Will Premier foods end up brown bread?

A shock trading update raises serious questions over the future of Hovis and Mr Kipling's parent company, reports Nick Clark

Mr Kipling, may bake exceedingly good cakes, but his parent company yesterday put out an exceedingly bad trading update. The shock announcement by Premier Foods prompted a 40 per cent collapse in its share price and raised questions about the company's future. Sales in the three months to the end of September fell by 3.6 per cent to £477m, it said.

The market had expected full-year profits to come in at between £214m and £232m, but Premier said it would miss those targets because its performance was "significantly below expectations". For a stock that peaked at 287p in early 2007, yesterday it fell to as low as 6p.

The owner of brands including Hovis bread and Oxo stock cubes has struggled as British consumers have tightened their belts, and its rivals have ratcheted up the price wars. Premier has also suffered from a spat with Tesco, its largest customer. The company's new chief executive, Michael Clarke, said: "Unfortunately, trading has not been good; we lost momentum from the beginning of the year."

Martin Deboo, an analyst at Investec, said the announcement amounted to a "significant profit warning" and added: "The question is whether this company can survive."

He expects consensus forecasts for full-year earnings before interest and taxation to be slashed by 10 per cent to below £200m. "To say that all this adds up to a baptism of fire for new chief executive Mike Clarke feels like the understatement of the year," Mr Deboo said.

Hovis came under particular pressure in the third quarter, with sales slumping by 6.2 per cent "driven by intense competition". Volumes fell by 13.5 per cent and margins were hit by higher promotional activity. Sales of own-brand Brookes Avana products fell by 13.2 per cent after Premier lost a significant pie contract at its RF Brookes subsidiary in Newport, south Wales.

Premier was set up in 1981 when Hillsdown Holdings bought Lockwood and continued to grow over the subsequent three decades with a series of acquisitions. Yet its £1.2bn purchase of RHM, which brought brands including Hovis, Bisto and Mr Kipling into the fold just before the credit crunch in 2007 saddled the company with high levels of debt.

Premier said its debts would rise further this year, with analysts estimating a figure of about £900m. The company also has a pensions deficit of about £500m.

Premier is still smarting from disputes with Tesco. Between March and June, the supermarket giant pulled about quarter of Premier's branded products from its shelves after an argument over proposed price increases. Five months earlier, it had dropped several Hovis lines for similar reasons. Mr Clarke, a former head of Kraft's European business, was appointed to turn the company around in July. He said: "I was aware when I joined there would be challenges. And it has lived up to that.

"I've covered a lot of ground during my first weeks with Premier Foods and am convinced that there are substantial opportunities here, but there are also significant challenges that we have to overcome."

He added that staff were determined to turn the business around. Mr Clarke outlined his short-term plan to keep the company afloat, firstly by agreeing a refinancing plan with the company's banks. He said the two sides were in a "constructive dialogue" as they sought to hammer out some headroom against the covenants. Much depends on the outcome of talks with bankers and Mr Deboo said a technical covenant breach "is almost inevitable".

The company is to focus on eight "power brands" – Ambrosia, Batchelor's, Bisto, Hovis, Loyd Grossman, Mr Kipling, Oxo and Sharwood's. Mr Clarke said that while there would not be a fire-sale of its other products, it had identified some brands it wanted to offload.

Yesterday's update said it would significantly exceed its £20m cost-saving target by 2013. It is still unclear what business will emerge at the other side, although it will be undoubtedly smaller. "I see know reason why we can't get it back on track," Mr Clarke said.