Atria and HKFoods: Profitability levels of meat processors on the rise

The operating profitability levels of Finnish meat processors Atria and HKFoods have been on a favorable trajectory this year, and both raised their earnings guidance during the third quarter. We expect the stabilizing cost environment and recent efficiency investments to support the companies' results. Falling interest rates could also have a favorable impact on consumer demand in the near term. However, the industry is quite capital-intensive, so we expect returns on invested capital to remain modest and long-term value creation to be low.

Potential for earnings growth also next year

Atria's improved performance is supported by the recently completed giant investment in a new poultry plant, efficiency measures in Sweden and Denmark, and market share gains in Estonia. We expect Atria's adjusted EBIT to reach 59 MEUR in 2024 (2023: 50 MEUR), with most of the improvement coming from Sweden.

In our view, earnings could continue to improve through 2025, for example through efficiency gains of the new poultry plant, or if consumer confidence picks up, boosting value chain sales and restaurant demand. However, we have prudently set our 2025 earnings growth forecast at the 2024 level, as potential restrictions on pork imports from China, for example, could negatively impact earnings by a few million euros. We also note that Atria's performance in 2024 was already good, helped in part by a weather-friendly barbecue season that may or may not be repeated every year.

HKFoods has a lower starting level of profitability, which means that the relative profit improvement in the current year will be more pronounced compared to Atria. During 2023-24, the company has made significant investments to improve efficiency, which will be fully reflected in the results from the second half of 2024. In addition, the transfer of the sale of the Polish bacon business to the Finnish operations could support EBIT by a good 3 MEUR between 2023 and 2025. We forecast adjusted EBIT to increase to 23 MEUR in the current year (2023:  12 MEUR) and to 24 MEUR in 2025.

However, we see significant uncertainty in the profitability outlook for HKFoods given its historically volatile earnings performance. In our view, longer-term evidence of the sustainability of earnings would be needed before investors should fully rely on the higher level of earnings. The risks (China) and opportunities (improving consumer demand) in the operating environment apply equally to HKFoods and Atria.

Development of adjusted EBIT (MEUR and % of revenue)

Source: Inderes The structure of HKFoods has changed and its size has decreased significantly with the divestments in 2022-24, which is not reflected in the graph for 2016-22.

Developments in the cost environment should provide some support to earnings levels

Costs for the food sector as a whole rose rapidly in 2022-23, particularly for materials and raw materials, which meant that meat plants also had to significantly increase the prices of the products they sell in order to protect profitability levels. However, the fall in grain and feed prices in 2023-24 has eased cost pressures on meat producers. Producer prices for both domestic beef and pork have fallen slightly over the past year (down 4-6% y/y in September). We estimate that easing cost pressures will also support meat processors' profitability levels compared to 2022-23, when rising costs will hurt earnings across the value chain. The decline in meat raw material prices is also partly related to weak consumer demand, so we do not expect changes in the cost environment to have a dramatic impact on profit levels. We expect wage inflation to remain slightly above its long-term level until 2025, which will also contribute to limiting the development of profitability margins. However, a reasonably good grain harvest in 2024 and lower feed prices could help keep meat raw material prices moderate in 2025, even if consumer demand recovers as interest rates fall.

Development of producer prices for domestic meat and feed grains

Source: Farmit.net

Investment in industrial operations at the heart of competitiveness

In the meat processing industry, it is important for competitiveness to systematically invest in industrial equipment to maintain and improve the efficiency of operations. We see Atria as historically more successful than HKFoods in this respect. The high level of debt on HKFoods' balance sheet has limited the company's ability to invest. With the sale of HKFoods' Swedish, Baltic and soon Danish operations, the company will be able to focus its investments in Finland, which we expect will also improve the efficiency of its operations. HKFoods has estimated that its investments in 2023-24 will enable a profit improvement of around 12 MEUR, part of which will be realized as early as 2023 and the second half as of the second half of 2024. In practice, food companies are constantly making efficiency investments to improve profitability and cover the effects of wage inflation, among other things.

HKFoods and Atria have a history of investing in growth areas such as poultry and ready meals. The companies have sought to diversify their product lines in response to the slow decline in red meat sales. HKFoods built a new poultry plant in Rauma in 2016-18, but the plant's efficiency did not meet expectations even in the first few years, and the resulting losses have contributed to undermining the company's ability to invest in later years. However, we believe that the company's automation investments at the Rauma unit in 2023-24 have significantly improved efficiency. Atria, for its part, built a brand new and modern poultry plant in Nurmo during 2022-24, which was completed in early 2024. We estimate that the ramp-up of the plant has gone well without major efficiency losses, but there is still room for optimization.

Investments in relation to revenue

Source: Inderes estimate HKFoods only includes Finnish operations. Excludes HKFoods’ land transactions for 2020-21.

Returns on investment remain low in the sector

The food industry is highly competitive and capital intensive, making it difficult to achieve high returns on investment. Atria and HKFoods have historically had low returns on investment (ROI). Atria's actual results were negatively impacted by write-downs of intangible assets and goodwill, primarily due to the poor profitability of the acquired Swedish and Danish operations. Excluding the write-downs, the ROI in recent history would have been quite close to the WACC, which is around 8%. HKFoods has had a positive but low ROI in recent years (3-4%).

We expect Atria's ROI to improve to just under 9% and HKFoods' to 5-6% in 2024-25. Our projected ROI for Atria is roughly in line with the average of its international meat industry peer group. The projected ROI levels do not significantly exceed the required return, and we do not expect the businesses to create significant long-term value.

We therefore consider the dividend yield to be the most important return component in the industry. We forecast Atria's dividend yield to be around 7% (2024e), but we do not expect HKFoods to pay a dividend in the coming years due to the high level of debt on its balance sheet. Of course, reducing balance sheet leverage will in itself increase the market value of the company until the balance sheet is strong enough to start paying a sustainable dividend.

Return on investment (ROI)

Source: Inderes