity would be the catalyst to drive a share price rerating.

In the short term, company results could benefit from a fall in EU sugar prices. Legislation brought in during July has removed the supply restriction formerly in place from sugar supply quotas. That has led to a fall in prices, and given that it is a commodity used extensively by Finsbury, it should help their production costs. The fall in sugar prices has been echoed by Read Good Food (RGD) and Associated British Foods, who are sugar suppliers.  In particular, RGD expressed concern about their sugar subsidiary, Napier Brown: "In Napier Brown we face a significant challenge following the well publicised dramatic drop in EU sugar market prices".

For the above reasons, Finsbury Food Group is an attractive company to have within a portfolio. Not only does it give diversity (most investors don't have food producers in their portfolio), but it should have limited downside. It promises steady growth, which could rise due to acquisitions, an improving profit trend, and a valuation lower than peers, meaning that there is likely to be upside for the share price. The company noted that "Although significant challenges remain in our business, a degree of momentum has become clearly apparent". That bodes well, and any improvement will probably send the shares far higher than what the market is pricing in. The recent price drop therefore represents an excellent opportunity to take a stake in a company that is undergoing a continuing transformation. I have placed a Buy tag on the shares at 59p.

UPDATE (30/06/14) - I have moved Finsbury Food from Buy to No Rating at 65p despite announcing that results would be ahead of expectations. This is part of a portfolio management in the event that there is any market decline in the coming months. The departure of Martin Lightbody may leave an overhang of stock, should he choose to dispose of his shares. Therefore, I have banked a circa 10% profit


  1. Looks baking hot ;-)! I hope you had a good xmas

    Excellent reviews as always, and of promising companies which is the hard bit!. It is one thing to review a company, and another thing to find the gems


  2. Picked up a slice. THanKs

  3. Nice article man. Right up there