HKFoods: Profitability turnaround making strong progress

This report is a summary translation of the report “Kannattavuuskäänne edistyy vahvasti” published on 9/26/2024 at 7:10 pm EEST.

The increase in the 2024 EBIT guidance shows that the efficiency investments made by the company are bearing fruit. Improved earnings levels could also help the company strengthen its balance sheet faster than we previously expected. Debt on the balance sheet is still high and we see the valuation of the stock as close to fair value given the rise in the share price. We therefore reiterate our Reduce recommendation with an increased target price of EUR 0.70 (was EUR 0.55).

Significantly improved earnings outlook for the current year

HKFoods issued a positive profit warning on Thursday September 26 at 2 pm EEST. According to the new guidance, the adjusted EBIT from continuing operations is estimated at 22-25 MEUR in 2024. According to the previous guidance, the adjusted EBIT from continuing operations was expected to improve from 2023 (11.6 MEUR). The new guidance thus provides a more precise range for the improvement of adjusted EBIT, which also exceeds our and the consensus' previous forecasts (between 17-18 MEUR). We estimate that the positive change in guidance reflects a successful Q3. The new guidance confirms the positive impact of the efficiency investments completed by the company at the beginning of the year on the earnings level. Other possible reasons for the positive development could be, for instance, commercial successes and the stabilization of consumer demand and the cost environment. We will have a more detailed picture of the earnings trend when the company reports its Q3 interim results on November 6.

Earnings growth could continue next year, but we believe that expectations need to be tempered

With the updated guidance, we increased our revenue forecast for 2024 by 1% and our adjusted EBIT forecast by as much as 32% to 23.2 MEUR. For 2025-26, our EBIT forecasts rose more modestly, by 6%. Our forecasts for 2025-26 include only a slight increase in earnings (EBIT: 23.5-24.6 MEUR). The efficiency investments that have been made and possible future measures could still provide further earnings growth in the coming years. In addition, a pickup in consumer demand as a result of falling interest rates could support the profitability of red meat sales in particular. On the other hand, possible Chinese restrictions on pork imports could partially limit the earnings improvement by a few million euros. It should also be remembered that HKFoods' performance has historically been volatile, so predicting a sustained higher level of performance requires evidence over a longer period of time.

Earnings growth strengthens balance sheet position, valuation close to fair value

The higher-than-expected earnings level improves the prospects of strengthening HKFoods' balance sheet. Our forecasts still assume that the company will not redeem its hybrid loan until September 2026, but with the improved earnings level, an earlier redemption could become possible if the company is able to accumulate higher safety margins on the covenants related to the balance sheet debt. Our net debt/EBITDA ratio is projected to be 2.7x at the end of 2024, assuming that the divestment in Denmark takes place in Q4 as expected. In our view, the current valuation of the stock is quite close to fair value. The EV/EBIT ratio is around 10x based on our forecasts for the current year. If the current earnings level proves to be sustainable and the moderate earnings growth we forecast materializes, EV/EBIT would already fall to just below 9x in 2026. However, we do not find this valuation level attractive without a dividend yield, as the company's indebtedness and the historical volatility of the earnings level increase the risk of the investment. On the other hand, if the earnings level were to improve on a sustained basis, the value of the stock would increase significantly due to the company's highly leveraged balance sheet.