By Edmond Jackson | Tue, 15/11/2011 - 00:00

The bombed-out shares of FTSE 250-listed food producer Premier Foods (PFD) have enjoyed a bounce from a recent 3p low after directors piled in following 7 November news that banks had deferred a key covenant test, and an analyst at Investec suggested "a plausible equity value of 20p in six months". Yet there was a drop from 7p to 5p briefly on Monday 14 November after UBS changed stance to 'sell', targeting 2p, given the risk that shareholders' interests are subordinate to bankers'. How to divine such conflicting signals?

While the scale of buying is not massive - 70,300 spread over four people, with the managing director of bakery accounting for 44,700 - it is interesting to see operational directors buying, representing belief in a turnaround. Directors can prove less good at judging wider issues however.

For more analysis of how to read directors' actions, read: Are directors' moves a signal to success?

There was also modest buying among directors near the 6p level in October, despite a weak interim management statement (IMS) depressing the shares. For the three months to end-September, trading was "significantly behind our expectations" as group sales slipped 3.6% to 477 million and this was accompanied by a profit warning.

The shocking aspect was this coming at a time when Premier is close anyway to its covenant of 3.9 times net debt - about 950 million - to EBITDA (earnings before interest, tax, depreciation and amortisation) which analysts have estimated at 250 million, hence a ratio of 3.8 times.

Since the next covenant test at end-December had stipulated 3.45 times, the banks most likely realise the situation needs dragging out - it being as much their problem as Premier's.

The saving grace for gamblers in the shares might be that bankers will ultimately fear taking control by a debt-for-equity swap. Some kind of facilities extension, rather like the way indebted European nations are being bailed out, might follow. Yet equity and debt plays alike are getting more alert to the proverbial 'kicking the can down the road'. It would be foolhardy to assume the bankers are in this so deep they won't take radical action.

Additionally there is a pension fund deficit of about 500 million; and so despite annual group sales of about 2.5 billion the equity value is necessarily low - about 150 million, with the shares currently at about 6p.

So the crux is whether Premier can define a trading turnaround that adds up to a bankable proposition without writing out shareholders. They may need to wait for the evidence, as last time there was no update between the October 2010 IMS and the mid-February prelims.

The main hope lies in the recovery plan defined by the new chief executive, ex-president of Kraft Foods Europe. Even if you lack appetite for Premier shares, the situation is now a classic test to follow, of a Warren Buffett wisecrack: "When a manager with a reputation for excellence tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that stays intact."

Operational priorities are on eight brands considered as having the best growth potential: Ambrosia, Batchelor's, Bisto, Hovis, Loyd Grossman, Mr Kipling, Oxo and Sharwood's. So a botulism poisoning alert over Loyd Grossman curry sauce, with a batch being recalled, is unfortunate publicity in the mainstream media currently, as the spores may have nothing to do with the food manufacturer's hygiene - instead, originate in farmers' soil. Yet it is an untimely dent to the Loyd Grossman food brand, whose sales may be affected.

Another key priority is to "work more collaboratively with our customer partners to deliver category growth through greater and more focused product innovation... and other brand-building initiatives". The firm will certainly need to be vigorous as supermarket shelves are a lot more complex compared with the 1970s when this group's products were dominant - for example "brown bread" effectively meant Hovis. Traditional brands have been elbowed aside by a lot more choice including "value" and "taste the difference" supermarket own-brands.

To its credit, Premier has adapted such that a third of its sales are non-branded, although it is hard for outsiders to figure what is involved from the group's financial statements.

Ironically, what appears a declining trend within the business amid challenged UK grocery sales, contrasts with broker expectations (as shown in Company REFS ) for substantial profit growth in both 2011 and 2012, implying earnings per share of 2p rising to 3p. (This nominally low level resulting from nearly 2.4 billion shares in issue.) The analysts apparently had these forecasts in mid-October after the weak IMS, although the consensus advice was 'sell'.

Investec appears to be the only broker turning optimistic, upgrading from 'hold' to 'buy' after the covenant test deferral. I would treat their idea of a rise to 20p as highly speculative while the group has yet to show how it can improve its cash flow. At the half-year stage there was a net outflow of 38 million compared with 13 million for 2010; quite to be expected though, as a result of disposals.

The 7 October IMS cited ongoing disposals needed to cut debt, so progress with this besides the group's trading position needs watching. The shares are high risk while Premier is caught between the pincers of reducing cash flow and being close to its banking covenants.

Gamblers in the shares do at least have in their favour the banks are in their own predicament here, hence likely to be supportive. The big question is whether the new chief executive can perform a Houdini-like escape from the debt shackles without too painful a debt-equity swap.

The trend in company's financial statements and a possible recession make this a tough challenge - but given his willingness to join, and the other directors' share buying, it will be interesting to watch how this plays out.