Editor’s note: The Supply Side section of The City Wire focuses on the companies, organizations, issues and individuals engaged in providing products and services to retailers. The Supply Side is managed by The City Wire and sponsored by Propak Logistics.
With groceries comprising in excess of 55% of Wal-Mart’s total annual sales, the financial health of those product suppliers who operate offices in Northwest Arkansas are important to the region’s overall economic health.
A recent report by Fitch Ratings gives the consumer packaged goods (CPG) sector a stable outlook for 2014, citing their ability to combat slow growth through more mergers and acquisitions and overall cost cuts.
Although Fitch Ratings anticipates macroeconomic factors including high unemployment and SNAP payment reduction will continue to pressure low income consumers in 2014, the rating firm notes that packaged food companies have the ability to manage their capital structures.
But Fitch expects CPGs will be focused on accelerating top line and volume growth in a modest input cost inflation environment, which is likely to prove difficult in the highly promotional retail environment. Some the region’s largest suppliers Nestlé and ConAgra Foods are still concentrating on debt reduction from recent leveraged transactions.
However, Fitch notes several suppliers who already substantially reduced transaction related leverage, such as General Mills, Kellogg Company and Mondelez International. H.J. Heinz remains highly leveraged but plans to reduce debt mainly through earnings growth this coming year.
One of the biggest threats to CPG profitability in 2014 is modest inflation with their input costs
The U.S. Department of Agriculture forecasts food at home prices to increase 2.5% to 3.5% in 2014, up slightly from inflationary pressures in 2013. In general, packaged food companies are expecting low single-digit cost inflation in raw material costs, which they can offset with savings from productivity initiatives without the need to raise prices, according to Fitch.
Companies like Hillshire Brands which include meat products will likely have to raise prices, which is challenging with retailers operating in a highly promotional environment or Wal-Mart who is keenly focused on winning the grocery challenge.
In contrast, coffee prices have fallen dramatically on oversupplies, so Nestlé, Mondelez and J.M. Smucker are passing through the savings.
GLOBAL GROWTH, M&A OUTLOOK
Packaged food companies are still betting heavily on growth in emerging markets to drive their overall top line. Several companies have touted investments in China and Brazil as a quick way to fuel growth, but those are proving less helpful due to decelerating consumer spending, according to Fitch.
The EU macroeconomic situation remains weak, but no longer deteriorating. Fitch anticipates companies will continue cost cutting, acquisitions and divestitures to optimize operations for higher top and bottom line growth.
The food sector has been a hot bed of merger and acquisitions in 2013, but Fitch cites this activity as the biggest threat to corporate credit ratings in 2014 from the rising debt leverage.
Acquisitions are still tempting in the low-interest financing environment. Fitch expects acquisitions in core categories that are margin or growth-enhancing are likely to continue in 2014. The private label market is still fragmented, and there is more room to consolidate, as evidenced by TreeHouse Foods’ recent acquisitions.
Recent examples of non-core divestitures include Campbell’s sale of its European Simple Meals business to CVC Capital Partners, Del Monte’s announced $1.675 billion exit of its sluggish consumer products business and Nestle’s sale of Jenny Craig (excluding France) to North Castle Partners. Unilever sold its Wish-bone salad dressing business to Pinnacle Foods Finance for $580 million.
Analysts expect Nestle is also assessing other underperforming businesses for potential divestitures and Unilever is not likely finished unloading some of it underperforming categories, such as dressings and spreads.
The Hillshire Brands Co., however, could be open to large acquisitions. The company has a stable rating and some attractive characteristics including a relatively small enterprise value of $4.7 billion, low leverage, a high cash balance and a streamlined protein centric portfolio with good cash flow. Because of such good metrics, Fitch believes Hillshire could be ripe for a takeover, including a leveraged transaction.