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Rating action

Scope Ratings GmbH (Scope) has affirmed its issuer rating of A-/Stable on Orkla ASA. Scope has also affirmed its senior unsecured debt rating of A- and the short-term debt rating of S-1.

Rating rationale

The rating affirmation reflects Orkla’s good competitive positioning within consumer branded products in its home Scandinavian markets, business diversification into hydropower and specialty chemicals (Jotun) and still strong financial metrics despite inflation pressures and rising indebtedness.

The business risk profile (assessed BBB+) continues to benefit from Orkla’s strong positions in its main home markets within branded consumer products, with market shares generally ranging between 30-80% and highly recognised local brands. Supports to the rating are the company’s relatively low blended industry risk of A-, as well as its moderate business diversification into unrelated industries of hydropower and specialty chemicals. Moreover, diversification in terms of the consumer product offering – which includes confectionery & snacks, food, ingredients, health, personal care, hygiene, professional cleaning (Lilleborg) and textiles (Pierre Robert) – is considered strong, same as the supplier and distribution networks, although Orkla relies on the grocery channel for over 50% of sales. This compensates to some extent for the geographical concentration, with the Nordics providing about 70% of revenues, although this is set to gradually improve over time, for example with the further development of Pizza Out of Home in Europe (it recently acquired New York Pizza in the Netherlands and Da Grasso in Poland) and recent acquisitions outside the Nordics (e.g. Denali Ingredients in the US, Eastern in India and Healthspan in UK). While overall profitability is still good and relatively stable, the Scope-adjusted EBITDA margin is slightly lagging those of its larger international peers. Finally, brand strength is partly constrained by the rather regional coverage of its over 300 brands, with no leading global brand. That however means diversification, with no real dependency on any single brand in the group.

9M 2022 organic sales growth for branded consumer goods was +9.6% YoY, driven by pricing effects despite declining volumes. In terms of profitability, Orkla improved its Scope-adjusted LTM EBITDA to NOK 9.5bn, including Jotun’s dividend of NOK 328m, corresponding to a Scope-adjusted EBITDA margin of 16.3% (calculated excluding the Jotun dividend), compared to NOK 8.1bn and a 15.5% margin as of FY 2021. The improvement is almost entirely due to the extraordinarily strong performance of the hydropower business (9M 2022 reported EBIT adj. NOK 1.7bn vs. NOK 287m in the prior year), which produces and distributes hydroelectric power and therefore strongly benefited from higher energy prices on the spot market. However, the core business of branded consumer goods experienced a decline in margins in almost all the divisions (foods Europe, confectionery & snacks, Orkla care, consumer investments) amid rapidly increasing raw material, packaging, energy and freight costs not offset in time by higher selling prices. Only the food ingredients unit was able to moderately improve margins.

Assuming revenue growth close to 15% for the current year, Scope forecasts Scope-adjusted EBITDA of around NOK 9.8bn in 2022, resulting in a Scope-adjusted EBITDA margin moderately above 16%, which factors in the negative impact of the introduced windfall charges on the hydro business (23% extra tax on power prices exceeding NOK 0.70/kWh to be applied from 28 September 2022) as well as continued cost inflation, the latter estimated in the high-teens for the entire year. For 2023 and 2024, the base scenario considers a Scope-adjusted EBITDA margin decline to the range of 15% to 15.5%. This reflects primarily a gradually diminishing contribution from hydropower driven by some price stabilisation after the highs of 2022 but also in view of the government’s introduced increase in the resource rent tax rate on hydropower from 37% to 45% from Jan 2022, which, along with the windfall charges, will impact EBIT. Conversely, Scope sees the profitability within branded consumer good business for 2023 broadly in line with 2022 amid a slight easing in inflationary cost pressures and supply-chain constraints but still sluggish volume growth and moderately higher operational costs amid organisational changes to take place during 2023. Scope sees some gradual recovery in the EBITDA margin for the consumer good business from 2024 on gradually improving economic conditions and improving product mix (higher exposure to health, declining portion of distribution business within food Ingredients) and increasing synergies within Pizza Out of Home. This translates into a Scope-adjusted EBITDA between NOK 9.4bn and 9.9bn during 2023/24 with an EBITDA margin of about 16%, supported also by the recurring dividend from Jotun assumed at around NOK 330-350m p.a.

The financial risk profile of Orkla is assessed at A- (lowered from A). Scope-adjusted debt increased to NOK 18.6bn as of Sep 2022 from NOK 14.9bn in Dec 2021 on materially higher net working capital and acquisitions. Scope-adjusted debt levels have more than doubled compared to NOK 8.5bn in Dec 2020, with NOK 6.0bn spent on acquisitions during 2021 being a major driver. As a consequence of increased indebtedness, LTM Scope-adjusted debt/EBITDA stood at 1.9x as of Sep 2022, representing a small deterioration compared to 1.8x as of Dec 2021. Scope forecasts Scope-adjusted debt/EBITDA remained at 1.9x at YE 2022. This factors in the assumption that while working capital needs remain high for the year, driven by a combination of more expensive stocks and supply chain restrictions, some destocking occurred in Q4. Moreover, the M&A spending for 2022 is estimated at around NOK 3.1bn, including the acquisitions of Denali and Da Grasso completed in Q4. For the years 2023/24, Scope sees leverage remaining slightly below 2.0x amid some margin pressure but a gradually improving working capital situation. This level is moderately below the company’s stated financial policy target of net debt/EBITDA below 2.5x. Scope’s capital allocation assumptions include dividends between NOK 3.0bn–3.1bn during 2022/24, while net acquisition spending is expected to decline moderately to the range between NOK 1.0bn to 2.0bn during 2023/24. Similarly, Scope-adjusted funds from operations/debt fell from the excellent levels above 60% pre-2021 and Scope projects it to fluctuate between 40% to 45% over the forecasted horizon.

Interest cover – as measured by Scope-adjusted EBITDA/Scope-adjusted cash interest – remains one of the strongest financial metrics for Orkla, standing consistently well above 10x. Nevertheless, a large part of Orkla’s debt is at variable rate (over 95% as of Dec 2021 vs. 43% a year before) and the current interest rate environment will negatively impact future interest charges. Scope-adjusted interest is projected to only moderately increase to NOK 320m in 2022, corresponding to an average interest rate around 2%, but is expected to more than double to around NOK 650–700m during 2023/24. Such higher payouts will likely result in an interest cover still strong at around 14x during 2023/24, yet a material decline compared to the levels above 30x until 2022.

Despite Orkla having a strong recurring free operating cash flow (FOCF) generation, the increased indebtedness has brought the Scope-adjusted FOCF/debt ratio below 25% in 2021 after standing consistently above 30% in the years 2017-20 after the Sapa disposal. For 2022, Scope projects elevated working capital needs at around NOK 2.4bn and high capex at NOK 3.0bn, which likely brings cash flow cover below 15%. Afterwards, Scope expects an improvement in the net working capital, while capex should normalise towards NOK 2.7bn. However, since Scope does not envisage Orkla materially reducing its indebtedness from current levels, Scope-adjusted FOCF/debt is set to range between 20% to 25%.

Liquidity is adequate based on good access to bank and bond markets. As of Q3 2022, the company had aggregated NOK 9.0bn in cash and undrawn credit lines, well above reported short-term debt of NOK 3.7bn. The fairly high portion of short-term debt at the moment is a result of the opportunistic issuance of commercial paper in the past two years.

Scope continues to not apply any adjustment for supplementary rating drivers.

No drivers of the credit rating are considered ESG-related factors with a substantial impact on the overall assessment of credit risk.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s expectation that the current inflationary environment will continue pressuring profitability within the branded consumer goods core business also during 2023, partly compensated by Orkla’s business diversification into hydropower and Jotun. The Stable Outlook also assumes that despite the favourable shareholder remuneration policy and active M&A strategy, Scope-adjusted leverage will remain below 2x over time, amid the absence of transformational deals, but the headroom to a negative rating action has now been reduced compared to Scope’s last assessment in January 2022. This also incorporates Scope’s expectation that Orkla will likely not use its leverage potential to the maximum leverage ratio as defined by the company (net debt/EBITDA) of 2.5x over the foreseeable future.

A positive rating action is possible if the company reduced its growth and M&A ambitions and focused on paying down debt, resulting in a Scope-adjusted leverage sustained below 1x. In the longer run, a positive action could stem from increased international market presence and global brands, while at the same time increasing profitability on a sustained basis.

A negative rating action is possible in case of sustained M&A activity beyond Scope’s expectations and/or materially declining margins, which could result in a Scope-adjusted leverage sustained above 2x.

Long-term and short-term debt ratings

The senior unsecured debt rating is in line with the issuer rating. Orkla ASA is also the bond-issuing entity. The short-term debt rating of S-1 is backed by adequate liquidity, strong banking relationships and a well-established capital market standing.

Stress testing & cash flow analysis
No stress testing was performed. Scope Ratings performed its standard cash flow forecasting for the company.

Methodology
The methodologies used for these Credit Ratings and/or Outlooks, (General Corporate Rating Methodology, 15 July 2022; Consumer Products Rating Methodology, 4 November 2022), are available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity and Scope Ratings' internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlook are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Eugenio Piliego, Director
Person responsible for approval of the Credit Ratings: Sebastian Zank, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 11 January 2022.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use/exclusion of liability
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