The Supply Side: Markets may improve in 2015 for consumer food companies

by The City Wire staff ([email protected]) 213 views 

Food suppliers to Wal-Mart Stores continue to struggle to improve market share despite a growing U.S. economy. However, a leading analyst with Credit Suisse said some struggles may persist but lower gas prices, industry changes and other factors should help the retail sector in 2015.

Robert Moskow, an analyst with Credit Suisse, said the benefits of lower prices and an overall healthier economy will be more broadly enjoyed by all demographics in 2015.

“While not a game-changer for U.S. food, we believe that the stronger economic backdrop will improve fundamental performance in 2015, especially in relation to the unusually weak 2014. Lower gas prices, a positive adjustment in SNAP benefits, and the slow but continuous improvement in employment should help improve consumer confidence, especially among lower-income consumers who have yet to enjoy any of the benefits of the broader economic recovery,” Moskow said. “Wal-Mart estimates that the SNAP cutbacks at the end of 2013 represented a 0.7% drag on its food sales in 2014, and lower gas prices are likely to boost U.S. disposable income by at least $80 billion. These factors aren't game changers, but they certainly must come as a relief for manufacturers and consumers alike.”

Based on 34 years of government data, Moskow said lower gas prices may not point to more sales for the packaged foods sector. He said when gas prices go down people eat out more often, and when gasoline prices rise, people tend to look for grocery savings.

Other trends in play in the food manufacturing sector include grocers seeking to expand private label and store brands to entice value-seeking shoppers. On the high-end, Moskow expects to see more consumers transitioning to organic foods while they also demand more transparency in labeling and a move toward healthier nutrition.

The following observations are from Credit Suisse analysts who provide updates on several food companies that are major suppliers to Wal-Mart Stores. These companies also run large sales office in Northwest Arkansas.

Moskow said the acquisitions of Bolthouse, Plum Organics, and Kelsen have added $1 billion of sales from faster-growing health-and-wellness categories and, in the case of Kelsen, emerging markets. The divesture of the struggling European soup business will help Campbell because the moves reduced the exposure of the portfolio to canned soup, which is arguably in structural decline.

He said judging food is an inherently subjective process, but the improvements at Campbell are noteworthy. Adding quality back to the soup formulations and backing away from sodium reduction has improved consumer testing to over 60% preferred versus competition, the report stated.

“In addition, we give credit to CEO Denise Morrison for upgrading the talent of the people around her. In total, 6 out of 11 of the top leaders are new to their roles or to the organization. As an example of the company's emphasis on performance, Ed Carolan was promoted to run U.S. Retail after successfully driving up soup sales in fiscal year 2013. Morrison strengthened the company's marketing capabilities by hiring Michael Senackerib as chief marketing officer,” Moskow said.

Late last year CEO Gary Rodkin announced his intent to retire effective May 2015. A successor has not been announced and management recently said there was no update on the search. Moskow said the company’s consumer foods division appears to be stabilizing.

Last year management said it had decided to reduce efforts to attract Millennials to its top brands and adopt a "fix and grow" strategy targeted at its core consumers. This strategic change appears to have stabilized the business, at least for now. Moskow said Chef Boyardee is turning around, gaining share and posting volume and dollar sales growth, albeit on an easy comparison. The company launched new innovation in the second quarter under the Healthy Choice brand that management thinks will help drive growth. Lastly, he said, Orville Redenbacher is seeing "positive developments" and management intends to duplicate the success they saw with the Act II brand by revamping the packaging graphics.

“We believe Lamb Weston has a better growth profile than investors realize.The Lamb Weston foodservice business has a leading market position in Japan, China, Korea, and the Middle East. It makes a high quality product and is known as a quality innovator and product developer, well-equipped to suit customers' needs,” Moskow said in the report.

