Hello, welcome to the Orkla Q3 2018 conference call. Throughout the call, all participants will be in listen-only mode. Afterwards, there'll be a question and answer session. Today, I am pleased to present CEO Peter Ruzicka and CFO Jens Staff. Please go ahead with your meeting.
Well, good morning, everyone, welcome to today's conference call. With me here today, I have our CFO, Jens Staff, and also our team from IR are present in the room here in Oslo. We will spend approximately 20 minutes presenting the quarter. After the presentation, we will be happy to take any questions. The presentation material is available at our website, orkla.com. We will refer to each slide number so that you can follow the presentation as we go along. First, we'll go through the highlights for the quarter, which you will see from page three. As you might understand, I will skip the disclaimer page. Looking at page three, we achieved moderate organic sales growth in the third quarter. I am pleased to see that performance in our Confectionery Snacks business has turned positive. Food Ingredients continued to grow steadily.
This progress was offset by a decline for Orkla Care. Orkla Foods saw growth in all its companies outside Norway, was hampered by its continued weak performance in Norwegian grocery market. Far in 2018, our organic sales growth has been too weak. I'm not happy with the levels we see. In addition, our fixed costs have increased. The higher costs are partly explained by targeted investments, like the investments in Naturli' brand from Orkla Food Ingredients. We still see an imbalance that I'm not happy about. We continue to shift the portfolio towards higher growth categories, channels, and geographies. In addition, we have launched a number of actions in the third quarter to address the rise in costs. In Orkla Foods companies in the Czech Republic and Slovakia, we have decided to merge Hamé and Vitana into a single company, Orkla Foods Česko a Slovensko.
At the same time, Orkla Food Ingredients has decided to establish a common management structure for all its companies in Denmark. Efforts to achieve cost improvements will be given high priority going forward. As you all know, my KPI, black above red, is an extremely important KPI for us. Over time, it's not acceptable to see that our fixed costs are increasing more than our top-line organic revenue growth. The drastic increase in sugar tax, which was implemented in Norway in the beginning of 2018, has had a negative impact on sales volumes in confectionery. We are pleased that the government has proposed to reverse this decision as from 2019. Needless to say, I am disappointed about Orkla Care. The decline is primarily related to our operations in the U.K. and in Poland.
In the U.K., the actions we have taken to turn around performance in Harris have not yet produced the results we wanted. The main actions we have initiated are change management in the U.K. and change management at our factory in China. We have cut costs to compensate for the loss of distribution to B&Q, and we are constantly working on reducing complexity and reducing number of SKUs. Poland is an important healthcare market for us. The challenging situation has developed more recently, and we will address this during Q4. I am following up these actions closely. It is important that we see real improvements from these operations over the next quarters. Overall, our progress in Branded Consumer Goods and investments resulted in an adjusted operating profit improvement of 7% for the group in Q3.
If you look at Branded Consumer Goods and HQ together, we have an improvement of 7%. In Jotun, sales growth continued and raw material prices stabilized. I am also glad to see that the order book in the shipping market is improving. Earnings per share from continuing operations improved by 3% in Q3. Let me take you through some more details on our organic growth performance. I am now moving over to slide four. Our Branded Consumer Goods operations have grown organically by 0.7% year to date, adjusted for the loss of Wrigley distribution. We see increased sales in Orkla Foods businesses in Central Europe, Finland, and India in the third quarter. You can also see that Orkla Confectionery & Snacks had good organic growth when adjusted for the loss of Wrigley distribution agreement, with strong sales growth in Norway, Denmark, and in Sweden.
