KERRY GROUP: The Hunger Games · Kerry Group Plc (“Kerry”) is a UK and Irish listed company,...

KERRY GROUP: The Hunger Games

Authors: Matthew Earl – Managing Partner Mike Dennis – Partner This research report is a combination of an initial research report first distributed to clients at 5pm GMT on 30 November 2018 and a subsequent update note that was distributed to clients at 10am GMT on 16 April 2019.

ShadowFall Capital & Research LLP. All rights reserved. This document may not be reproduced or redistributed in whole or in part without prior written permission from ShadowFall Capital & Research LLP.

2

Contact: [email protected]

Terms & Conditions:

ShadowFall Capital & Research LLP’s terms and conditions (collectively, these “Terms”) are available here on the ShadowFall website (www.ShadowFall.com) and set out the basis on which you may make use of the ShadowFall website and its content, whether as a visitor to the ShadowFall website or a registered user. Please read these Terms carefully before you start to use the ShadowFall website.

By using, downloading from, or viewing material on the ShadowFall website you indicate that you accept these Terms and that you agree to abide by them. If you do not agree to these Terms, you must not use the ShadowFall website nor any of its content.

You must not communicate the contents of this report and other materials on this website to any other person unless that person has agreed to be bound by these Terms. If you access this website, download or receive the contents of reports or other materials on this website as an agent for any other person, you are binding your principal to these same Terms.

Investment Research Recommendation Disclaimer and Disclosures:

This research report, which contains an implicit research recommendation, has been produced by ShadowFall Capital & Research LLP (“ShadowFall”) which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN 782080), and published onto the ShadowFall website (www.ShadowFall.com) on 5 June 2019.

The content of this research report was produced exclusively by Matthew Earl who is the Managing Partner of ShadowFall and Mike Dennis who is a Partner at ShadowFall (the “authors”). This research report is a combination of an initial research report which was completed and first distributed to ShadowFall clients at 5pm GMT on 30 November 2018 and a subsequent update note which was distributed to ShadowFall clients at 10am GMT on 16 April 2019.

ShadowFall Capital & Research LLP manages an alternative investment fund (the “fund”) which inter alia takes positions in traded securities. At the time of publication on the ShadowFall website on 5 June 2019 the fund holds a short position in the issuer, which may include through options, swaps or other derivatives relating to the issuer. The fund may take further positions in the issuer (long or short) at a future date. In addition, at the time of publication on the website, an author of this research report is invested in the fund.

Neither the authors nor ShadowFall are aware of any factor, subject to the paragraph above, which might reasonably be expected to impair their objectivity in the preparation of this updated research report. The authors and ShadowFall are not aware of any direct or indirect conflicts of interest, subject to the paragraph above, that might exist between the authors or ShadowFall and any issuer which is the subject of this research report (the “issuers”). In particular, neither the author nor ShadowFall has any affiliation with the issuers.

Unless otherwise specified, the information and opinions presented or contained in this document are provided as of the date’s noted above. ShadowFall is under no obligation to update, revise or affirm this research report.

ShadowFall has taken all reasonable steps to ensure that factual information in this research report is true and accurate. However, where such factual information is derived from publicly available sources ShadowFall has relied on the accuracy of those sources.

Some of the open source data contained in this report may have been sourced from public records made available by Companies House, which is licensed under the Open Government License; https://www.nationalarchives.gov.uk/doc/open-government-licence/version/3/

All statements of opinion contained in the research report are based on ShadowFall’s own assessment based on information available to it. That information may not be complete or exhaustive. No representation is made or warranty given as to the accuracy, completeness, achievability or reasonableness of such statements of opinion.

This research report is only intended for and will only be distributed to investors who qualify as FCA defined Professional Clients (the “Recipient(s)”), who are expected to make their own judgment as to any reliance that they place on the research report. This document is not suitable for, nor intended for any persons deemed to be a “Retail Client” under the FCA Rules. In addition, distribution is not intended for any jurisdiction outside of which ShadowFall has permissions to distribute research.

This research report is for informational purposes only and is not an offer or solicitation to buy or sell any investment product. This report is the property of ShadowFall.

ShadowFall does not take responsibility or accept any liability for any action taken or not taken by the Recipient of a research report as a result of information and/or opinions contained in a research report. Specifically, Recipients of this document agree to hold harmless ShadowFall and its affiliates and related parties, including, but not limited to any partners, principals, officers, directors, employees, members, clients, investors, consultants and agents (collectively, the “ShadowFall Related Persons”) for any direct or indirect losses (including trading losses) attributable to any information and content on the ShadowFall website or in a research report.

In no event shall ShadowFall or any ShadowFall Related Persons be liable for any claims, losses, costs or damages of any kind, including direct, indirect, punitive, exemplary, incidental, special or, consequential damages, arising out of or in any way connected with any information or content on the ShadowFall website or in this document.

mailto:[email protected]

https://www.shadowfall.com/terms-and-conditions/

http://www.shadowfall.com/

https://www.shadowfall.com/terms-and-conditions/

http://www.shadowfall.com/

https://www.gov.uk/government/organisations/companies-house

https://www.gov.uk/government/organisations/companies-house

https://www.nationalarchives.gov.uk/doc/open-government-licence/version/3/




3

Recipients must exercise their own judgment and where appropriate take their own investment, tax and legal advice prior to taking or not taking action in reliance on the contents of this research report.

Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. ShadowFall makes no representation herein that forward-looking predictions shall come to pass. ShadowFall is committed to providing services and products which are unbiased and impartial and have implemented a Conflicts of Interest Policy pursuant to FCA rules which is available on request.

The existence and content of this research report has not been discussed in any way with the issuers or their corporate brokers prior to completion and publication. Neither the authors nor ShadowFall has received any payment from the issuer, its corporate broker or any connected party for preparing this research report.

Prior to completion and distribution, this research report has been seen by ShadowFall’s legal advisers and its regulatory advisers.

For US recipients: This report is being distributed in the US in compliance with the “Foreign Private Adviser” exemption under rule 202(a)(30) of the Investment Advisors Act 1940. The information contained in this report is intended solely for institutional investors only and may not be used or relied upon by any other person for any purpose. Such information is provided for informational purposes only and does not constitute a solicitation to buy or an offer to sell any securities under any U.S. federal or state securities laws, rules or regulations.

For Hong Kong recipients: This report is intended for Professional Investors only under the rules of the Hong Kong Securities and Futures Commission.


4

KERRY GROUP: THE HUNGER GAMES Kerry Group Plc (“Kerry”) is a UK and Irish listed company, capitalised €18.4bn. Kerry is a global provider of foods ingredients for the food, beverage and pharmaceutical industries. It has principally grown through a series of acquisitions. The group also produces and distributes branded consumer foods and private label foods in Ireland and the UK.

Kerry reported revenue of €6.6bn and net income of €596m in 2018.

Figure 1 Shepherd's Pie Trifle. NOTE: Not a Kerry product. Source: Bright/Kauffmann/Crane Productions. Warner Bros. Television.

The market seems to perceive Kerry as an innovative ingredients and flavourings business, driven by acquisitions, synergy gains, restructurings and underlying economic growth. Kerry’s share price is close to all-time highs, as it commands a valuation of 18.8x EV/EBITDA.

Over the decade past, Kerry certainly has been acquisitive, spending a cumulative €3.0bn on acquisitions since 2009 or 75% of its Free Cash Flow (FCF) generated during the same period. All paid for in cash. However, when we examine some of these acquisitions, we find a portrait of either loss making or generally low margin businesses, that in our view, stretch credulity as to how they collectively might assist Kerry in more than doubling its net income during the decade past. As such we have reason to question whether Kerry’s profitability may be inflated?


5

FOCUS ON ACQUISITIONS: WHAT IS KERRY BUYING?

LOW MARGIN TO LOSS MAKING ACQUISITIONS?

For an acquisitive business such as Kerry, we find that there is relatively limited disclosure regarding the financial metrics of the acquired businesses. When on occasion data is provided, it suggests that Kerry is buying relatively low margin businesses. According to this data provided by Kerry, the PAT margins of the businesses it acquired in the following years, collectively were:

2011: 1.0%

2015: 5.8%

2017: 4.3%

2018: 4.9%

These PAT margins are around half of that which is achieved by Kerry at a group level.

For such an acquisitive business it is unclear to us how Kerry consistently achieves margin progression when the businesses it acquires are apparently half as profitable as the existing group.

2019 ACQUISITIONS: ONE EX-GROWTH, ANOTHER AN EYE-WATERING VALUATION?

In December 2018, Kerry announced the acquisitions of Ariake USA and Southeastern Mills (SEM), for a combined consideration of €325m (completing Q1 2019). We calculate that Kerry paid c. 13.6x EBIT for Ariake USA and c. 24.7x EBIT for SEM. However:

1. From Ariake Japan’s filings, it appears that in Q4 2018, Ariake USA had gone ex-growth and that Ariake USA’s operating margin may have fallen by 890bps to 19.2% from the year prior.

2. Our view is that SEM is a fairly unspectacular seasonings and coatings business, with c. €78m in revenue. We believe that 24.7x EBIT is an eye-watering valuation to pay for such a business.

2018 ACQUISITIONS: €202M PAID FOR BUSINESSES WITH LESS THAN ZERO PROFITS AND ZERO

NET TANGIBLE ASSETS?

In October 2018, Kerry announced its acquisitions of Fleischmann’s Vinegar Company, Inc. (FVC) and AATCO Food Industries (AATCO), for a combined consideration of €365m.

In total, Kerry spent €502m on acquisitions in 2018, entirely satisfied in cash with a €3.6m deferred payment.

FVC has now had three owners since 2015. We calculate that Kerry paid 13.5x EBITDA for FVC, when its previous owner, Green Plains, two years prior paid a sub 10x EBITDA multiple.

Excluding FVC, Kerry made 9 other acquisitions in 2018. We calculate that:

1. Kerry paid €202.3m for these 9 businesses; 2. Between them they would have reported combined losses of €4.7m; 3. FVC contributed net tangible assets of €53.7m, suggesting that the 9 other businesses had net

tangible assets of €0.3m between them.

It appears to us that Kerry paid €202.3m for a group of businesses which combined had less than ZERO profits (estimated losses of €4.7m) and just €0.3m of net tangible assets between them.


6

2015 ACQUISITIONS: €216M PAID FOR BUSINESSES WITH LESS THAN ZERO PROFITS?

In October 2015, Kerry announced its acquisitions of Red Arrow Products (Red Arrow), Island Oasis, and Biothera Inc.’s Wellmune® (Wellmune®).1 The total consideration for the three businesses was reported as US$735m (c. €677m). Red Arrow, Island Oasis and Wellmune® were reported to have annualised revenues of US$301m (c. €249m) and EBITDA of US$59m (c. €49m) in 2014.

Excluding Red Arrow, Island Oasis and Wellmune®’s, Kerry purchased 7 other businesses in 2015. We calculate these other 7 businesses combined:

1. Were bought for €216.3m; 2. Would be expected to contribute c. €126.4m in full year revenue; 3. Would have been loss making by c. €13.1m in 2015.

2011 ACQUISITIONS: €386M PAID FOR BUSINESSES WITH ALMOST ZERO PROFITS?

In 2011, Kerry made 14 acquisitions at a cost of €386m (€362m in cash). At the point of purchase, we calculate that these businesses were achieving combined profit after tax of what we view as a relatively paltry €2.7m on €261.5m in revenue.

As an example of Kerry’s possible poor choice of acquisitions, we would highlight SuCrest GmbH. Kerry acquired the German based sweet ingredients and flavours business, SuCrest GmbH, in 2011 for €53.6m. Within five years of acquisition, SuCrest’s revenue and profitability had almost halved.

LIMITED REVENUE GROWTH EXCLUDING ACQUISITIONS?

On a constant currency basis, we calculate that net acquired revenues have contributed 82% to Kerry’s top line growth since 2010. Since we find that these acquisitions have typically achieved PAT margins which are around half that achieved by Kerry, we believe this makes Kerry’s margin progression all the more puzzling.

