Time for Distressed Investors to Look at Freedom Foods

Summary

• Freedom Foods saw its CFO resigned, CEO going on leave, and management reshuffle last week.
• FNP has disclosed additional inventory write-downs and provision for doubtful debts.
• An investigation is underway by PwC and Ashurst.

Distressed investors like when businesses are wrangled in trouble and investor sentiments are pessimistic about the business, which eventually leads to destruction for existing shareholders of the business as investors get reasons to sell.

Remember when Warren Buffet bought preferred shares of Goldman Sachs with warrants at the heart of Great Financial Crisis. He didn’t stop there and bought into large businesses like Bank of America, Mars and Dow Chemical over the years.

A similar distressed story seems to unfold on ASX after Freedom Foods has reported a number of issues. Additional information would be provided when the Company concludes investigations, which are being handled by PwC and Ashurst.

Freedom Foods Group Limited (ASX:FNP)

Shareholders of Freedom Foods have been left stranded after the Company’s latest release and a conference call last week. A lot has happened at the Company during the last week:

• Campbell Nicholas, who was FNP Chief Financial Officer and Company Secretary, has resigned from the Company. A Non-Executive Director in the Board, Mr Trevor Allen was appointed as Company Secretary.
• Chief Executive of Freedom Foods, Rory Macleod is on leave, and Perry Gunner, who was the Chairman, has been appointed as Executive Chairman.
• Among insiders, FNP has also appointed Brendan Radford as Acting Chief Executive, while Stephanie Graham took the role of Acting Chief Financial Officer.

Additional Inventory Write-Downs

In the latest filing with the exchange, FNP has acknowledged further write-downs to its inventory. In May, the Company had reported an initial estimate of approximately $25 million write-downs to its inventory in FY20. The initial estimate was due to consolidation of external warehousing activities and a detailed review of product offerings.

As the Company continues to review carrying value of its inventory and inventory levels, FNP has become aware of additional write-downs, which would be required due to product withdrawals, out-of-date and obsolete stocks.

Now, the Company expects to incur inventory write-down of around $60 million in FY20, after adding $35 million in additional write-downs. This total estimate is subject to year-end review, including audit. FNP would also decide whether the inventory held outside Australia, which is indicated at $2 million at 31 May 2020, is required to be impaired or not.

The revised write-downs reported by the Company date back from 2017 to the current year. In May, it was estimated that inventory could be reprocessed, but now the Company believes that this would not be an optimal solution.

It has also found that initial estimate did not include current fiscal year’s product withdrawals and deletions. And, the cost of goods was carried forward as a capital item instead of cost of sales, which requires further investigation.

Additional Doubtful Debts

In May, the Company reported that doubtful debts provision of $4 million would be needed in this trading period. A further detailed review of its revenue recognition and doubtful debt provisioning was conducted.

Now, FNP expects that reversal of prior period revenue recognition and additional doubtful debt provisioning would be required in FY20. This adjustment is expected to lower EBITDA by around $10 million.

The Company may be required to adjust the timing of revenue recognition of prior periods and debtor balances. The revised estimate is subject to year-end review, including audit.

Funding facilities

In May, Freedom Foods also agreed with its long-term banking partners to increase short-term liquidity by $100 million. The Company undertook the restructuring of its syndicated and bilateral debt facilities to ensure financial flexibility and balance sheet strength.

This restructuring has provided the Company with better covenant headroom, ability to accommodate changes in sales and inventory mix, and fund the growth over the medium term. FNP continues to engage with its bankers and keep them updated.

Employee Share Plan

In March, the Company was engaged in reviewing its employee share option policy. During mid-March, FNP reported that it intends to issue up to 2.1 million shares to employees. In March and April, around 1.545 million shares were issued to employees.

Now, the Company has unveiled that no further issues are planned, and it expects to report non-cash share-based payment charges of $5.9 million in this fiscal year or spread across FY20 and previous periods.

Positions Terminated - FNP has also reported that a total of 61 positions were terminated, and 41 employees were made redundant.

Conference Call Highlights

Executive Chairman, Perry Gunner stated that the Company’s largest shareholder Perich family continues to support the business. The Company has employment obligations, and an announcement related to its CEO would be made public soon.

When asked about any potential fraud, he said that additional investigations are underway and issues like fraud would be made public. On inventory issues, it was noted that the issue came into light when warehouse consolidation was ongoing.

It was also unveiled that the business is performing better than the expectation in May, as reopening continues in Australia and the Company’s lactoferrin plant is running. FNP expects to fulfil its contractual obligations related to customer contracts. However, exports orders were cancelled, and part of the obsolete stock was meant for contracts with other parties, which have not utilised the full amount in contracts.

FNP intends to develop its own brands, which is a time taking process. And, it sources contract manufacturing to fulfil the excess capacities in factories. Over time, the potential new products of the Company would replace contract manufacturing.

When asked what Mr Gunner expects out of the potential new CEO, he responded that the Company would look for someone who could drive the business, use the plants and machinery that the business has invested. Moreover, they are looking for someone who can drive the business forward and develop brands.

FNP considers its plant-based business as a strategic segment to develop markets, especially in China and South-East Asia. Plant-based segment also enables the business to develop products for out-of-home category.

It does not anticipate any large capital expenditure plan in the next year. The Company is only left with the installation of the PET bottle line, and only installation costs would be incurred as equipment has been purchased.

Mr Gunner stated that the current issues are having no impact on operational performance.

FNP last traded at $3.01 on 24 June, and its share trading volumes hit around 14.9 million and share price cracked by 14.5%. Since 25 June, the Company is in trading suspension for 14 days.