The recent announcement that Premier Foods (LSE: PFD) has asked its suppliers for payments in order to continue doing business with the firm has shocked many investors in the company. After all, the consequence of not doing so is apparently a nomination to be de-listed according to an email seen by the BBC.
This appears, then, to be a demand to either pay up, or risk losing a contract to supply Premier Foods in future. However, is this a reason to sell shares in the company, with the potential reputational damage and chance of a customer backlash meaning that sentiment in Premier Foods could decline? Or, is it a case of a necessary move by a company that is attempting to boost its cash flow at a challenging time? Shares fell around 3% in early trade after the Newsnight broadcast, so lets take a look.
While the challenges faced by UK supermarkets are well documented, the difficulties of food producers and manufacturers are given far less airtime. However, their problems are arguably even greater than those of the supermarkets, since until recently they had to endure rapidly rising input costs, alongside downward pressure on prices from the stockists of their goods: the major supermarkets. As such, the margins of food manufacturers such as Premier Foods have come under sustained pressure in recent years, which means that they have had to cut costs themselves.
Clearly, many people will be disappointed that the manufacturer of Mr Kipling, Bisto, Oxo and other food favourites has put its suppliers in a difficult and, many people would argue, unfair position. After all, it is likely that Premier Foods is a major customer for many of its small suppliers and, as a result, they are perhaps less able to refuse the terms than larger, more diversified peers would be.
The move could backfire on Premier Foods, since although it has stated that it is confident its demand does not break any rules under competition law, the government has said it is concerned about the reports. In order to warrant an investigation into the demand, it is likely that a number of Premier Foods suppliers or customers will need to complain. There is a fair chance that this could happen and Premier Foods could see its sentiment decline in the short term as a result.
Of course, payments from suppliers could help to boost the cash flow of Premier Foods and, looking ahead, there could be light at the end of the tunnel for the business. Certainly, its vast debt is a major problem for which there is no simple solution. But, with interest rates set to stay low over the medium term, Premier Foods could navigate its way through the next few years and, in the meantime, is expected to deliver profits in the current year, as well as next year.
With shares in Premier Foods trading on a price to earnings (P/E) ratio of just 4.1, they are clearly incredibly cheap. And, while sentiment could decline in the short run due to the view that its pay and stay policy is unfair, the medium term could prove to be a profitable one for investors in the company. As such, for less risk-averse investors, Premier Foods could be a company worth holding over the next couple of years.
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Peter Stephens owns shares of Premier Foods. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.