Kerry’s acquisitive appetite for revenue appears to us to be so voracious, that in 2011 we calculate it paid €140m for c. €17m of acquired revenue; i.e. an 8.2x revenue multiple.

KERRY COMPARED TO PEERS Kerry list several peers, we view Givaudan, IFF, Glanbia and Symrise as the principal peers, although out of these, Kerry appears to resemble Glanbia the most. Givaudan, IFF and Symrise report EBITDA margins of over 19%, by contrast, Kerry and Glanbia’s EBITDA margins are 14.3% and 13.7% respectively.

THE MARGIN MYTH

The market may be under the impression that Kerry’s lower EBITDA margins relative to its more profitable peers is driven by Kerry spending more on R&D as compared to those peers. However, this does not appear to be the case. We calculate that Kerry’s R&D as a percentage of its sales was 4.2% in 2018. This is less than half that of Givaudan at 8.6%, whilst also lower than IFF at 7.8% and Symrise at 6.4%. Even in absolute terms of euros spent, Kerry’s R&D expenditure does not appear extraordinary. In the competitive markets of flavourings and ingredients, such relatively low R&D investment does raise the question how Kerry hopes to compete in developing flavourings and ingredients?

1 Kerry announces US$735m further development initiatives in global Taste & Nutrition

https://www.investegate.co.uk/kerry-group-plc--kyga-/rns/kerry-group-announces-us-735m-acquisitions/201510151310144147C/


7

RESTRUCTURING COSTS – SIGNS OF LIMITED BANG FOR BUCK

Kerry has incurred a total of €556m in restructuring charges since 2009. This compares to Givaudan, IFF, Glanbia and Symrise which have spent €294m, €291m, €79m and €59m respectively over the same period. In terms of improving EBITDA margin, we calculate that Kerry’s incremental margin increase since 2009 has resulted in €847m in cumulative EBITDA gains, i.e. if €556m of restructuring costs has led to efficiencies and improved margins, then the apparent gain is €847m, or an incremental return of 1.52x of restructuring costs.

Kerry’s 1.52x return compares relatively poorly to the returns of Givaudan (3.38x), IFF (1.80x) and Symrise (8.26x) on incremental EBITDA gains from each of their respective restructuring costs. In our view, it raises the question as to how effective Kerry’s restructuring has been, especially when considering that Kerry’s restructuring expenditure has been significantly greater than its peers.

CASH TAX – PEERS SEEM TO PAY IN CASH WHAT THEY REPORT

When it comes to tax, Kerry appears to be an outlier against its peers in regard to how much tax it pays in cash compared to how much tax it reports on its P&L. Since 2013, Kerry has paid on average 52% of its P&L tax in cash, this compares to Givaudan (98%), Glanbia (82%), Symrise (108%) and IFF (78%).

DISPOSALS WHICH APPEAR TO CONTRADICT THE PURCHASER'S FILINGS

Kerry reports it received €115.7m in cash disposal proceeds in 2015. From our review of local filings of the disposed companies we find discrepancies between these filings and the figures which Kerry reports.

Our interpretation is that if the local filings are an accurate reflection of events, then it would lead us to conclude that Kerry’s 2015 and 2016 financial statements contain inaccuracies, or vice-versa. Further, in the light of the fact that Ms. Marguerite Larkin (Kerry’s current CFO) signed off on Kerry’s 2015 financial statements, when she was Kerry’s auditor, does not in our view inspire great confidence in her recent appointment as Kerry’s CFO (see corporate governance section).

Kerry reports a €115.7m disposal related cash receipt in 2015, whereas local filings make c. €110.8m of this tricky to reconcile.

KERRY’S CORPORATE GOVERNANCE We have some concern regarding Kerry’s corporate governance. Since 2015, almost half of Kerry’s fifteen-member Board (at that time) have retired, including its CEO and Chairman. In terms of the key replacement positions of CEO and Chairman, Kerry appointed a new CEO who had joined the Group through its graduate programme in 1996 and a Chairman who has been with the Group since 2012, formerly Chairing its Audit Committee.

The appointment that raises the proverbial eyebrow is that of Kerry’s CFO, Ms. Marguerite Larkin. It would appear that in the years prior to joining Kerry, Ms. Larkin was a Partner at Kerry’s former audit firm, Deloitte, and whilst there was personally responsible for the oversight and sign-off of Kerry’s 2014 and 2015 annual audits.

The Financial Reporting Council (FRC) specifically highlights ethical standards pertaining to this situation. While not in breach of these standards, nonetheless, Ms. Larkin’s appointment was recommended and approved by Kerry’s Board less than two years after her having signed-of Kerry’s 2015 financial statements. In our view, the timing of this decision somewhat stretches the Audit Assurance Ethical standards as prescribed by the FRC.


8

SIGNS OF WEAKENING CASH, P&L AND CASH TAX DIFFERENCES, A DSO BOOST

Kerry’s Free Cash Flow generation appears to have weakened somewhat over recent years. In nominal terms, we calculate that Kerry’s FCF peaked in 2016 at €569.9m and declined to €446.5m in 2018. Cash conversion from EBITDA appears to have fallen from 65% in 2016 to 47% in 2018.

As we mention, Kerry’s cash tax paid has, in our view, been markedly lower than its adjusted tax stated in its P&L statement since 2013. Our concern is that were it not for a deferral of c. 50% of Kerry’s P&L tax each year, then FCF might have been weaker. Another of our concerns is that if Kerry’s cash tax was paid at the statutory rate then Kerry’s profits may be inflated. For example, if in 2018, Kerry’s €46.1m in cash tax paid accurately reflected the Irish Standard Rate of Tax of 12.5%, then this would imply that the corresponding profit before tax (PBT) would have been €368.8m in 2018. This compares to adjusted PBT on Kerry’s P&L of €684.8m, an implied potential overstatement of €316.0m in 2018.

Kerry’s cash generation also appears to us to have been somewhat reliant on it extending the time it takes to pay its suppliers. We calculate that since 2008, Kerry’s Days Payable Outstanding (DPO) have risen from 83 days to 123 days. Put another way, had Kerry maintained its DSO and DPO at 2008 levels, then we believe that Kerry’s cash generated from operations (CGFO) would have been as much as €291m lower in 2018; or 38%.


9

FOCUS ON ACQUISITIONS: WHAT IS KERRY BUYING?


10

KERRY ACQUISITIONS

Since 2010, Kerry has spent a cumulative €2,798m on acquisitions, of which €1,246m relates to brand related intangibles and €1,153m is attributable to goodwill.

Figure 2 Kerry cumulative acquisition consideration and allocation to acquired asset base. Source: Kerry financial statements.

During this time, while volume growth has increased revenue by 30%, pricing growth has been flat at 1%. Given such significant spend on brand related intangibles, we question the value of such brand value when pricing power is apparently lacking. A counter argument could be that without such brand value, pricing would have been worse over the same time period.

Figure 3 Kerry cumulative acquisition of brand related intangibles and revenue volume and price growth. Source: Kerry financial statements.

32 155 221 262 291668 680 932

1,246

79224 312 381 477

886 8941,020

1,153

51

170192 204

216

322 324

344

398

0

500

1,000

1,500

2,000

2,500

3,000

2010 2011 2012 2013 2014 2015 2016 2017 2018

Cumulative acquisit ion consideration and breakdown, €m

Cumulative brand related intangibles expenditure

Cumulative goodwill

Cumulative other

32 155 221 262 291

668 680932

1,246

0

200

400

600

800

1,000

1,200

1,400

95%

100%

105%

110%

115%

120%

125%

130%

135%

2010 2011 2012 2013 2014 2015 2016 2017 2018

Kerry Group - volume and pr ice growth (%) as compared to brand related intangibles expenditure (€m)

Cumulative brand related intangibles expenditure

Volume growth (lhs)

Price (lhs)


11

For a business as acquisitive as Kerry’s, we are surprised how little information is provided regarding the financial metrics of the businesses being acquired. For example, Kerry made 10 acquisitions in 2018, at a consideration of €502.2m. When it comes to valuation multiples paid for these businesses, the disclosure is, in our view, somewhat lacking.

The only disclosure within Kerry’s 2018 financial statements is:

From the date of acquisition, the acquired businesses have contributed €34.0m of revenue and €0.2m of profit after taxation attributable to owners of the parent to the Group. If the acquisition dates had been on the first day of the financial year, the acquired businesses would have contributed €206.9m of revenue and €10.1m of profit after taxation attributable to owners of the parent to the Group.

From this information we calculate that Kerry collectively paid c. 2.4x revenue and c. 50x profit after tax for its 2018 acquisitions. However, in our view, this masks significant disparities between the financial metrics of the 10 businesses acquired (see Major 2018 Acquisitions).

When on the rare occasions, in our view, still limited data is provided, it suggests that Kerry is buying relatively low margin businesses. Since 2010, Kerry has provided revenue and profit after tax contribution information from its acquisitions in four years; in 2011, 2015, 2017, and 2018. This disclosure would appear to reflect the fact that these years incurred significant acquisition spend. However, according to the information provided, the PAT margins of the businesses acquired in these years, collectively were:

2011: 1.0%

2015: 5.8%

2017: 4.3%

2018: 4.9%

These PAT margins are generally at least half that of which Kerry was achieving at the time of acquisition; they average 4.0% as compared to Kerry’s average PAT margin of 8.1% during the period 2010 to 2018. Further, detail on the 2018 acquisitions is provided in figure 4.

Figure 4 Kerry disclosures on acquisitions contributions to revenue and profit after tax. Data unavailable for 2010, 2012, 2013, 2014, and 2016. Source: Kerry financial statements.


12

Figure 5 ShadowFall estimates of PAT margins of Kerry’s 2011, 2015, 2017 and 2018 acquisitions as compared to Kerry’s adjusted PAT margin. Data unavailable for other years. Source: Kerry financial statements. ShadowFall estimates.

We provide further detail in sections below regarding Kerry’s major acquisitions in 2015 and 2018 and the implications regarding the remaining businesses acquired in those years. However, in summary, we calculate that while Kerry’s major 2015 acquisitions of Red Arrow, Island Oasis and Wellmune® likely achieved a combined PAT margin of 12.8%, this would suggest that the remaining 7 businesses acquired in 2015 were loss making, with a combined Loss After Tax (LAT) margin of negative 10.4%. Similarly, we calculate that although Kerry’s major 2018 acquisition of Fleischmann’s Vinegar Company (FVC) likely achieved a PAT margin of 16.6%, that this would imply the remaining 9 businesses acquired in 2018, were loss making.

Figure 6 ShadowFall estimates of PAT margins of Kerry’s major 2015 and 2018 acquisitions and implications for PAT margins of remaining businesses acquired in 2015 and 2018, as compared to Kerry’s adjusted PAT margin. Source: Kerry financial statements. ShadowFall estimates.

6.8% 6.8%7.5%

8.3% 8.4%8.9% 9.0% 9.0%

1.0%

5.8%

4.3%4.9%

0%1%2%3%4%5%6%7%8%9%

10%

2011 2012 2013 2014 2015 2016 2017 2018

Kerry Group - PAT margins of acquired businesses as compared to Group PAT margin, %

Kerry adjusted PAT marginPAT margin of acquired businesses

12.8%

-10.4%

8.4%

16.6%

-4.0%

9.0%

-12%-9%-6%-3%0%3%6%9%

12%15%18%

Red Arrow, IslandOasis and

Wellmune®

Others Kerry Group Fleischmann'sVinegar Company

Others Kerry Group

Estimated PAT margins of major 2015 & 2018 acquisit ions and implications for remaining businesses acquired , %

2015 2018


13

MAJOR 2019 ACQUISITIONS: ARIAKE USA AND SOUTHEASTERN MILLS

In December 2018, Kerry announced its acquisitions of Ariake USA, the North American Business of Ariake Japan Co., and Southeastern Mills North American coatings and seasonings business (SEM).2 The total consideration for Ariake and SEM is expected to be €325m (completed Q1 2019). Ariake and SEM were reported to have annualised pro-forma third-party revenues of c. €125m, implying a price to revenue cost of 2.6x. We calculate that Kerry paid c. 13.7x EBIT for Ariake USA and c. 24.7x EBIT for SEM. However:

1. From Ariake Japan’s filings, it appears that in Q4 2018, Ariake USA had gone ex-growth and that Ariake USA’s operating margin may have fallen by 890bps to 19.2% from the year prior.