Credit Suisse noted that General Mills has dominant positions in two of the fastest growing categories in the U.S. – snack bars and yogurt. Moskow said the U.S. is still an emerging market for the yogurt category with per capita consumption rates growing rapidly as consumers look for healthier meal and snack products. In snack bars, the company has developed an “outstanding franchise” for its Nature Valley granola brand and Fiber One.

The company has realigned the U.S. retail business into five operating units: cereal, yogurt, snacks, meals, and baking products. As part of this, sales of natural and organic brands will be folded into their respective units which will allow for the smaller brands to benefit from increased sourcing, manufacturing, and R&D resources as part of a larger operating unit. 

Moskow is not optimistic about future growth for General Mills. He said the food maker is “clinging to unrealistic long term growth objectives in an environment where consumers keep shifting to more organic, natural, and less processed food solutions.”

He said approximately 22% of General Mills’ sales are in ready-to-eat cereal and this is a category that has struggled for some time. Cereal has consistently underperformed overall food sales since 2009. In that time period, cereal volume was down 3% annually compared to overall food that was flat.

Moskow said Hershey has taken back some lost market share it lost to Mars and Nestle last year. He expects Hershey sales growth of 7.6% in 2015, driven primarily by pricing and acquisitions, and partially offset by modest volume declines.

Hershey announced an 8% price increase in July 2014, when main input costs peaked. Since this increase was announced, cocoa prices have fallen 4% and sugar has dropped 2%. 

“We expect continued declines in these costs in the near term, and we think dairy prices could fall 15% in 2015. We expect total company pricing to increase 6% in 2015,” Moskow noted in the report.

Last year Kellogg's percent of sales from breakfast cereal fell to 45% from 50%. Given the declining demand profile of breakfast cereal, Credit Suisse analysts think Kellogg is taking appropriate steps by cutting its manufacturing capacity in North America and adding capacity in lower-cost countries like India. 

Moskow expects more plant closures for U.S. cereal makers going forward and he makes a bearish case for Kellogg in 2015.

“Breakfast cereal lands in the cross-hairs of several dietary movements at once: gluten-free, lactose-free, and the backlash against ‘added sugars’ and ‘empty carbs.’ Just about every nutritionist, dietician,and athlete seemed to have something negative to say about carbohydrates in 2013 and 2014 and something positive to say about protein and ‘good fats. In the past, we too would have considered these issues faddish rather than structural. But the sustainability of these trends has been shocking,” Moskow noted.

CEO John Cahill’s recent ascension indicates that the board likely wants to accelerate the pace of change, according to Moskow.

“He may take a more aggressive stance than his predecessor to selling brands to streamline the portfolio. Selling Oscar Mayer and Maxwell House, for example, could unlock a fair degree of value for shareholders if they fetch the similar multiples that Tyson and JAB paid for meat and coffee business in 2014. However, selling these on-trend businesses would probably dilute Kraft's growth, and therefore pose an even bigger challenge to the remaining portfolio,” Moskow noted.

He expects Kraft’s gross margin will expand in 2015 to some degree amid lower commodity prices. The report also noted that Kraft is also still in the middle innings of reducing its overhead costs and improving supply chain efficiency. 

“At the time of its spin from Mondelez, management said it lacked cost leadership in almost every one of its categories despite its size and scale. Overhead as a percent of sales has significantly improved to 7.6% in 2013 from 12% in 2010. However, its supply chain ran into some significant start-up problems and quality control issues in 2014 as it tried to consolidate manufacturing lines,” Moskow noted.

He said Kraft has not been able to engage Millennials with its media spends despite moving more dollars away from television and more to social and digital platforms.

Moskow said Mondelez – the company with products that include Cadbury, Chips Ahoy!, Oreo and Ritz crackers – is ripe for untapped pricing power this year as the company is poised to see gross operating margins improve thanks to a leaner supply chain.

“Mondelez can likely achieve an extra 1% of margin leverage from making better pricing decisions. This includes raising price or reducing promotion modestly in the markets where its market share is 70% or higher than its nearest competitor and making more conservative decisions in markets without clear leadership,” Moskow noted in the report.