Merger speculation is over for now

The company confirmed in its Q4 results statement that it has ended “exploratory discussions” with American Industrial Partners (AIP), owner of Attindas.

This ends close to ten months of speculation about a potential merger of the two brands that could have constituted a change of control under Ontex’s bond docs (which clients can read here). Management note in the release that though there was a “strong business rationale for a combination”, the currently weak macro environment outweighs those benefits, perhaps inferring that AIP’s valuation opinion of Ontex didn’t meet expectations.

Focus now firmly turns to delivering “significant value for shareholders”, though the strong combination rationale assertion may just leave the door open for a possible future deal.

The development is credit negative for Ontex as it removes the near-term possibility of an early bond redemption. Furthermore, now is the time for management to enhance visibility into North American expansion plans and to better educate the market on the particulars of the accelerated execution of its strategy. Regrettably there hasn’t been a lot of tangible information provided.

Non-core earnings improve but still no progress

In a similar vein, there was yet again no concrete update on the disposal program of non-core assets, a process that began in October 2021. As we said at Q2 22 earnings, former CEO Esther Berrozpe suggested non-binding bids were received some time in the summer of 2022.

The Mexican asset disposal should close in early Q2 23 with some minor delay, as it was previously signposted to close in Q1 23. That said, there is little concern for creditors here regarding execution risk as management confirmed that everything is on track and reiterated an intention to fully pay down the ~€217m term loan with net disposal proceeds.

CFO, Peter Vanneste, did suggest progress was being made with the Middle East assets, with management hopeful of making steps there soon. A concrete development is long overdue here as the protracted process distracts from the important development of the core assets.

The storied Brazilian asset suffered yet another setback with Vanneste outlining during the earnings call that a €4m provision for bad debts in Q4 22 relates to bankruptcy protection sought by a key customer in the country. It looks like this key customer is retail chain Americanas (more here).

This, Vanneste added, was the cause for the sequential drop in the non-core EBITDA margin in Q4 22 to 5.1% (€11m) from 5.4%. Adjusting for this, the margin increases to just under 7% which is a better reflection of the underlying improvement seen in Q4 22.

Q4 turns the tide

As expected, pricing and cost initiatives finally overcame input cost inflation in Q4 22. Core Markets EBITDA of €40.3m delivered a margin 8.8% which was a 50bps improvement from 4Q 21. This consolidated the trend seen in Q3 (clients can read our coverage here) wherein pricing and volume really started to make a dent on inflation. Pricing alone doesn't yet cover inflation entirely and there is more work to do in 2023, but Ontex exits 2022 in a good position.

Stepping up the P&L to revenue, Core Markets revenue of €1.67bn came in right on budget representing a 15% year-on-year (YoY) like-for-like (LfL) increase. FX added another 4%, pushing the growth per reported figures to 19%. The 15% LfL growth was driven by a pricing contribution of 8% and volume and mix of 7%.

Core Markets EBITDA, boosted by the particularly strong Q4, reached €104m at a margin of 6.2% which was a 4.9 point YoY decline. Emerging Markets or non-core operations contributed €792m of revenue (28% YoY growth) and decent EBITDA of €32m (4% margin) to take consolidated revenue to €2.46bn and EBITDA of €135.7m at a 5.5% margin (3-points YoY decline).

Leverage came in at 6.4x, compared to 7.7x as of Q3 22, and should decline marginally further after the sale of the Mexican business closes.

Market tailwinds show benefit of inflation

Another positive take-away from earnings was management’s assertion that retailer brands gained market share in Europe in 2022, particularly the second half. This is a function of retailer brands being more affordable and consumers trading down in light of tightening household budgets and high inflation. This has been a much discussed and touted trend, but it is certainly positive to see it translate into earnings.

The positive trend should support Ontex’s pricing strategy and margins in 2023, even if the YoY benefit on volumes will be lower compared to 2022.

Less glossy is the 30% volume growth the company says baby pants achieved in 2022. We are inclined to see this as more idiosyncratic to Ontex and one-off in nature as the company had been behind key European competitor Drylock Technologies on baby pants technology by some margin (our Deep Dive from February 2022 is available for clients here or you can request a copy here). The 2022 volume surge is likely a function of a rebalancing of the competitive landscape in Europe as Ontex’s technology catches up and the company is potentially more price competitive given its larger size and scale relative to Drylock.

Outlook a little underwhelming

Management’s outlook for FY 23 is a little underwhelming. They characterise it as “prudent”, as Vanneste did with Q4 22 guidance during the Q3 22 earnings call, though Q4 ended up only hitting budget.

Broadly, Core Market revenue is expected to grow by a high-single digit amount on a LfL basis and the adjusted EBITDA margin is guided to range between 8% and 10%. Considering the Core Market margin reached 8.8% in Q4 22, the implied margin change doesn’t reflect much easing of input cost inflation despite the recent softening of energy prices and certain commodity prices.

Importantly, Vanneste again reiterated that FY 23 guidance was derived based on current spot price and an assumption that these remain flat across FY 23. Fluff (17% to 18% of COGS in normal operations) prices remain elevated and what may be additionally hurting Ontex is the fact it purchases its fluff in USD. It is also indirectly exposed to the USD through its purchasing of oil-based materials such as polyethylene and super-absorber polymers.

There are therefore two possible upsides to the earnings outlook in a better-than-expected commodity price landscape and an improving EUR/USD curve, though this is not simply one way with the increasing proportion of revenues derived in USD partially offsetting cost base benefits.

Importantly, leverage is guided to decrease to below 4x by the end of FY 23. This would bring it back below the FY 21 level of 4.2x and should offer relief to creditors given the core business is likely to command a higher multiple if earnings continue to stabilise and improve.