2. SEM appears to us to be a fairly unspectacular seasonings and coatings business, with c. €78m in revenue. We believe that 24.7x EBIT is an eye-watering valuation to pay for such a business.

ARIAKE USA

Ariake USA produces natural clean label savoury taste solutions derived from poultry, pork and vegetables at its facility in Harrisonburg, Virginia.

SOUTHEASTERN MILLS (SEM)

SEM manufactures coatings and seasonings at its strategically located manufacturing base in Rome, Georgia.

ARIAKE JAPAN DISCLOSURE

As appears to be a theme with Kerry, despite the total consideration paid being in the hundreds of millions of euros, the group provides relatively minimal information regarding the financial metrics of the acquired businesses. However, Ariake Japan Co., provides fuller details regarding its disposal of Ariake USA to Kerry.3

According to Ariake Japan, Ariake USA reported to 31 December 2017 (see figure 8):

• Revenue of $53.0m (€46.9m); • Operating income of $13.1m (€11.6m).

Further, Ariake Japan discloses that it disposed of Ariake USA for ¥20Bn, implying Kerry paid c. $178.6m (€158.7m) for Ariake USA. This would equate to 3.4x sales, and 13.7x operating income.

Figure 7 Ariake Japan disclosure regarding Ariake USA disposal. Source: Ariake Japan Q3 2019 financial statements, ShadowFall estimates for 2018.

2 Kerry announces two further strategic acquisitions 3 Ariake Japan press release on disposal of Ariake USA to Kerry Group

http://www.ariakejapan.com/en/ir/pdf/eng20190222_3q.pdf

https://www.investegate.co.uk/kerry-group-plc--kyga-/rns/kerry-announces-two-further-strategic-acquisitions/201812140700024519K/

http://www.ariakejapan.com/en/release/pdf/20181214.pdf


14

ARIAKE JAPAN DISCLOSURE OF SALES OF ARIAKE USA TO KERRY GROUP

Figure 8 Ariake Japan disclosure regarding Ariake USA disposal. Source: Ariake Japan Q3 2019 financial statements, ShadowFall estimates for 2018.



15

IMPLICATION 1

If the consideration for both Ariake USA and SEM totals €325m, then the above would imply that Kerry paid c. €146.4m for SEM, and that SEM is expected to contribute revenue of c. €78.1m. Further, that Kerry paid c. 1.87x sales for SEM.

SELL SIDE VIEWS

According to a Sell Side research report on the Ariake USA and SEM acquisitions, the combined businesses are estimated to currently generate a trading margin that is slightly lower than Kerry’s Taste & Nutrition (T&N) division. Kerry’s T&N division reported a trading margin of 15.3% in 2018. However, Ariake was expected to achieve an above T&N margin, due to its specialised extraction technology. Further, that the Ariake USA and SEM purchases would contribute just below 1% to Year 1 EPS.

IMPLICATION 2

On the basis of the disclosures by Ariake Japan for the Ariake USA business and the assumptions in the market from the Sell Side, we are able to extrapolate a calculation for the performance of SEM and its corresponding valuation paid by Kerry. This calculation can be seen in figure 9 and it implies that Kerry paid almost 25x EBIT for the SEM business.

In our view, paying 25x EBIT for a coatings and seasonings business seems high.

Figure 9 ShadowFall estimates of valuations paid for Ariake USA and Southeastern Mills based on Ariake Japan disclosures and Sell Side research views. Source: Ariake Japan and a Sell Side research note. ShadowFall.

HAD ARIAKE USA GONE EX-GROWTH?

Ariake Japan’s disclosures detailing the performance of Ariake USA showed that the business grew revenue by 21.8% to CY2017, and achieved an operating margin of 24.6% in the same period. However, at the time of its disposal to Kerry in early 2019, it appears that the Ariake USA business may have experienced a revenue decline of around 6.5% YOY and its operating margin having fallen to 19.2%.

Figure 10 shows that in the 9 months to 31 December 2018, Ariake Japan reported its US based revenue as having declined from ¥4.12Bn (US$36.8m) to ¥4.01Bn (US$35.8m), or by -2.7% YOY. Further, the final 3 months of CY2018 compared to the same period of CY2017, reported US revenue as having declined by -6.5% YOY.

In the final quarter of 2018, Ariake Japan’s US operating margin fell to 19.2% as compared to 28.1% a year prior.

The full year revenue attributable to the US broadly reflects the same level of revenue as Ariake USA, which was sold to Kerry in February 2019. We believe this suggests that Kerry acquired the Ariake USA business at a point when its revenue was in decline and its operating margin had fallen by 890bps.


16

Figure 11 also illustrates that historically, Ariake Japan’s US based revenue had been somewhat volatile, although there is likely to be some currency drivers to this.

Figure 10 Ariake Japan geographical revenue and operating income breakdown, Q1-Q3 2019 (to 31 December 2018). Source: Ariake Japan

Figure 11 Ariake Japan, US revenue. Source: Ariake Japan financial statements.

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

Q12015

Q22015

Q32015

Q42015

Q12016

Q22016

Q32016

Q42016

Q12017

Q22017

Q32017

Q42017

Q12018

Q22018

Q32018

Q42018

Q12019

Q22019

Q32019

Ariake US revenue, ¥Bn (Q3 2019 = 1 Oct to 31 Dec 2018)



17

Figure 12 Ariake Japan – revenue growth in the US. Source: Ariake Japan financial statements.

Figure 13 Ariake Japan, US operating margin. Source: Ariake Japan financial statements. Q4 periods = ShadowFall estimate.

-40%

-20%

0%

20%

40%

60%

80%

100%

Q1 2017 Q2 2017 Q3 2017 Q4 2017 Q1 2018 Q2 2018 Q3 2018 Q4 2018 Q1 2019 Q2 2019 Q3 2019

Ariake US revenue growth (%YOY)(Q3 2019 = 1 Oct to 31 Dec 2018)

0%

5%

10%

15%

20%

25%

30%

35%

0.00

0.10

0.20

0.30

0.40

0.50

0.60

Q12015

Q22015

Q32015

Q42015

Q12016

Q22016

Q32016

Q42016

Q12017

Q22017

Q32017

Q42017

Q12018

Q22018

Q32018

Q42018

Q12019

Q22019

Q32019

Ariake US operating income (¥Bn) and margin (%)(Q3 2019 = 1 Oct to 31 Dec 2018)


18

MAJOR 2018 ACQUISITIONS: FLEISCHMANN’S VINEGAR COMPANY AND AATCO FOOD INDUSTRIES In October 2018, Kerry announced its acquisitions of Fleischmann’s Vinegar Company, Inc. (FVC) and AATCO Food Industries LLC (AATCO).4 The total consideration for FVC and AATCO was reported as expected to be €365m. FVC and AATCO were reported to have annualised revenues of c. €150m. The deals were completed on 28 November 2018. As, in our view, is a trend with Kerry, the bare minimum details of the financial performance of each business were disclosed.

Figure 14 Kerry Group 2018 acquisitions and contributions. Source: Kerry financial statements.

FLEISCHMANN’S VINEGAR COMPANY, INC (FVC)

FVC is a USDA certified producer and US nationwide supplier of concentrated and specialty vinegars. Since 2010, FVC has changed ownership four times.5,6,7

Just two years prior to Kerry’s purchase of FVC, it was purchased by Green Plains Inc. from Stone Canyon Industries for $258.3m (€246m) in October 2016, for somewhere between a 2.0x to 2.5x multiple of revenue.8 Stone Canyon itself had acquired FVC just one year prior.

4 Kerry announces further strategic acquisitions 5 RLJ Equity acquires Fleischmann's Vinegar in 2010 6 Stone Canyon Industries acquires Fleischmann's Vinegar in 2015 Stone Canyon Industries acquires Fleischmann's Vinegar in 2015 7 Green Plains acquires Fleischmann's Vinegar in 2016 8 Green Plains acquires Fleischmann's Vinegar 2016 EUR:USD 1.05

https://www.kerrygroup.com/docs/news/featured/Kerry-announces-further-strategic-acquisitions-25.10.2018-(002).pdf

https://www.genewsroom.com/press-releases/senior-secured-loan-fund-provides-53-million-facility-fleischmanns-vinegar-232933

https://www.harriswilliams.com/transaction/fleischmanns-vinegar-company-inc-0

https://mergr.com/stone-canyon-industries-acquires-fleischmann-s-vinegar

https://mergr.com/stone-canyon-industries-acquires-fleischmann-s-vinegar

https://www.foodprocessing-technology.com/news/newsstone-canyon-completes-sale-of-sci-ingredients-for-250m-5022683/

http://investor.gpreinc.com/static-files/11712422-e825-4747-856e-4e2dcf739f40


19

In terms of profitability, Green Plains indicated that FVC was acquired on a forward sub-10x EBITDA multiple before any synergies. Further, that FVC had a “stable and predictable earnings stream”, and a “consistent earnings growth rate, well above industry average due to scale and scope of operation.”

At the time of acquisition in October 2016, Green Plains detailed FVC as having sales of between $100m to $125m, with the business growing at 2% to 3%.9 This would imply sales of €95m to €119m, and on c. 9x EBITDA multiple, likely EBITDA of $27.7m (c. €26.4m).

Around two years later in August 2018, Green Plains indicated that FVC‘s sales had experienced cumulative annual growth in revenue and EBITDA of 8% and 15%, respectively10, suggesting that FVC’s revenues had grown to between $108m to $135m (€96m to €120m) while EBITDA had risen to c. €32.4m. However, according to correspondence with Green Plains’ IR, around the time of its disposition, “FVC generated around $105m [€89m] of revenue annually”.

Figure 15 Green Plains summary of Fleischmann’s Vinegar Transaction from 3 October, 2016. Source: Green Plains Inc

9 Green Plains acquires Fleischmann's Vinegar Company - M&A call 10 Green Plains Earnings Call Q2 2018 - 1 August 2018

http://investor.gpreinc.com/static-files/11712422-e825-4747-856e-4e2dcf739f40

http://investor.gpreinc.com/static-files/1403c269-34ed-4f57-b861-69011c200657

http://investor.gpreinc.com/static-files/75d15cf8-d416-42d9-81e6-ed05ffc70e7b


20

Figure 16 FVC's identifiable assets when acquired by Green Plains Inc., in October 2016. Source: Green Plains Inc.

Figure 17 FVC identifiable assets disposed of when Green Plains Inc., disposed of FVC to Kerry Group in November 2018. Source: Green Plains Inc.

http://investor.gpreinc.com/static-files/49a31029-5b1a-41a9-9f0a-c5be762f26ad

http://investor.gpreinc.com/static-files/c7023802-272b-4814-9301-1b4fe63887d6


21

IMPLICATION 1

The above would suggest that:

• FVC has had four owners since 2010 and three since 2015.

• FVC’s revenues appear to have grown relatively modestly, if at all, under ownership by Green Plains until its disposal to Kerry.

• Green Plains, having purchased FVC in October 2016 for $258.3m sold the business two years later to Kerry for $353.9m; a $95.6m mark-up in value in two years.

• When acquired by Green Plains, Green Plains attached $142.8m in goodwill and $94.5m in intangible asset value to FVC; $237.3m (€226m) combined.

• When sold to Kerry, FVC’s net tangible asset value was $63.4m (€53.7m), implying Kerry ascribed $290.5m (€246m) in value to FVC relating to goodwill and intangibles.

• Acquired by Kerry for $353.9m (€300m), if FVC was generating revenue of around $105m, then we calculate that Kerry paid c. 3.4x revenue for FVC.

• Green Plains purchased FVC for sub 10x EBITDA multiple. Assuming this meant 9x, implies that FVC was achieving EBITDA margins of c. 25% at the time of acquisition in October 2016.

• If FVC’s revenue was $105m, when Kerry acquired it and it remained at a c. 25% EBITDA margin, then this would imply Kerry paid a 13.5x EBITDA multiple.

Kerry only disclosed the price paid and revenue expectation for the combined businesses of FVC and AATCO Food Industries LLC.

Figure 18 Announcement of FVC and AATCO acquisitions. Source: Kerry RNS.

IMPLICATION 2

If Kerry paid $353.9m (€300m) for FVC, then this implies €65m was paid for AATCO. Further, if FVC was achieving $105m (€89m) in full year revenue, then this would imply that AATCO was achieving €61m in full year revenue and that Kerry paid 1.06x sales for AATCO.

AATCO FOOD INDUSTRIES LLC (AATCO)

Headquartered in Muscat, Oman, Kerry describes AATCO as a leading provider of culinary sauces to the food service channel. There is little information available regarding AATCO, other than an Owler reference which estimates AATCO’s revenue at $16m (€14.2m), although without any reference date.11 However, this Owler estimate would obviously contradict the estimate above which suggest that AATCO’s revenues are over 4x this level.

11 Owler: AATCO's Revenue

https://www.investegate.co.uk/kerry-group-plc--kyga-/rns/kerry-announces-further-strategic-acquisitions/201810250700031036F/

Owler:%20AATCO's%20Revenue


22

OTHER ACQUISITIONS OF 2018 AND IMPLICATIONS We calculate, excluding FVC and AATCO, the other 8 businesses which Kerry acquired in 2018, would be expected to contribute c. €56.9m in full year revenue. Further, that this would imply that these businesses were acquired for c. 2.4x revenue.

What we find more interesting is that when excluding FVC, we calculate that the remaining 9 businesses acquired by Kerry in 2018, would have been loss making by c. €4.7m in 2018.

Kerry states that if acquired at the start of its 2018 financial year then the 10 acquisitions would have contributed €10.1m of profit after taxation. However, if FVC was achieving a c. 25% EBITDA margin as per Green Plains’ indication above, and FVC’s D&A was in line with Kerry’s at c. 2.7% of sales, then at a 20% tax rate, this would suggest that FVC would contribute c. €14.8m in profit after tax in 2018. Therefore, the remaining 9 businesses would be expected to contribute a combined loss of €4.7m.

While FVC appears to be a good quality business, it does seem to us that FVC’s contribution somewhat conceals the combined losses of the other 9 remaining businesses which were acquired in 2018.

Did Kerry really pay €202.3m for a group of businesses that combined lost €4.7m?

We calculate that for the other 9 business to have made ZERO profits in 2018, would imply FVC would have to achieve an 18% EBITDA margin or lower. This would put the acquisition multiple paid by Kerry at c. 18.7x EBITDA, when Green Plains had paid sub 10x just two years earlier. We believe this is unlikely, supporting our view that Kerry paid €202.3m for 9 business that made less than ZERO profits.

Figure 19 2018 acquisition contribution to Kerry's 2018 financial result. Source: Kerry 2018 financial statements.

Figure 20 Kerry 2018 acquisitions revenue contributions. Source: Kerry financial statements. ShadowFall estimates.


23


FURTHER IMPLICATIONS

As per Green Plains disclosures, when FVC was sold to Kerry, Green Plains reported that FVC had $64.6m (€54.7m) in PPE, and $63.4m (€53.7m) in net tangible assets.

Figure 22 FVC assets and liabilities reported by Green Plains Inc. when FVC disposed to Kerry. Source: Green Plains Inc.

http://investor.gpreinc.com/static-files/c7023802-272b-4814-9301-1b4fe63887d6


24

However, when Kerry reports the combined assets and liabilities contributed by its ten acquisitions in 2018 it highlights a PPE contribution of €79.8m and a net tangible asset addition of €54m. But if FVC had €54.7m in PPE and €53.7m in net tangible assets then this would imply that the nine remaining businesses acquired contributed €25.1m in PPE and €0.3m in net tangible assets.

Did Kerry really pay €202.3m for a group of businesses which combined had less than ZERO profits (estimated losses of €4.7m) and had just €0.3m of net tangible assets between them?

Figure 23 Asset and liability contributions from Kerry's 2018 acquisitions. Source: Kerry financial statements.


25

Figure 24 Estimated asset and liability contribution from 2018 acquisitions. Source: Green Plains Inc. and Kerry financial statement. ShadowFall calculations.


26

MAJOR 2015 ACQUISITIONS: RED ARROW PRODUCTS, ISLAND OASIS, WELLMUNE® In October 2015, Kerry announced its acquisitions of Red Arrow Products (Red Arrow), Island Oasis, and Biothera Inc.’s Wellmune® (Wellmune®).12 The total consideration for the three businesses was reported as US$735m (c. €677m). Red Arrow, Island Oasis and Wellmune® were reported to have annualised revenues of US$301m (c. €249m) and EBITDA of US$59m (c. €49m) in 2014. The deals were completed on 22 October 2015.13

Figure 25 Kerry major 2015 acquisitions. Source: Kerry Q3 2015 IMS

OTHER ACQUISITIONS OF 2015 AND IMPLICATIONS

Assuming Red Arrow, Island Oasis and Wellmune®’s combined revenues and EBITDA remained stable in 2015, we calculate, excluding these three businesses, the remaining 7 businesses which Kerry acquired in 2015 would be expected to contribute c. €126.4m in full year revenue. Further, that this would imply that these businesses were acquired for c. 1.7x revenue. However, what we find more interesting is that when excluding Red Arrow, Island Oasis and Wellmune®, we calculate that the remaining 7 businesses acquired by Kerry in 2015, would have been loss making by c. €13.1m in 2015. While Red Arrow, Island Oasis and

12 Kerry announces US$735m further development initiatives in global Taste & Nutrition 13 Source: Bloomberg.

https://www.kerrygroup.com/investors/results-presentations/Q3-2015-IMS-Presentation-Final.pdf

https://www.investegate.co.uk/kerry-group-plc--kyga-/rns/kerry-group-announces-us-735m-acquisitions/201510151310144147C/


27

Wellmune® appear to be good quality businesses, it seems to us that their contribution somewhat conceals the combined losses of the other 7 businesses which were acquired in 2015.



28

MAJOR 2011 ACQUISITIONS: WHAT DID KERRY BUY FOR €386.4M? In 2011, Kerry spent €386.4m on 14 bolt-on acquisitions. When accounting for what appear to be the three largest acquisitions of 2011, we calculate that Kerry paid €140.3m for an expected €17.2m full year revenue contribution from the remaining 11 acquisitions in 2011. This equates to 8.2x revenue. We are surprised to find such a lofty implied revenue multiple paid.

REVENUE AND PRICES PAID OF ACQUIRED BUSINESSES

The greatest acquisition expenditure in 2011 was attributable to the purchase of Cargill Flavour Systems (CFS), for €172.6m in cash.14,15 With regards to CFS, Kerry states the following (our bold for emphasis):

Due to the fact that CFS was acquired near the end of 2011, the revenue included in the Group’s reported revenue is not material and loss after tax and acquisition related costs included in the Group results was €3m. In a full year CFS is expected to contribute revenue of €142.9m.16

Kerry also indicates:

The main acquisitions contributed revenue of €56.6m to the Group in 2011. If these acquisitions had been completed on 1 January 2011, total Group revenue for the year would have been €5,507.1m.17

AN 8.2X REVENUE MULTIPLE?

Kerry’s total revenue was €5,302.2m in 2011. If 2011’s acquisitions had contributed €56.6m to this reported figure, then we calculate that excluding this contribution, Kerry’s revenue would have been €5,245.6m.18

As Kerry mentions, if the main acquisitions had been completed on 1 January 2011, then total revenue would have been €5,507.1m in 2011. We calculate this to imply that these acquisitions would have contributed €261.5m in revenue for a full financial year.19

Whereas Kerry discloses the price it paid for CFS as €172.6m, and CFS’s expected contribution to revenue of €142.9m in a full year, it does not disclose the price paid nor any other individual revenue contribution by any other acquisition.

Among the 14 acquisitions of 2011, the following businesses were also acquired:

• SuCrest GmbH, domiciled in Germany, a provider of sweet ingredients; and

• Headland Foods Limited, domiciled in the UK, a manufacturer of frozen customer branded ready meals.

14 Kerry Group 2011 Annual Filing – “The most significant acquisitions in the year were Cargill Flavour Systems which closed in December and SuCrest GmbH acquired in October.” 15 Ibid – Note 30. Page 131. 16 Ibid – Note 30. Page 132. 17 Ibid. 18 Calculated as Full Year 2011 revenue of €5,302.2 million less the acquisition contribution of €56.6 million equals revenue excluding the acquisition contribution of €5,245.6 million. 19 Calculated as revenue excluding the acquisition contribution of €5,245.6 million (as calculated in the note above) plus €261.5 million equals €5,507.1 million stated as the event if the acquisitions had contributed a full financial year’s revenue. Hence, the full year contribution from the acquisitions would have been €261.5 million.


29

According to information available for the above companies at their respective registers (see figures 28 and 29), Kerry paid:

• €53.6m for SuCrest GmbH20; and

• £17.3m or €19.9m for Headland Foods.21

Figure 27 Purchase details of SuCrest GmbH. Purchased for €53.6 million. Source: Kerry Ingredients GmbH 2013 Annual Filing, www.bundesanzeiger.de

Figure 28 Purchase details of Headland Foods Limited. Assets disposed by Headland Foods for £17.3 million. Source: Headland Foods Limited 2011 Annual Filing

20 Kerry Ingredients GmbH 2013 Annual Filing. 21 Headland Foods Limited 2011 Annual Filing. FX Rate of 0.87 EUR:GBP used.

http://www.bundesanzeiger.de/


30

As detailed above, in 2011, corporate filings show that Kerry paid a total of:

• €172.6m for CFS;

• €53.6m for SuCrest GmbH; and

• €19.9m for Headland Foods Limited.

In total, Kerry appears to have paid €246.1m for the three businesses.

In terms of 2011 revenue, these three businesses either reported or were expected to achieve as follows:

• €142.9m for CFS;

• €42.8m for SuCrest GmbH; and

• €58.7m for Headland Foods Limited.22

Total reported or expected revenue for the three businesses was €244.3m.

Since Kerry paid a total of €386.4m for the 14 acquisitions it made in 2011, and as highlighted above, €246.1m of this related to payment for CFS, SuCrest, and Headland Foods, then we calculate that the remaining €140.3m must relate to the other 11 acquisitions.

On the basis that a full year’s revenue contribution from Kerry’s 2011 acquisitions would have contributed €261.5m (as calculated above) and that either reported or expected revenue related to CFS, SuCrest, and Headland Foods was €244.3m, then we calculate that the remaining 11 acquisitions would have contributed €17.2m to 2011’s full year revenue.

We calculate that Kerry paid €140.3m for an expected €17.2m full year revenue contribution in 2011. This equates to 8.2x revenue. We are surprised to find such a lofty implied revenue multiple paid. Kerry trades on c. 2.7x revenue23. Further, an 8.2 x revenue multiple seems elevated when also considering that Kerry paid:

• c. 1.2x revenue for CFS;

• c. 1.3x revenue for SuCrest GmbH; and

• c. 0.3x revenue for Headland Foods

22 Headland Foods Limited 2011 Annual Filing – Revenue for 53 weeks ended 2 April 2011 totalled £51.1 million. Revenue of 15 months ended 27 March 2010 totalled £88.9 million or c. £71.1 million 12 month run rate. FX rate of 0.87 EUR:GBP used. 23 Bloomberg consensus multiple as at report date.


31

Figure 29 Kerry Group revenue and acquired revenue from 2011 acquisitions and prices paid, € million. Source: Kerry Group, SuCrest GmbH, Kerry Ingredients GmbH and Headland Foods Limited Annual Filings. Note. Headland Foods Limited revenue for 53 weeks ended 2 April 2011. FX rate of 0.87 EUR:GBP used.

COMBINED LOSSES OF €0.9M?

Aside from the seemingly lofty revenue multiples paid for some of Kerry’s 2011 acquisitions, the profitability of these businesses also, in our view, appears weak. For example, Kerry highlights (our bold for emphasis):

During 2011 after allowing for acquisition related costs the main acquisitions contributed a loss after tax of €10.8m. If these acquisitions had been completed on 1 January 2011, the Group profit after tax would have been €370.6m.24

Kerry reported a profit after tax of €360.7m in 2011. If the 2011 main acquisitions had contributed a loss of €10.8m to this reported figure, then we calculate that excluding this contribution, Kerry’s profit after tax would have been €371.5m.25

24 Kerry Group 2011 Annual Filing – Note 30. Page 132. 25 Calculated as Full Year 2011 profit after tax of €360.7 million add back the acquisition loss contribution of €10.8 million equals profit after tax excluding the acquisition contribution of €371.5 million.


32

As Kerry mentions, if the main acquisitions had been completed on 1 January 2011, then total profit after tax would have been €371.5m in 2011. We calculate this to imply that these acquisitions would have contributed a loss after tax of €0.9m for a full financial year.26

Expenditure of €386.4m on acquisitions in 2011 seems to us as somewhat high considering the combined losses that we calculate would have been attributable in a full financial year to those acquisitions.

GOODWILL OF €110M ASSOCIATED WITH €17.2M OF ANNUALISED REVENUE?

Another feature of the 2011 acquisition spend is the asset base that appears to have been acquired. Kerry’s 2011 annual filings detail CFS as reporting €52.8m in total identifiable assets prior to acquisition. A review of SuCrest’s annual filings reveals that it reported €7.9m in total identifiable assets in its financial year to 31 December 201127. Further, Headland Foods details within its 2011 annual filings that it disposed of £12.0m in tangible fixed assets and £5.3m in stock (€19.9m combined). Given that Kerry reported total identifiable assets of €110.9m for CFS and €110.9m for its 13 other acquisitions before combination, this would indicate that excluding CFS, SuCrest and Headland Foods, the eleven remaining acquired companies had combined identifiable assets of €30.4m. On the basis that we calculate €140.3m was collectively paid for these eleven businesses, it would appear that c. €110.0m was attributable to Goodwill.

As we calculate above, €110.0m in Goodwill for businesses which we estimate would contribute €17.2m in annual revenue, strikes us as a lofty valuation. Post-acquisition, a sizeable portion (€123.2m) of Goodwill appears to have been adjusted to reflect value attributable to “Brand related intangibles”.

Figure 30 Kerry Group 2011 acquisitions, carrying amounts pre and post-acquisition, € million. Source: Kerry Group, SuCrest GmbH, Kerry Ingredients GmbH, Headland Foods Limited 2011 Annual Filings

26 Calculated as loss after tax excluding the acquisition contribution of €371.5 million (as calculated in the note above) less €0.9 million equals €370.6 million stated as the event if the acquisitions had contributed a full financial year’s revenue. Hence, the full year contribution from the acquisitions would have been a loss of €0.9 million. 27 This figure was also echoed by Kerry Ingredients’ GmbH 2012 Annual Filing which took ownership of the SuCrest GmbH.


33

QUALITY OF ACQUISITIONS: SUCREST GMBH

From the 2011 acquisitions detailed above, which we calculate would have contributed combined losses after tax of €0.9m in a full financial year, SuCrest appears to be one of the more sensible acquisitions. We say sensible due to the fact that SuCrest was profitable in 2011.

SUCREST GMBH

Kerry acquired SuCrest in October 2011 for €53.6m. SuCrest reported revenue and EBIT of €42.8m and €4.4m respectively to 31 December 2011; revenue was at a seven-year high. The acquisition was described as “significantly expanding the Group’s sweet ingredients & flavours business in the EMEA region”.

Five years after its acquisition and there does not appear to have been much of an expansion28. By contrast, SuCrest’s revenue has fallen by 44% to €24.1m as at 31 December 2016.

During the same period, when we separate out the reimbursed income received and costs allocated to other Kerry Group companies, we find that SuCrest’s EBIT has declined to €2.1m in 2016. I.e. SuCrest’s profitability has more than halved since Kerry acquired it. A review of SuCrest’s local filings highlights aggressive competition and difficulty to pass on price increases from increased costs.

If SuCrest is an example of the general quality and success of Kerry’s acquisitions, then in our view, it is not an encouraging sign for such an acquisitive business.29

28 SuCrest GmbH’s Annual Filings are available to 31 December 2016. We expect 2017’s filings to be available in February 2019.

Figure 31 SuCrest GmbH revenue in the lead up to its acquisition by Kerry in 2011 and post-acquisition, € million. Source: SuCrest GmbH Annual Filings, www.bundesanzeiger.de


29 To be clear, there has been no “cherry-picking” of acquisitions to find those that have performed poorly. It is simply that SuCrest is the only acquisition where we could find financial information post-acquisition. Whether SuCrest is a wider reflection of Kerry’s other acquired companies is uncertain.

20

25

30

35

40

45

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

SuCres t GmbH revenue , €m

0

1

2

3

4

5

6

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

SuCres t GmbH EBIT exc lud ingne t revenues and cos t a l l oca t ions to o the r Group compan ies , €m




34

SUCREST GMBH: WIDER GERMAN ISSUES?

Whilst reviewing the performance of SuCrest we would also highlight what appear to be more wide-spread competitive issues within the German market itself.

Kerry Ingredients GmbH is a long-standing business in the German market. Kerry Ingredients’ revenue has fallen sharply from €71.2m in 2011 to €45.2m in 2016. Admittedly a sharp decline was reported in 2013, when revenue reportedly fell by €16.3m, which was largely due to the close of a plant in 2012. Nonetheless, in a similar fashion to SuCrest, Kerry Ingredients reports industry-wide pressures in key European export markets, high pressure on margins and limited growth potential in future years.

Profitability at Kerry Ingredients also seemingly suffered around 2012 and 2013, although has made some rebound more recently.

When Kerry Ingredients reported the purchase of SuCrest it had indicated that it expected to receive synergy benefits on the cost side by combining certain administrative areas with SuCrest. However, it is not altogether clear to us where this has occurred.



48.651.9

60.5

68.764.7 66.9

71.2

59.4

43.0 41.0 40.545.2

25

35

45

55

65

75

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Kerry Ingredients GmbH revenue, €m

6.67.8

6.78.2 8.1

9.610.9

1.20.0

5.87.0

4.3

0

2

4

6

8

10

12

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Kerry I ng red ien ts GmbH EBIT exc lud ing ne t revenues and cos t a l l oca t ions to o the r Group compan ies and pro f i t / ( loss ) t rans fe r

f rom SuCres t , €m




35

KERRY COMPARED TO PEERS


36

KERRY VS. PEERS

Kerry list a number of peers within its accounts.30 In our view, the main peers are:

Givaudan – a Swiss manufacturer of fragrances and flavours.

Glanbia – an Irish based producer of dairy, consumer foods, and nutritional products.

International Flavors & Fragrances (IFF) – US manufacturer and supplier of flavours and fragrances.

Symrise – a German listed producer of perfume oils, fragrances, ingredients, and flavourings.

We believe the best peer is Glanbia, principally due to the comparable lines of business and the clear discrepancy in EBITDA margins whereas Givaudan, IFF, and Symrise, achieve significantly greater margins than Kerry and Glanbia.

30 Kerry 2018 financial statements – page 125

Figure 35 Kerry peers. Source: Respective company financial statements, Bloomberg Finance L.P., Data accurate as of 20 May 2019.

Figure 36 EBITDA margins of Kerry and its peers. Source: Respective company financial statements, Bloomberg Finance L.P.

7%9%

11%13%15%17%19%21%23%25%

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

EBITDA Margin, %

Kerry Givaudan Glanbia IFF Symrise


37

KERRY VS. PEERS

As highlighted in figure 37, while Kerry has seemingly achieved improvements in its profitability per employee over recent years, it still falls short of peers.

We calculate Kerry’s EBITDA per employee to be less than €40,000.

This compares to IFF, Symrise and Givaudan which we calculate to achieve EBITDA per employee north of €50,000 and in Givaudan’s case, over €70,000 per employee.

Figure 37 EBITDA per employee. Source: Respective company financial statements, Bloomberg Finance L.P, ShadowFall estimates.

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

Kerry Glanbia IFF Symrise Givaudan

EBITDA per employee, €

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018


38

CASH TAX VS. PEERS As we go into more detail below, since 2013, Kerry’s cash tax paid has been around half of the figure reported on its P&L statement.

When compared to Kerry’s peers this shortfall in cash tax paid compared to P&L reported tax appears to be an outlier.

It’s unclear to us why Kerry consistently pays significantly less tax than it reports. A Financial Times journalist, Dan McCrum, apparently queried the company on this in an article from July 2016:

“So, why is the €68m total for tax paid on the cash flow statement for the last two years less than half the bill described on the income statement?

Answer: investment, of a type which defers tax payments in a way which before 2014 it had not.”

Assuming this to be accurate, we find this unusual for three reasons:

1. Kerry’s lower cash tax compared to P&L tax appears to have begun to diverge from 2011/12.

2. Why do Kerry’s peers not use this type of investment to defer their tax?

3. For how much longer can Kerry defer its tax?

Figure 38 Cash tax paid as compared to tax reported on the P&L statement. Source: Respective company financial statements. Bloomberg Finance L.P and ShadowFall.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

120%

130%

140%

150%

160%

Kerry Givaudan Glanbia Symrise

Cash tax paid as % of income tax expense

2013

2014

2015

2016

2017

2018

https://www.ft.com/content/7523ee90-4f38-11e6-8172-e39ecd3b86fc


39

CASH TAX VS. PEERS

The cash tax against P&L tax disparity between Kerry’s peer group is, in our view, more apparent on a cumulative basis.

During the period 2013 to 2018, Kerry reports a cumulative total of €505.2m in tax within its P&L statement. This compares to a cumulative total of €263.2m in tax paid within Kerry’s cash flow statement over the same period.

This implies that during the period 2013 to 2018, Kerry has paid in cash terms c. 52.1% of the tax it has reported in its P&L.

Over the same period, Kerry’s peers pay in cash between 78% (IFF) to 108% (Symrise) of the actual tax reported on their respective P&L statements.

Figure 39 Cumulative cash tax paid as compared to tax reported on the P&L statement (2013-2018). Source: Respective company financial statements. Bloomberg Finance L.P. and ShadowFall.

52.1%

77.9%82.2%

97.7%

107.9%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

Cash tax paid as % of tax reported on the P&L (2013-2018)

Cash tax paid as % of income tax expense

Kerry IFF Glanbia Givaudan Symrise


40

RESTRUCTURING COSTS VS. PEERS

Kerry has incurred significant restructuring costs during the decade past. For example, in 2012 and 2013, Kerry incurred a combined €345m in restructuring charges. In 2018, a further €44m was incurred.

Cumulatively, Kerry has incurred €556m in restructuring charges since 2009.

Cumulative restructuring costs since 2009:

Kerry €556m

Givaudan €294m

Glanbia €79m

IFF €291m

Symrise €59m

Figure 40 Restructuring costs incurred since 2009. Source: Respective company financial statements. ShadowFall.

-

25

50

75

100

125

150

175

200

225


Restructuring costs, €m

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018


41

BANG FOR BUCK VS. PEERS

Kerry has achieved good EBITDA margin progression since 2009. Its EBITDA margin has risen from 11.5% in 2009 to 14.3% in 2018; or by 24%.

Kerry’s peers have also reported EBITDA margin progression during this period. However, we note that margins have fallen at Givaudan, IFF and Symrise over the last two years, whereas Kerry and Glanbia have seemingly been able to withstand margin pressure.

Our question is: was Kerry’s €556m in restructuring costs since 2009 a principal driver of its margin improvement?

It seems to us that peers’ restructuring efforts have driven greater returns.

Figure 41 EBITDA margin progression (2009 = 100). Source: Respective company financial statements. ShadowFall.

70

80

90

100

110

120

130

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

EBITDA margin progression (2009 = 100)



42

RESTRUCTURING COSTS VS. ACQUIRED REVENUE Kerry has spent a cumulative €3,075m on acquisitions since 2009. We calculate at an average price to revenue cost of 1.9x, that Kerry has acquired c. €1,618m in revenue during this period.31

Cumulative restructuring costs, which according to Kerry, typically relate to acquisition integration and restructuring, have totalled €556m since 2009.

This implies that cumulative restructuring costs as a percentage of cumulative estimated acquired revenue equates to 34% since 2009. In our view, this is a remarkable percentage of estimated revenue acquired spent on restructuring.

Figure 42 EBITDA margin progression (2009 = 100). Source: Kerry financial statements. ShadowFall.

92 92 103223

448 448 456 476 512 556

146 231

434

527 591

663

1,133 1,145

1,354

1,618

63%

40%

24%

42%

76%

68%

40% 42%38%

34%

0%

10%

20%

30%

40%

50%

60%

70%

80%

- 100 200 300 400 500 600 700 800 900

1,000 1,100 1,200 1,300 1,400 1,500 1,600 1,700

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Kerry 's cumulative restructuring costs as compared to cumulative estimated revenue acquired, €m

Cumulative restructuring costsCumulative estimated revenues acquiredCumulative restructuring costs as a % of cumulative estimated revenues acquired (rhs)


43

BANG FOR BUCK VS. PEERS

Since 2009, despite incurring €556m in restructuring costs, we calculate that Kerry’s incremental increase in EBITDA margin, has resulted in a cumulative increase in EBITDA of €847m.

Seemingly, Kerry’s incremental EBITDA return on restructuring costs incurred is 1.52x.32

By contrast, since 2009, Givaudan has spent a cumulative €294m on restructuring, and achieved a cumulative increase in EBITDA of €994m over the same period from its EBITDA margin progression.

Givaudan’s incremental EBITDA return on restructuring costs incurred would appear to be 3.38x33; i.e. apparently twice as effective as Kerry’s.

32 1.52x = €847m / €556m

Figure 43 Cumulative EBITDA gains from margin progression divided by cumulative expenditure on restructuring. Source: Respective company financial statements. ShadowFall.

33 3.38x = €994m / €294m

1.52 1.80

3.38

8.26

-

1

2

3

4

5

6

7

8

9

Kerry IFF Givaudan Symrise

Cumulative EBITDA returns relative to cumulative restructuring costs, €m

2010 2011 2012 2013 2014 2015 2016 2017 2018

We calculate that Kerry's total spend of €556m inrestructuring costs since 2009 has resulted in incrementalEBITDA gains of €847m. I.e. a 1.52x return on restructuringcosts incurred.

This seems to contrast poorly with its major peers, whichhave spent less on restructuring but still achieved EBITDAmargin progression.


44

R&D LOWER VS. PEERS

The market appears to view Kerry as having migrated its revenue base into higher value flavourings and ingredients markets.

However, it is noteworthy, how Kerry’s Research and Development (R&D) expenditure as a percentage of its sales, is, in our view, considerably lower relative to its peers.

Research and development as a percentage of 2018 sales:

Kerry 4.2%

Givaudan 8.6%

Glanbia n/a

IFF 7.8%

Symrise 6.4%

Figure 44 Research and development expenditure as a percentage of sales. Source: Respective company financial statements. ShadowFall.

3%

4%

5%

6%

7%

8%

9%

10%

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

R&D as % of sales

Kerry Givaudan IFF Symrise

On the basis of a seemingly lower rate of expenditure onresearch and development, it begs the question, how doesKerry compete with peers that spend greater rates on R&Din order to enhance existing and develop new ingredientsand flavourings?


45

CAPEX INLINE VS. PEERS

While Kerry’s R&D spend as a percentage of its sales is, in our view, markedly lower than its peers. Capex as a percentage of sales appears to be in line with peers.

Of course, R&D is expensed whereas Capex is capitalised and does not pass through the P&L.

If Kerry is possibly underspending on R&D, are acquisitions vital for new flavourings and ingredients?

Capex as a percentage of 2018 sales:

Kerry 4.5%

Givaudan 4.3%

Glanbia 1.3%

IFF 4.3%

Symrise 6.7%

Figure 45 Capex as a percentage of sales. Source: Respective company financial statements. ShadowFall

1%

2%

3%

4%

5%

6%

7%

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Capex as % of sales



46

DISPOSALS WHICH APPEAR TO CONTRADICT THE PURCHASER’S FILINGS?


47

THE DISPOSALS

In our view, Kerry’s disclosure on its disposals is as hazy as that relating to its acquisitions. We discuss below the two main disposals that Kerry has made in recent years, both of which occurred in 2015 and reportedly reaped a sizeable cash inflow of €115.7m.

Our concern with these disposals, is that, following our analysis of the respective disposal companies and acquiring companies’ filings, we find what appear to be some contradictions. If the purchaser’s filings are an accurate reflection of events, then it might suggest that Kerry’s 2015 and 2016 financial statements contain inaccuracies, or vice-versa. If so, we believe this could present an issue for Kerry, since it was its current CFO who appears to have performed the audit and sign-off of Kerry’s financial statements in those years. An alternative explanation for the contradictions may relate to tax planning, however, this may open further questions with adverse implications.

TWO MAJOR DISPOSALS

Acquisitions and Disposals

During the year, the Group completed 10 acquisitions at a net cost of €888.1m. The Group also disposed of the Pinnacle lifestyle bakery business in Australia and the Consumer Foods Direct-to-Store business in the UK. The total consideration was €153.8m before disposal related costs.

Kerry Group 2015 Financial Statements

The disposal related costs equated to what we view as an eye-watering €38.1m and appear to have been cash costs, resulting in a net cash receipt of €115.7m from the disposals.

THE DIRECT-TO-STORE DISPOSAL

Kerry Group disposed of its Direct-To-Store business, which traded as Kerryfresh, in early 2015. On the basis of our research below, we believe that the Direct-To-Store (DTS) disposal contributed no more than a cash consideration of £0.94m (€1.3m) to Kerry Group in 2015.

The MBO appears to have been led by Mr Darren Haynes34, who according to a LinkedIn profile had worked for Kerry Foods since 1999. Filings suggest that Mr Haynes, funded a significant £16.0m cash subscription to capitalise the disposed business, DTS, in 2015. Following Mr Haynes personal insolvency in 2017, and the DTS business’ Administration in 2018, it is unclear why DTS had an outstanding loan to Kerry Group of £1.0m at the point of Administration. For context, this loan value equated to 163% of the DTS’ cash balance at a time when presumably access to cash would have been critical for a business facing administration.

34 https://www.linkedin.com/in/darren-haynes-8b6b4214/

https://www.linkedin.com/in/darren-haynes-8b6b4214/


48

Kerry appears to disclose very little surrounding the disposal by MBO of its Direct-To-Store (DTS) business in 201535,36,37. Darren Haynes is described as having led the MBO of the DTS business, which traded as Kerryfresh38,39 (under Kerry) and changed its trading name to Fresh to Store Limited, a UK based company incorporated on 9 January 201540 - when as a separate entity.

Fresh to Store’s ownership was transferred to a UK based holding company, F2S Holdings Limited. F2S Holdings was incorporated on 1 May 2015 and its accounts detail that the group is controlled by Darren Haynes as the majority shareholder.

Although Kerry does not detail the name of its disposal in 2015 – describing it as an MBO of its Direct-To-Store business – we have assumed that Kerryfresh/Fresh to Store, which was acquired by an MBO in the same month (February 2015) as the Direct-To-Store disposal, is the business that Kerry refers to.

Further, there is the fact that within its 2015 financial statements Fresh to Store discloses:

On 31 January 2015 the company [Fresh to Store Limited] acquired the trade and assets of Kerry Foods Limited.

The purchase of trade and assets was reported to have been for a cash outflow on acquisition of £943,011. On this basis, we do not believe that the disposal of Kerry’s Direct-To-Store business in 2015 is likely to have contributed more than €1.3m to Kerry’s 2015 cash flow41. As a reminder, Kerry reports that it received a cash inflow of €115.7m in relation to the disposal of its Australian Pinnacle Bakery and its UK Direct-To-Store businesses. If €1.3m was due to the DTS MBO, then this would suggest to us that €114.4m cash proceeds stemmed from the Australian Pinnacle Bakery Business.

35 The disposal of its Direct-To-Store business is mentioned three times within Kerry’s 2015 annual filing. The actual business that was disposed of is not specifically mentioned by name. What is detailed is that it was a management buyout in the UK completed at the end of February 2015. 36 https://www.slrmag.co.uk/tag/kerryfresh/ 37 https://www.conveniencestore.co.uk/news/new-kerryfresh-owner-announces-100-new-products/516022.article 38 https://www.scottishgrocer.co.uk/blog/2015/04/07/fresh-firm-promises-new-options/ 39 https://www.linkedin.com/in/darren-haynes-8b6b4214/ 40 https://beta.companieshouse.gov.uk/company/09380752 41 We assume an FX rate of GBP:EUR of 0.73.

https://www.slrmag.co.uk/tag/kerryfresh/

https://www.conveniencestore.co.uk/news/new-kerryfresh-owner-announces-100-new-products/516022.article

https://www.scottishgrocer.co.uk/blog/2015/04/07/fresh-firm-promises-new-options/

https://www.linkedin.com/in/darren-haynes-8b6b4214/

https://beta.companieshouse.gov.uk/company/09380752


49

Figure 46 Fresh to Store Limited 2015 accounts highlighting purchase consideration for the trade and assets of Kerry Foods. ShadowFall believes that this relates to the Direct-To-Store disposal. Source: Fresh to Store Limited 2015 Annual Filings

Fresh to Store fell into administration in March 201842.

Aside from the apparent de minimis proceeds that Kerry received from the sale of its DTS business, several other factors from the transaction seem to us to be somewhat unusual.

FURTHER FEATURES REGARDING THE TRANSACTION WHICH WE FIND UNUSUAL

DARREN HAYNES

According to Fresh to Store’s and F2S Holdings’ filings with UK Companies House, Fresh to Store was capitalised in February 2015 by £15,949,059. This was raised by the issue of 48 ordinary shares and 15,949,011 deferred shares. The deferred shares were entitled to receive the priority payment of any dividend.

Through its Fresh to Store’s holding company, FS2 Holdings, these shares were ultimately held by Mr Darren Haynes, as shown in figure 47.

42 The Administrator’s Report from June 2018 indicates that Fresh to Store’s administration was driven in part by the withdrawal of credit insurance cover on Fresh to Store, and its exposure to both Palmer and Harvey and Poundland.


50

Figure 47 Shareholding of F2S Holdings Limited - parent company of Fresh to Store Limited. It is not altogether clear to ShadowFall how Mr Haynes funded his subscription for £15,949,011 in deferred shares. Source: F2S Holdings Limited 2016 annual return

As highlighted above, prior to the MBO of Fresh to Store, Darren Haynes worked for Kerry for over 15 years. As such, it is unclear to us from where the funding for Mr Haynes’ subscription of £15,949,059 in deferred shares originated. According to the UK’s Insolvency Service43, Mr Haynes entered into an Individual Voluntary Insolvency Arrangement on 11 January 2017.

REVENUE IMPLICATIONS

The DTS business was reportedly a disposal made by Kerry Foods Limited44,45 (Kerry Foods). When under its new ownership, the DTS business reported sales of £84.2m in the 45 weeks to 31 December 2015. Further, it highlighted that this was 15% higher than for the same period under Kerry’s ownership46. This would suggest that under Kerry’s ownership the DTS achieved c. £73.2m in sales during the 45 weeks to 31 December 201447.

Kerry Foods reported a revenue decline of £127.5m or 23.5% YOY to 31 December 2015, from £542.8m in 2014 to £415.3m in 2015. Assuming £73.2m of this revenue decline related to the disposed revenues of the DTS business would imply that excluding DTS, Kerry Foods’ revenue declined by £54.3m. This would suggest that Kerry Foods’ revenue fell organically by c. 13.5%YOY in 2015. We also calculate that Kerry

43 https://www.insolvencydirect.bis.gov.uk 44 Kerry Foods Limited (UK Company number 02604258) 2015 Annual Report – Page 4: “In 2015, the company sold two businesses including the management buy-out of the Direct-To-Store business, which were classified as held for sale.” 45 Fresh to Store Limited (UK Company number) 2015 Annual Report – Page 28: “Acquisition of certain trade and assets from Kerry Foods Limited.” 46 Ibid – Page 6 47 £84.2 million / 1.15 = £73.2 million.

https://www.insolvencydirect.bis.gov.uk/


51

Foods’ revenue fell by 9.8%YOY in 2016. We interpret this to mean that despite the disposal of the DTS business, Kerry Foods experienced significant revenue pressure in 2015 and 2016.

A LOAN TO KERRY GROUP

According to the Administrator’s Progress Report, filed with UK Companies House on 24 October 2018, amongst the DTS business’ assets was a loan that the company had made to Kerry Group. This loan totalled £984,215, and is not far away from its original purchase consideration of £949,011. It is unclear to us why DTS, which entered administration, made a loan to Kerry Group totalling 24% of its reported cash balance at 31 December 201648, and 164% of its reported cash balance at the point of its administration49.

Figure 48 Fresh to Store Limited Administrator’s Report detailing loan of £984,215 from Fresh to Store to Kerry Group Source: Fresh to Store Administrator’s Progress Report

48 Fresh to Store Limited reported a cash balance of £4,138,516 within its 2016 Annual Filing to 31 December 2016. 49 Fresh to Store Limited reported a cash balance of £601,202 within the Administrator’s Report.


52

DISCREPANCIES DOWN UNDER: THE PINNACLE BAKERY DISPOSAL

Kerry Group reportedly disposed of its Australian bakery business, Kerry Pinnacle, in May 2015. From our research, we find a discrepancy in cash flows between the disposal receipts which Kerry reports and the cash flows it appears to have injected into the Kerry Pinnacle business shortly prior to its sale. This might suggest that contrary to the implied cash proceeds of €114.4m from the Kerry Pinnacle disposal, no more than €3.6m in cash was received by Kerry Group in 2015. Further to the uncertainty in cash proceeds we also find discrepancies between Kerry’s filings and those of the acquirer of Kerry Pinnacle, which feature contradictory share counts. An explanation for these discrepancies may be due to tax arrangements.

KERRY PINNACLE PTY LTD. (KERRY PINNACLE)

Kerry Pinnacle50 was incorporated on 13 November 2012 and purchased the bakery business assets from Kerry Ingredients Australia Pty Limited (Kerry Australia) and its controlled entities on 1 December 2012. There was reportedly no cash outflow on the acquisition of the assets made by Kerry Pinnacle. It was stated as being funded with the intercompany payables from Kerry Australia.51

In the years following its incorporation to disposal, Kerry Pinnacle reported the key financial metrics detailed in figure 49.

Figure 49 Pinnacle Bakery & Integrated Ingredients PTY Ltd (Kerry Pinnacle) - key metrics of the Australian bakery business disposed of in 2015. Source: Pinnacle Bakery & Integrated Ingredients PTY LTD annual filings

50 Kerry Pinnacle PTY Ltd has undergone several name changes: Kerry Pinnacle PTY Ltd, Pinnacle Food Group PTY Ltd, Pinnacle Bakery & Integrated Ingredients PTY Ltd, Allied Pinnacle PTY Limited. 51 Kerry Pinnacle PTY Ltd 2013 Annual Filings – Note 16. We presume that this means that the assets provided to Kerry Pinnacle from Kerry Australia were in lieu of payables owed by Kerry Australia to Kerry Pinnacle. The net assets acquired were reported as totalling AUD$33.2 million of which AUD$24.1 million related to PPE.


53

KERRY INGREDIENTS (S) PTE LTD (KERRY SINGAPORE)

Following a sale of assets to Kerry Pinnacle by Kerry Australia in late 2012, ownership of Kerry Pinnacle was by a Singaporean based company: Kerry Ingredients (S) PTE Ltd (Kerry Singapore). Kerry Pinnacle was sold by Kerry Singapore to a private equity buyer in May 2015. Kerry Singapore reported revenue of:

2013: SGD$1.1m (€0.7m);

2014: SGD$1.8m (€1.1m). Restated to SGD$28.6m (€17.0m) in 2015;

2015: SGD$45.3m (€29.7m). Restated to SGD$43.4m (€28.4m) in 2016;

2016: SGD$57.0m (€37.3m);

2017: SGD$61.4m (€39.3m).

Kerry Singapore is a relatively small cog in the Kerry Group. Kerry Singapore’s revenue rose sharply post disposal of Kerry Pinnacle, apparently almost entirely driven by Agency Fee Income from related companies or Research and Development income. Sales of goods to third parties is de minimis.

According to Kerry Singapore’s filings, it made an initial subscription of SGD$3 in 2012, for 3 shares in Kerry Pinnacle52,53. On 27 January 2015, four months prior to Kerry Pinnacle’s disposal, a further additional payment was made by Kerry Singapore into Kerry Pinnacle. This payment is detailed as totalling SGD$196.5m (€128.8m) for an additional 1 ordinary share in the share capital of Kerry Pinnacle54 (see figures 50 and 51). Somewhat oddly, in our view, despite this subscription, the share count in Kerry Pinnacle is not reflected as having increased from 3 to 4 within Kerry Singapore’s filings.

Whereas Kerry Singapore states that it paid SGD$196.5m or AUD$196m for one additional share in Kerry Pinnacle, for the same share it would appear that Kerry Pinnacle states that one share had a value of AUD$67.2m. The description of events can be seen below and from the official respective company filings in figure 53.

Kerry Singapore’s description of an additional share issue (our bold for emphasis):

On January 27, 2015, the Company [Kerry Ingredients (S) Pte Ltd] acquired an additional 1 ordinary share in the share capital of its wholly owned subsidiary, Kerry Pinnacle Pty Ltd, at a consideration of $196,453,697 (equivalent to AUD196,000,000).

Kerry Pinnacle’s description of an additional share issue (our bold for emphasis):

Prior to the sale of Pinnacle Bakery & Integrated Ingredients Pty Ltd [Kerry Pinnacle Pty Ltd] to PFG Bidco Pty Ltd, one share ($67,224,2350 was issued to Kerry Ingredients (S) Pte Ltd.

On 29 May 2015, Kerry Singapore reports as having entered into a Share Sale Agreement (SSA) with a third party relating to the disposal of Kerry Pinnacle. Kerry Singapore details as having received SGD$202.1m (€132.4m) in cash associated with the disposal, which is reflected within Kerry Singapore’s statement of

52 Kerry Ingredients (S) PTE Ltd 2012 Annual Filing – Note 12. 53 Ibid – the cash flow section also clearly states the cash outflow of SGD$3 associated with the subscription of the 3 equity shares in Kerry Pinnacle PTY Ltd. 54 Kerry Ingredients (S) PTE Ltd 2015 Annual Filing – Note 12.


54

cash flows. Kerry Singapore also reports a net loss of SGD$7.2m associated with the disposal. The above financials can be seen in figures 51 and 52 below.

KERRY PINNACLE’S VERSION OF EVENTS

Kerry Pinnacle’s filings appear to us to reveal a clear discrepancy of events as compared Kerry Singapore’s. Aside from the quantum of consideration for an additional share, Kerry Singapore reports that it held 3 equity shares in Kerry Pinnacle through 2012 to 201555 while Kerry Pinnacle reports that it had 2 shares in issue through 2012 to 2014.56 Further, Kerry Singapore reports that it subscribed for that additional 1 equity share in Kerry Pinnacle on 27 January 2015; although noticeably it did not report a corresponding increase in its shareholding. Kerry Pinnacle reports the subscription of an additional share; however, it reflects the resultant increase in its share count from 2 to 3 shares.

The implications of this is that contrary to Kerry Singapore’s reporting, which states that it transferred AUD$196m, if Kerry Pinnacle is to be believed, then AUD$67.2m was transferred, i.e. a discrepancy of AUD$128.8m or €88.2m. This is reflected in figure 53, which shows the respective filings of each company and the contradictions.

Figure 50 Kerry Ingredients (S) PTE Ltd (Kerry Singapore) investing cash flow section. Eagle-eyed readers will also note an SGD$10.7 million “True-up” cash outflow the following year related to the disposal of Kerry Pinnacle. Source: Kerry Ingredients (S) PTE Ltd 2016 Annual Filing

55 Kerry Ingredients (S) PTE Ltd Annual Filings 2012 to 2016 – Notes 11 & 12. 56 Kerry Pinnacle PTY Ltd Annual Filings 2012 to 2015 – Notes 13 & 14.


55

Figure 51 Kerry Ingredients (S) PTE Ltd investment into subsidiary Kerry Pinnacle Pty Ltd and related cash flows Source: Kerry Ingredients (S) PTE Ltd annual filings


56

SUMMARY OF DISPOSALS

Kerry reports that it disposed of its Pinnacle lifestyle bakery business in Australia and the Consumer Foods Direct-to-Store business in the UK during 2015 and that the total consideration was €153.8m before disposal related costs. These disposal related costs were reported to be what we view as an eye-watering €38.1m and were apparently a cash cost.57

However, according to our research into these disposals:

• The Direct-To-Store business was sold for a cash consideration of €1.3m.

• It is unclear to us how the purchaser, a former Kerry employee of 16 years, of the Direct-To-Store business funded a capital injection of €21.9m into his newly acquired business.

• Kerry injected €128.8m into Kerry Pinnacle four months prior to sale and received €132.4m at point of sale, i.e. a net receipt of €3.6m.

• The purchaser of Kerry Pinnacle reports that contrary to Kerry’s filings of a €128.8m transfer, €46.0m was received.

On the basis of the above, we are unable to reconcile c. €110.8m in cash reportedly received by Kerry Group in relation to its disposals. We also highlight the seemingly large €38.1m in cash disposal related costs.

Figure 52 Differences between disposal related companies’ financial statements and Kerry Group’s reporting Source: Fresh to Store Limited, Kerry Pinnacle PTY Ltd, Kerry Group 2015 Annual Filings

Despite these apparent discrepancies, we note that Ms. Marguerite Larkin signed-off Kerry’s 2015 Annual Filings, when she was Kerry’s Auditor, prior to joining the Group as its CFO in September 2018.

57 Kerry Group 2015 Annual Filings – Note 5.


57

Figure 53 Contradictions between Kerry Ingredients (S) PTE Ltd (Kerry Singapore) reporting as compared to Kerry Pinnacle PTY Ltd (Pinnacle Bakery & Integrated Ingredients Pty) reporting. Source: Kerry Ingredients (S) PTE Ltd 2015 Annual Filing & Pinnacle Bakery & Integrated Ingredients PTY Ltd 2015 Annual Filing.


58

KERRY’S CORPORATE GOVERNANCE


59

CORPORATE GOVERNANCE Since 2015, almost half of Kerry’s fifteen-member Board (at the time) have retired, including its CEO and Chairman. While, in our view, it would have been preferential to see at least one external appointment to the key positions of CEO and Chairman, in the event, Kerry appointed a CEO who had joined the Group through its graduate programme in1996 and a Chairman who has been with the Group since 2012, formerly Chairing its Audit Committee.

While the appointment of Ms. Marguerite Larkin as Kerry’s CFO was external, it would seem that immediately prior to joining Kerry, as Partner at Kerry’s former audit firm, Deloitte, Ms. Larkin was personally responsible for the sign-off of Kerry’s FY2014 and FY2015 audits.

In the light of the Audit Assurance Ethical standards as prescribed by the Financial Reporting Council (FRC), we have some unease with appointments such as Ms. Larkin’s to the important role of CFO. The FRC specifically highlights ethical standards pertaining to this situation58. The fact that Ms. Larkin’s appointment was recommended and approved by Kerry’s Board less than two years after Ms. Larkin having signed-off Kerry’s 2015 Financial Statements, in our view, is somewhat stretching the Audit Assurance Ethical standards as prescribed by the FRC.

SEVEN OF FIFTEEN DIRECTORS HAVE RETIRED FROM KERRY’S BOARD SINCE 201559,60.

