Investing in food companies should be a safe bet in times of crisis (whatever else happens, people need to eat). So what to make of Northern Foods, producer of Goodfella’s Pizzas, Fox’s biscuits and own-label products such as sandwiches, salads, ready-meals and Christmas puddings? Since 2006 the shares have been on a one-way ticket south, due to worries over the recession and its £183m debt pile. It now trades at near all-time lows. Yet to me, the sell-off looks overdone.
Although Northern Foods is being hit by challenging conditions, it has closed loss-making factories, such as the one in Swansea, and replaced unprofitable contracts with the likes of Birds Eye with new business from British Airways and Costa Coffee. That has protected its 5.6% margins, while at the same time nudging like-for-like sales 1% higher.
In fact, such is the board’s confidence that the group is now further automating production facilities and ramping up investment in its brands. Examples include a timely £5m advertising campaign for Goodfella’s to take advantage of the World Cup. Despite this extra cost, the numbers are still attractive. The City forecasts 2010 turnover and underlying earnings per share of £990m and 6.7p respectively, rising to £1.0bn and 7.6p 12 months later. That puts the shares on undemanding forward p/e ratios of less than seven, and the firm also offers a yield of more than 9%.
Gamble of the week: Northern Foods (LSE: NFDS)
Fine, but what are the potential wildcards? The dividend may come under pressure in the event of another recession, but net debt at 1.9 times Ebitda is well within banking covenant limits of 3.5. And although CEO Stefan Barden admits the firm is exposed to a double-dip, its performance should prove resilient as cash-strapped households opt to eat in rather than go out to dine. The £150m pension deficit may also hold back the shares on concerns that the firm might have to top-up contributions after its triennial review next year. Yet Barden added that any payment wouldn’t be made until 2012, by when market swings may have reduced the deficit.
Lastly, the cut-throat food retail market will, of course, continue to be highly competitive. Of the firm’s sales, 71% are derived from its top five accounts – Asda, Marks & Spencer, Morrisons, Sainsbury’s and Tesco – so fostering good relations with these chains is vital. In conclusion, given its number one or two position, I would value the stock on a 12-times Ebita multiple. After adjusting for the debt and pension positions, I get an intrinsic worth of 69p per share. The next trading statement is scheduled for 13 July.
Recommendation: SPECULATIVE BUY at 45.25p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments