Zetar – sweet prospects, low rating

Chocolates and snacks maker Zetar’s fall from grace since it bought baked snacks business Britannia has been galling for management and investors alike. 

Floated as a shell with a buy-and-build strategy in 2005, the company’s shares had risen from 100p to a 590p peak by the spring of 2007 as it built a collection of confectionery and fruit and nut businesses. But in May that year, management made a departure from its strategy of buying profitable businesses when it forked out £4.7 million on baked snacks maker Britannia to further develop the healthy snacking offering.

The negative impact of this relatively small addition led to a share price collapse to 95p, with the market’s concerns about this loss-making division only heightened by the onset of recession and the collapse of major customer Woolworths.

‘[Britannia] was in the right product area, tapping into the healthy-eating market,’ explains chief executive Ian Blackburn, who was previously part of the successful acquisitive expansion of Perkins Foods a decade ago, ‘but it had a half-built factory and was losing money. We were in conversations with major brand houses for new products but it ended up being a distraction as the economy collapsed. When Woolworths went bust we were left with a bad debt of just under £1 million and at the same time our margins in natural snacks were being smashed by the dollar exchange rate.’

However, the market’s harsh reaction seems more akin to a company going bust, rather than one still poised to produce around 30p of annual earnings. And now, with natural snacking margins having come back and the Baked Snacks division sold back to its management for £2.7 million, Zetar’s prospects look much better.

Zetar’s confectionery arm generates the majority of group revenues, via the manufacture of private-label products for supermarkets (Marks & Spencer, Tesco and Sainsbury’s are its three largest customers) and licensing – making chocolates branded with The Simpsons, High School Musical, Barbie and the like – with the remaining sales derived from third-party manufacturing and its own brands.

A recent update from the company informed that a good Easter, when it increased its share of the chocolate egg market by almost 19 per cent to five per cent, had helped it to a strong year to April. This helped the confectionery arm lift revenues ten per cent to £75 million, exactly the same enlargement enjoyed by the natural and premium snacks arm, which produces fruit and nut mixes, yoghurt-covered raisins and so on, mainly under private labels for the same supermarket customers.

All in all, despite the loss of what would have been around £2 million to £3 million of business from Woolworths, Zetar says it will deliver a ten per cent increase in revenues from continuing activities to £119 million when results are unveiled in July.

However, while sales have been driven forward, it has been at the expense of margin, as the company has adapted to the new needs of recessionary Britain. Says Blackburn: ‘We have increased our levels of high-volume, lower-margin production. There is about £4 million to £5 million of new turnover in there derived from economy products.’

Nevertheless, he says that pre-tax profits should still be in line with the market’s £4.3 million forecast. Furthermore, even after £3.5 million of capital expenditure, a strict focus on costs enabled Zetar to reduce net debt to a better-than-expected £16 million.

Despite having picked itself up, the company’s shares still command only a lowly rating, trading on less than five times forecast consensus earnings of 33.2p for next year. Although some scepticism may persist as to whether the company can deliver its predicted earnings growth, Zetar continues to attract business from the supermarkets and major brand houses due to its flexible and innovative methods, and Blackburn mentions that ‘significant new business wins’ have been clinched for the group’s new value products. At 152.5p Zetar shares therefore look appetising. Buy.