Stan McCarthy, CEO since Jan 2008, Kerry graduate recruit in 1976, retired in Sep 2017;

Michael Dowling, Chairman since Jan 2015, appointed to the Board in Mar 1998, retired in May 2018;

Brian Mehigan, CFO since Feb 2002, joined Kerry in 1989, assumed the role of CSO in Sep 2018;

Flor Healy, Kerry Foods’ CEO, Board Member since Feb 2004, retired in Aug 2017;

Patrick Casey, Board since May 2014, retired in Apr 2017;

Michael Ahern, Board since Jan 2014, retired in Dec 2016;

James Devane, Board since Jan 2014, retired in Dec 2016; and

John Joseph O’Connor, Board since Jan 2014, retired in Dec 2016.

Kerry’s recently (May 2018) appointed Chairman, Philip Toomey, has been with the Group as an NED since 201261, and Chaired the Audit Committee since February 2015.

Kerry’s CEO, Mr. Edmond Scanlon, was appointed CEO in October 2017. Mr. Scanlon has been with the Kerry since he joined in 1996 through its graduate development programme. Previous roles with Kerry include Vice President Mergers and Acquisitions, and President and CEO of Kerry Asia-Pacific.

While age may be expected to have played a part in some of the retirement decisions, the fact that key new appointments have come from within the Group, is in our view a cause for concern. We believe that some “fresh eyes” may have been preferable for at least one of these key positions to have been appointed to a person with no former connection to the Group.

58 Financial Reporting Council - Audit and Assurance - Revised Ethical Standard 2016 59 Note that Kerry’s former CFO, Brian Mehigan, has not retired from its Board but has switched role from CFO to CSO. 60 Kerry Group had fifteen Board Members in 2015. Since then, seven of these have retired, while one has switched roles. 61 https://www.kerrygroup.com/our-company/leadership/non-executive-board-membe/index.xml

https://www.frc.org.uk/getattachment/0bd6ee4e-075c-4b55-a4ad-b8e5037b56c6/Revised-Ethical-Standard-2016-UK.pdf

https://www.kerrygroup.com/our-company/leadership/non-executive-board-membe/index.xml


60

THE CLASS OF 2015

Figure 54 Kerry Group's Board of Directors in 2015, and those members who have since either retired from the group or resigned from the Board. Source: Kerry Group Annual Filings.


61

KERRY’S CFO IS ITS FORMER AUDITOR

Figure 55 Kerry Group CFO appointment of Ms. Marguerite Larkin. Ms. Larkin had signed off Kerry Group’s accounts in the final two years of which Deloitte were its auditor in 2015 and 2016. Source: Kerry Group Annual Filings.

As figure 55 highlights, in the final two years of Deloitte’s appointment as Kerry’s long-standing audit firm, Ms. Marguerite Larkin acted on behalf of Deloitte’s to sign-off Kerry’s Auditors’ Report in February 2015 and 2016. Thereafter, Ms. Larkin was appointed as CFO to Kerry Group, assuming her role on 30 September 2018, and was also appointed to Kerry’s Board.

Regarding this appointment and its timing, we note the Financial Reporting Council’s (FRC), Audit and Assurance, Revised Ethical Standard 201662. The FRC highlights (our bold for emphasis):

2.51 As required by legislation63, a natural person appointed as a statutory auditor or key audit partner for an entity subject to a statutory audit shall not take up:

(a) any key management position; (b) membership of the entity’s audit committee;

(c) membership of any body performing equivalent functions to an audit committee in relation to the entity;

(d) any other position as director of the entity or, where the entity’s affairs are managed by a management body or other committee, membership of that management body or committee;

before the end of:

(a) in the case of a public interest entity, two years; and

(b) in any other case, one year;

beginning with the day on which the person ceased to be the entity’s statutory auditor or key audit partner in connection with the statutory audit of the entity.

While Ms. Larkin did not assume the role of CFO and Board Membership with Kerry until 30 September 2018, we note that Ms. Larkin’s recommended appointment was approved by Kerry’s Board on 19 February 2018. This was less than two years after Ms. Larking having signed-off Kerry’s 2015 Financial Statements on 22 February 2016. In our view, this is somewhat stretching the Audit Assurance Ethical standards as prescribed by the FRC.

62 Financial Reporting Council - Audit and Assurance - Revised Ethical Standard 2016 63 SI 2016/649 The Statutory Auditors and Third Country Auditors Regulations 2016, Schedule 1, paragraph 7.

https://www.frc.org.uk/getattachment/0bd6ee4e-075c-4b55-a4ad-b8e5037b56c6/Revised-Ethical-Standard-2016-UK.pdf


62

SIGNS OF WEAKENING CASH FLOW, P&L AND CASH TAX DIFFERENCES

AND A BOOST FROM DSO?


63

CASH CONVERSION

Kerry reported its cash conversion to be 72% in 2018 (2017: 83%).

However, this is a conversion rate of FCF expressed as a percentage of adjusted earnings after tax.

While Kerry’s measurement of its cash conversion has declined in percentage terms since 2016, we would note that when it comes to a more widely used measure of cash conversion, FCF conversion from EBITDA, that this has typically been below 60%.

Figure 56 Kerry’s reported cash conversion rate, based on conversion of adjusted earnings after tax into Free Cash Flow (FCF) as compared to conversion of EBITDA into FCF. Source: Kerry financial statements, ShadowFall estimates.

49%46%

51%57%

41%

55%

65%

55%

47%

91%

74%

84%

91%

62%

85%

100%

83%

72%

0%

15%

30%

45%

60%

75%

90%

105%

2010 2011 2012 2013 2014 2015 2016 2017 2018

Kerry reported cash conversion compared to FCF conversion from EBITDA, %

Kerry FCF conversion from EBITDA Kerry calculated cash conversion


64

• Kerry’s EBITDA has continued to steadily rise over recent years.

• However, Kerry’s FCF peaked in 2016.

• EBITDA rose to €942m in 2018 (2017: €917.5m, 2016: €882.4m).

• FCF declined for the second consecutive year to €446.5m in 2018 (2017: €501.3m, 2016: €569.9m).

Figure 57 Kerry EBITDA compared to Free Cash Flow (FCF). Source: Kerry financial statements.

Figure 58 Kerry EBITDA compared to Free Cash Flow (FCF). Source: Kerry financial statements.

0

200

400

600

800

1,000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Kerry EBITDA compared to FCF, €m

Kerry reported FCF ShadowFall calculated EBITDA

303453

570501

447

742829

882 918 942

200

400

600

800

1,000

2014 2015 2016 2017 2018

Kerry EBITDA compared to FCF, €m

Kerry reported FCF ShadowFall calculated EBITDA


65

CASH TAX

For the seventh consecutive year, Kerry’s cash tax paid was, in our view, markedly lower than its adjusted tax stated in its P&L statement.

Kerry reported €89.2m in adjusted tax on its P&L in 2018 (2017: €89.5m). However, in its cash flow statement, the Group reportedly paid €46.1m in cash tax in 2018 (2017: €54.7m).

Cash tax paid as a percentage of adjusted P&L tax totalled 52% in 2018 (61% in 2017).

Figure 59 Kerry cash tax paid as a percentage of adjusted tax stated on its Profit and Loss statement. Source: Kerry financial statements, ShadowFall estimates.

66%

113%

79%

104%

69%

46%38%

47%

66%61%

52%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

120%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Kerry Group cash tax paid as a percentage of tax reported(2008 to 2018)

Cash tax paid as % of adjusted P&L tax


66

CASH TAX

As figure 60 illustrates, in our view, the difference between the tax which Kerry reports and the actual cash it appears to physically pay has significant implications as to the perceived profitability of the Group.

For example, if in 2018, Kerry’s €46.1m in cash tax paid accurately reflected the Irish Standard Rate of Tax of 12.5%, then this would imply that the corresponding profit before tax (PBT) would have been €368.8m in 2018. This compares to adjusted PBT on Kerry’s P&L of €684.8m, an implied potential overstatement of €316.0m in 2018.

Figure 60 Kerry adjusted profit before tax (PBT) as compared to adjusted PBT reported if cash tax paid was reflected as tax on the P&L statement and paid at the Irish standard rate of tax. Source: Kerry financial statements. ShadowFall estimates.

317336

394

435474

516556

593633

668685

196

305

227

434

276

221 208

306

458438

369

0

100

200

300

400

500

600

700

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Kerry Group adjusted PBT and adjusted PBT if cash tax paid is at Ir ish standard rate of tax, € mil l ion (2008 to 2018)

Adjusted PBTAdjusted PBT if cash tax paid is at Irish standard rate of tax


67

CASH GENERATION APPEARS TO HAVE BEEN SOMEWHAT RELIANT ON PAYING SUPPLIERS LATER

As figure 61 below highlights, since 2008, Kerry has seen a steady increase in its Days Payable Outstanding (DPO). Whereas in 2008 we calculate that Kerry’s DPO was 83 days, by 2018 this had increased to 123 days; a rise of 40 days or over an extra month. Days Sales Outstanding (DSO) has also increased, which would be expected to have adversely affected Kerry’s cash generation, however the increase in DSO of 6 days is relatively negligible as compared to the increase in DPO.

As a result of this change in DSO and DPO, we estimate that Kerry’s cash flow has benefited by €291.4m in 2018, by seemingly paying its suppliers 40 days later and receiving cash from customers 6 days later, as compared to 2008 standard. Put another way, had Kerry maintained its DSO and DPO at 2008 levels, then we believe that Kerry’s cash generated from operations (CGFO) would have been as much as €291.4m lower in 2018; or by 38%.

Figure 61 Kerry Group revenue and raw materials and consumables costs (COGS) as compared to trade receivables and trade payables. Source: Kerry Group, ShadowFall estimates. DSO calculated as (average TR/Revenue)*365, DPO calculated as (average TP/COGS)*365.


68

Figure 62 ShadowFall estimates of Kerry Group’s Days Sales and Payables outstanding. Source: Kerry Group Annual Filings, ShadowFall estimates.

Figure 63 ShadowFall estimates of benefit to cash flow from increase in Kerry Group’s DSO and DPO since 2008. Source: Kerry Group Annual Filings, ShadowFall estimates.

Figure 64 ShadowFall estimates of Kerry Group’s Days Sales and Payables outstanding. Normalised (2008 = 100). Source: Kerry Group Annual Filings, ShadowFall estimates.

Figure 65 ShadowFall estimates of benefit to cash flow from increase in Kerry Group’s DSO and DPO since 2008 as compared to reported CGFO. Source: Kerry Group Annual Filings, ShadowFall estimates.

30

50

70

90

110

130

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Days sales and payables outstand ing

Days sales outstanding Days payable oustanding

077

160 162

212234 236 243

284 288 291

0

100

200

300

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Est imated net benef i t of DPO and DSO extens ion in cash f low re lat ive to 2008, €m

95

115

135

155

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Days sales and payables outstand ing (2008 = 100)

DSO normalised (2008 = 100) DPO normalised (2008 = 100)

0%

10%

20%

30%

40%

50%

0100200300400500600700800900

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Operat ing cash f low with and exc lud ing net benef i t of DPO and DSO extens ion , €m

Operating cash flowOperating cash flow excluding net benefit of DPO and DSO extensionEstimated net benefit of DPO and DSO extension as % of operating cash flow (rhs)


69

KERRY TAKES ON A SOLUTION FOR IMPROVED PAYMENT TIMES?

The extension of DPO is somewhat surprising to us as in 2014, Kerry renewed its e-Invoicing contract with Tungsten Network, a provider of e-Invoicing and invoice discounting solutions. The announcement highlighted that it would enable Kerry Group to “achieve straight-through processing and improve payment on time for suppliers.” However, contrary to improving payment times for suppliers, DPO appears to have continued to steadily rise.

Given that we estimate that DPO has risen to 123 days or 4 months, we would question as to whether there is further mileage in Kerry’s ability to continue to extend payment terms to its suppliers?

Figure 66 Announcement of Kerry Group signing e-Invoicing solution with Tungsten Plc. Source: www.tungsten-network.com

http://www.tungsten-network.com/


70

KERRY GROUP: The Hunger Games · Kerry Group Plc (“Kerry”) is a UK and Irish listed company,...

Documents

Transcript of KERRY GROUP: The Hunger Games · Kerry Group Plc (“Kerry”) is a UK and Irish listed company,...