In addition, Ice Cream Ingredients and Wound Care progressed nicely. On the opposite side, Orkla Health in the U.K. and Orkla Health in Poland saw organic sales decline in the quarter, and we need to turn this around in the coming quarters. This growth pace is clearly too low, and as I mentioned, I will follow up the turnaround initiatives in U.K. and Poland closely going forward. Let's have a look at our margin performance. I am now turning to slide number five. If you look at our margin progress for the previous 12 months, you see that underlying EBIT margin improved by 0.4 percentage points. Reported margin was up 0.2 percentage points. The difference from the 0.4 to 0.2 is mostly related to M&A because acquired businesses on average had lower EBIT margins. Variable margins improved because we have exited less profitable businesses.
In addition, our actions to compensate for higher input costs were effective. Raw material prices have stabilized, we still face significant headwinds related to currency, and especially in Sweden, where we see that the Swedish currency has weakened substantially, especially versus EUR. Other costs consist of fixed costs, advertising, and depreciation. We continue to see good progress from our costs and supply chain initiatives. The improvement in Q3 in isolation was, however, driven by positive effects from a change in the entitlement model related to the group's Long-Term Incentive Program. This had an estimated impact of NOK 20 million in the quarter. With that, I will now leave the word to Jens, and he will take you through our financials in more detail.
Thank you, Petter. Let's start with the top-line performance illustrated on page seven. We increased revenues in Branded Consumer Goods by 3.1% in the quarter. This progress was a mix of organic growth and M&A. As Petter showed, organic sales improved by 0.8%, adjusted for lost Wrigley distribution. M&A added 2.3% to growth. HSNG in Orkla Care, as well as add-ons in Orkla Food Ingredients, were main contributors. Divestments, including K-Salat in Denmark, had the opposite effect. Let's have a look at the performance of each business area in more detail. Starting with Orkla Foods on page eight. Outside Norway, we have good growth, especially in Finland and Central Europe. In Norway, lower campaign activity and higher grocery retail prices reduced our sales. We had a significant negative effect on input costs from a weakened SEK in Q2 and in Q3.
Despite this input cost headwind, we have succeeded in increasing EBIT and the EBIT margin. This progress was mainly driven by cost improvements. For example, we have set up a more efficient organization in Denmark after disposing of the salad business as of December last year. Let's now have a look at Orkla Confectionery & Snacks, turning to page nine. Orkla Confectionery & Snacks had a positive organic top-line growth of 3.5% when adjusted for the loss of the Wrigley distribution agreements. We had positive effects from timing of campaigns and launches. The snacks category had good progress, but confectionery markets are slower. We still see challenges in the Norwegian confectionery market after the increase in sugar tax from January 1st. A weaker SEK impacted our margins negatively also in this business area. We have compensated for this by reducing costs throughout the organization.
In sum, our EBIT margin improved by 110 basis points. Let's have a look at Orkla Care, moving on to page 10. I'm sure you are disappointed about our performance in Orkla Care this quarter, and I can assure you that so am I. Orkla Health delivered negative organic growth. Our sales in Poland declined, mainly because the largest wholesaler reduced their stock level. However, retail sales are relatively stable. We are still experiencing sales decline in our health care operations in the U.K. As many of you remember, we lost a contract there in 2017. In addition, weaker demand and increased competition among retailers have pressured prices in the U.K. market. This means our performance in the U.K. resulted in organic sales decline for the overall health care business. As Petter mentioned and described, we have launched actions to turn the U.K. business around.
In sum, the other Orkla Care business units had decent progress in the quarter. EBIT for Orkla Care declined, mainly because of the weak performance in Poland and U.K. Lower sales, higher input costs, and dilutive effects from M&A also led to a margin decline in the quarter. Lastly, let's turn to Orkla Food Ingredients on page 11. Orkla Food Ingredients grew the top line by 8% in the quarter, of which 1.4% was organic improvement. Ice cream ingredients and the vegan portfolio contributed positively. We exited some less profitable distribution businesses, and this reduced our organic top line, but had a positive effect on the contribution margins. Good organic performance and add-on M&A drove EBIT up by 17%. Improved variable margins contributed to a margin improvement of 0.5 percentage points. We continue to have relatively high fixed costs in Orkla Food Ingredients.
This is a trend we are not pleased with and that we are addressing. Let's now turn to page 12 for an update on our sales growth relative to the growth, the black over red graph. As you can see, the gap between our growth in organic sales and underlying fixed costs has narrowed lately. This is a challenge for us, and we need to improve. As Petter mentioned, the pace of our organic sales growth in 2018 is too low. Growth in our biggest market, Norway, has been impacted by lower campaign activity and increased retail prices. To reduce our dependency on the Norwegian grocery sector, we continue to grow in channels and geographies outside grocery in the Nordics. As mentioned, we have a few turnaround cases in Care that have been a drag on growth. Our patience here is limited. Moving on to costs.
We continue to reduce fixed costs both in supply chain and our go-to-market organizations. Some of the fixed cost growth are related to the investments we make in new growth areas, such as ice cream ingredients and vegan food. We are addressing the rise in costs and have launched a number of actions in the third quarter to turn this negative trend around. One example is an ongoing project in Denmark that Petter also mentioned, where we are simplifying the go-to-market organization. The other example from Petter is the process we started earlier in October to merge our go-to-market organizations in the Czech Republic and Slovakia. We continue to make our supply chain more efficient. We are in the process of closing eight of our factories and several factory turnaround projects are ongoing. We'll talk more about cost actions next week at our Capital Markets Day.
I'll now show you cash flow performance, which is presented on page 13. Our periodic cash flow from operations the first nine months was lower than last year because of higher working capital and replacement investments. Our net replacement investments have increased because of the ongoing ERP project and supply chain restructuring. Working capital has been relatively stable in the recent years, but with a slight weakening since Q1, and this is clearly below our ambition. We have obtained positive effects by reducing our supplier base. Payments have improved some 10% since 2016. On the other hand, we have tied up more capital in inventory and worsened in receivables. The decline in performance is entirely driven by our care business, which has the broadest portfolio, and we are not pleased with this development. Foods and confectionery snacks have both improved.
We will address working capital specifically at our Capital Markets Day next week. A few words on Jotun on page 14. Jotun continues to grow in all segments except marine. Marine coatings continue to be challenging. The decline in growth margins have leveled off, partly due to price actions. Jotun may continue to adjust prices to compensate for a period of rapidly increasing input costs. Operating results year to date for August were down by 11% compared to last year, and this is mainly due to the increase in raw material prices. Looking ahead, Jotun sees signs of improvement in the shipping market and the order book for new building contracts is up year on year. Jotun also expects to see continued improvements in its protective segment as the oil and gas market is considered to have bottomed out.
Jotun's CEO, Morten Fon, will do a presentation on the Capital Markets Day next week. Let me summarize the highlights this quarter, looking at the P&L slide on page 15. Earnings from Branded Consumer Goods were up 3% year-on-year. All Branded Consumer Goods areas contributed positively except Care. Higher power prices gave a strong result in hydropower, this increased the contribution from Orkla Investments. We had lower net costs in HQ than usual, this is partly explained by a change in the Long-Term Incentive program, as also Petter mentioned earlier. As a consequence, provisions of approximately NOK 15 million for Q1 and Q2 were released in Q3. Going forward, this will be reported on an accrual basis over the entire entitlement period. As a result, adjusted operating profit for the group improved by 7% compared to the previous year.
Other income and expenses will, as you know, vary over time depending on the restructuring and M&A activity. The amount in Q3 is primarily related to both of these two items. Profit from associates were up 13%, predominantly related to Jotun. The lower financial net and adjusted tax contributed positively to Orkla's share of Jotun's net profit in this quarter. As a result, earnings per share from continued operations reached NOK 1.01 per share. I'll now hand back to Peter for his final remarks.
Okay. Thank you, Jens. Yeah, as you have seen, we see a mixed pictures in our different business areas. Overall, I'm not happy with our total performance, and we need to improve. I will come back to that a little bit. On the other side, I'm glad to see that growth in Confectionery & Snacks has turned positive despite the higher sugar tax in Norway. We also see a steady improvement in Food Ingredients and good growth in our Foods businesses outside Norway. As we have explained, in Norway, lower campaign activity and increased retail prices to consumers have led to volume decline in the grocery retail channel. We are working on actions to address this. Another concern this quarter has been the poor performance in some of our Care businesses, notably Poland and the U.K. We have implemented measures to turn around the U.K. business.
I'm following up these actions closely, and it is important that we see real improvements from these operations over the next quarters. In Jotun, we have seen continued sales growth, more stabilizing raw material prices, the order book in the shipping market is improving. In sum, earnings per share from continuing operations improved by 3% in the third quarter. We will give you more comprehensive update on our plans and priorities at our Capital Markets Day next week in London. I hope to see you all there, or for those of you who are not able to participate physically, I hope you will listen in on the webcast available at orkla.com. Before we open up for Q&A, I would like to show you some examples of recent product launches in our businesses. Now turning to page 18.
As you can see from this slide, we have some exciting innovations coming out this autumn. They are all spot on the main consumer trends that we see. First, we see the new Toro ready-made sauce are convenient, made with good ingredients, and free from preservatives. The chocolate-coated licorice from Panda has a fantastic taste and texture and meet consumers' need for indulgence. This product is launched in all our confectionery markets where we are present. The Jordan Green Clean is a toothbrush made from 100% recycled plastic and with environmentally friendly packaging. Lastly, we continue to expand our Naturli' range of vegan products and have now launched a plant-based mince, which is also organic and gluten-free. Actually, we're also launching a few of those Naturli' products in selected stores in the U.K., in Switzerland, in Poland, and in Germany.
With that, we also contribute to better health for our consumers in many European countries. With that, I would now like to ask the operator to open up for Q&A, please.
Thank you. Ladies and gentlemen, if you do have a question for the speakers, please press 01 on your telephone keypad now. Please hold until we have the first question. The first question is from the line of John Ennis from Goldman Sachs. Please go ahead. Your line is now open.
Good morning, Peter. Good morning, Jens. I've got three, actually. My first one's on organic growth, in particular, within the Orkla Care business. I wondered if you could tell us how big the house care business is within that Orkla Care division. Then I wondered if you could give us a bit of an idea of the magnitude of the declines you're seeing in the U.K. and Poland versus the rest of the business. I know you mentioned the rest of the business is healthy, but if you could just maybe give us a few more numbers around that would be useful. Then related to that, could you, I guess, give us a bit more color on what you're doing there to try and improve and turn around the performance? That's the first question.
The next one was actually on the balance sheet because your gearing ratio is very low. I wondered if you could give some color on what you think you're going to do with that strong cash position. Do you think higher dividends or a buyback is a plausible cash use going forward? The last question is on your BCG EBIT target, which was 6%-9% for 2016-2018. Because that excludes some of the bigger acquisitions, I wondered if you could tell us the EBIT growth you think you achieved in 2016 and 2017 on the way you measure it. Thanks.
Okay. Thank you for those three questions. When it comes to organic growth in Orkla Care, we don't disclose exact figures for each business unit. What I can say is that the impact of Orkla House Care in U.K. and impact of Orkla Health in Poland has a substantial impact on total organic growth figures for Orkla Care. Orkla House Care sales, total share of Care. Do you have that figure, Jens, approximately? Yeah.
15%.
15% of Care's total sales. The other question, what do we do about this role? As I mentioned, we have changed management in our Orkla House Care business in U.K. and in our factory in China. We have continuously reduced costs to meet the lower sales volume that we are facing and especially due to the loss of the quite big contract to B&Q. We are reducing complexity in the organization and in the factory and in the warehouses, but also by reducing number of SKUs. These things take some time. Of course, our patience are not unlimited, so we need to see substantial improvement in the coming quarters before we are satisfied and confident that this will turn around in the right direction. When it comes to Orkla Health in Poland, the situation is somewhat different.
It's more, we believe, of a more temporary character, as we see that our sales into the distributors to wholesalers are substantially reduced, while sales to consumer out of stores, out of retail, is at a stable and quite good level. We see that distributors, wholesalers are reducing their inventory. We expect this negative sales impact to disappear in the coming months and quarters. That was the answer to question number one. Your second question was about our strong balance sheet and what do we intend to do with it. I think as we have said many times, that our first priority is to find attractive assets to buy, to use the excess capital for M&A, to buy companies that fit with our strategy, where we can extract synergies or enter into higher growth, either geographies or higher growth categories.
Of course, and that way create shareholder values. That's our main priority. We have also, during the last 12 months, we have paid out special dividend of NOK 5, we did last year when we sold the Sapa. We have bought back approximately 2% of the shares, own shares, during this year. We have also returned a substantial part back to shareholders through either ordinary dividends, special dividend, or share buyback. You have the last question was about the Branded Consumer Goods EBIT growth target of 6 to 9 in the period 2016-2018, and specifically, you asked about performance in 2016 and 2017. According to the definition we announced in Capital Markets Day in London in the fall of 2015, we grew 6.8% in 2016 and 6.1% in 2017.
That is including smaller add-ons, but excluding any big M&As in the period.
Okay, thank you for that.
Next question is from Preben Rasch- Olsen from Carnegie. Please go ahead. Your line is now open.
Yes, hi, good morning. Just two little question from my side. Could you be a bit more specific on what's going on in Norway? Is this just the warm weather effect, or do you see other changed consumer behavior? Also on the headquarter costs being a lot lower, is this a new trend? Should we expect lower costs going forward? Thanks.
The sound on your question, Preben, was very bad and low. It was actually difficult to hear all details of your question. Could you please repeat it?
I'll try. Can you hear me better now?
A little bit better.
Okay, I'll try. Norway, what is actually happening? Is there a change in the consumer behavior, or is it just a warm weather effect?
Okay. I would not say it's about consumer behavior. It's several things that are hampering top-line growth. One is, of course, the warm weather has had a negative impact, no doubt about that. We also see that prices on a lot of our, I would say, bestsellers has increased substantially in the retail. A lot of our products have been used in price wars and price campaigns among the Norwegian retailers, especially last year in 2017, actually also 2016, and that drove high volume. What you're now seeing is that these price wars have shifted to other categories and other products, and prices of our products has increased substantially. In several cases and also on some really big SKUs, we see that retail prices has increased from 20%, 30% and even up to 70%-80% increase. That, of course, at least short time, hampers volume.
Also, of course, the extremely warm weather has impacted consumer behavior during the summer, but that is a temporary effect, of course.
Okay, thank you.
Was the second question around the run rate for HQ costs going forward, Preben?
Yeah.
This quarter, as I said, was influenced by some one-offs. They will not do an accrual for the LTI or the long-term incentive cost in Q4 neither. The run rate that we've communicated earlier is around NOK 90 million per quarter, and you should expect that going forward. When it comes to this, call it long-term incentive adjustment this year, it's a one-off. As I said, going forward, this cost will gradually be accrued over the entitlement period, which is now for three years. It will be a four-year effect of the same cost that we reversed this year.
Okay, thank you.
As a reminder, if you have any questions for the speakers, please press 01 on your telephone keypad now. There are currently no further questions registered, I'll hand the call back to the speakers. Please go ahead.
Okay, thank you everyone for participating on this early morning conference call, hope to see as many as possible in London next week on our Capital Markets Day. For those of you who are not able to participate, you can follow our presentations on our webcast on orkla.com. Thank you very much.
This now concludes the conference call. Thank you all for attending. You may now disconnect.