HKScan Sweden’s absurdly bad H1 and recovery during Q3

Future is important, history not so much.  So let’s first look at HKscan’s own future prospects.  This is what HKScan Group tells about them in the Q3 interim report:

Prices of meat raw material are difficult to predict under cost pressure in primary production. The Group will improve its profitability through its development programmes, and passing raw material price increases to sales prices. Rectifying the performance level of the business in Sweden will have a significant impact on the Group during the end of the year.

HKScan maintains the outlook for 2012 which stated that due to the weak development of business in Sweden, there is a risk that the Group’s EBIT will come out below the level of 2011. However, including the estimated non-recurring income of fire insurance compensation is very likely to improve the reported EBIT compared to 2011.

Last year was not a good year for HKScan and it is obvious that the company aims to do better now.  The company reckons that the result in Sweden is crucial. In addition, the company anticipates that fire insurance compensation – the fire took place in Vinderup’s plant in Denmark last June - will help HKScan to improve the result when compared to the last year.

The figures below support the company's views.  Finland, Baltics and Poland all are on their way to a good annual result, Sweden evidently has passed the rock bottom and Denmark may avoid losses this year.  Please note that the chart shows the cumulative EBITs.

Figure: Cumulative earnings before interest and taxes by quarter and year in HKScan’s five market areas and the whole HKScan Group. 

Now a bit of history - but only for a couple of quarters back

There is no way to assess the company's fire insurance issues in Denmark but we are able to recall the stated reasons for the exceedingly weak H1 in Sweden.  The motive for this ultra-unscientific excursion to interim report piles and files is that HKScan Sweden's massive losses during Q1 and Q2 seemed to come unexpectedly, almost out of nowhere and today the troubles seem to be cured without actually doing much of anything.  Let’s look first at HKScan’s Q1 interim report.

According to it, one of the reasons was decline in primary production partly due to changes in state’s subsidy policy.  As a consequence, prices of domestic beef and pork rose.  This in turn increased import, which was further intensified due to strengthening currency. In addition to these, increased share of private label products was mentioned as one reason for bad results.

Citation #1:  In the area of primary production, the changes in subsidy policy for beef production have weakened the profitability of production. This has further weakened the availability of Swedish beef, thus making room for exports. Consumer demand in beef has increased as a whole.

Citation #2:  “Performance in the quarter was particularly affected by the decline in pork and beef primary production in Sweden, as well as by the high procurement price of Swedish beef and lower beef slaughter volumes. The strong Swedish krona has significantly increased meat imports and made it difficult to raise the price of products based on Swedish meat raw material, especially in retail. Price increases and cost adjustment have been made in Sweden, but the measures have been inadequate so far both in terms of timing and scope. A further challenge in retail is the growing share of private labels.”

In HKScan’s Q2 interim report (See pages 1-4) the reasons for the bad Q2 were reported to be practically the same as those above, with the addition of lower demand due to rainy weather in June.   However, in the report it was also stated, that the bottom was passed at the beginning of the second quarter.

Many of those reasons mentioned in both interim reports suggest substantial reductions in sales.  However, Q1 net sales reduced only by € 5,4 million or 2,1% compared to Q1 in 2011, and it is amazing to note that Q2 net sales even increased by € 4,0 million, when compared to Q2 2011.

Perhaps the company stubbornly tried to keep its market share, and cost control failed to the full.  But who knows, if there were some entirely other sudden events.  Poor management, pressure from producers, bad luck, whatever the principal reason, the reduction in EBIT during H1, also illustrated in the chart above, was simply monumental.  It may also indicate that the company is extremely prone to exogenous shocks. 

Some of the reasons mentioned in the interim reports look just strange. 

Reports' statement that the strong Swedish krona has significantly increased meat import is true as such but the fact is also – if I get it right – that the Swedish Krona has not been particularly strong during the first half of the year.  It certainly strengthened in December 2011 but during H1 this year it has been at about the same level where it was for instance in the beginning of the year 2011 (one SEK about € 0,11 or slightly higher).  Also, the private label growth has long been 100 percent clear to everyone and it cannot be the principal reason for suddenly deteriorated results. One can also quite safely assume that growth in meat imports was not any kind of a surprise to the company.  The thing is, that HKScan Sweden had already taken steps to improve its competitiveness against private labels by introducing in November 2011 its new low or medium price brand Hansa based on imported meat.  In addition,  HKScan’s subsidiary Annerstedt Flodin AB has launched a new premium concept Chosen by Farmers, a brand using imported high quality beef and mutton. 

What about Q3?

What does the latest Q3 interim report tell us in addition to the future prospects above?  Pork production was reported to decrease further and rainy weather was reported to reduce sales.   Interestingly no more mention of currency rate changes although during Q3 SEK really was strong – for instance throughout August it was as high as 0,12 or more.  There is no more mention of private label products.  Where did they go?  There is one significant announcement, namely that the price of imported meat rose rapidly, supporting also HKScan’s sales price increases.  Perhaps we still should not conclude that the mighty HKScan Sweden is  just a price follower.

It is also interesting to note that now, despite the fact that prices were raised, net sales decreased by € 6,0 million compared to last year’s Q3.    Also HKScan’s Q3 EBIT decreased to € 3,2 million from last year’s corresponding figure of € 5,4 million.  Bad summer, of course, is part of the explanation but volumes decreased to the extent that also earnings went down.

Nevertheless, as illustrated in the chart above, situation turned better in the third quarter, and it is the main thing.  However, the first half performance was exceptionally weak, and in my opinion it is not possible to know the real principal reasons. The recovery was rapid but one gets the feeling that the improvement came without doing almost anything but just following others by raising prices.

We will go into HKScan’s businesses again later but on Friday 23^rd November we are going to scope out Atria Plc’s topical matters.  Some 200 long days to summer. I’m not sure but I think it is anyway less than a year.

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