Investing in functional ingredients is a good way of getting exposure to the food sector with potentially less downside from the rise of small brands, fragmentation of channels and digital media lowering barriers to entry - all of which are compromising growth for some of the larger players.
Ingredients companies supply the unseen ‘intel inside’ that can make or break brands and play a key role in innovation - increasingly important as traditional food companies accelerate reformulation.
Millennial consumers are shunning artificial ingredients. Food ingredients companies should benefit as they help propel growth in ‘clean label’ and are also are a key part of the solution to increased regulation, a trend we see accelerating given current global health concerns.
We have seen a real shift in recent years. After the 2008 financial crisis, a lot of product reformulation was to reduce costs. Although this still continues, we are increasingly seeing what we believe to be much more positive innovation - such as maintaining mouthfeel as salt and fat are reduced, and replacing artificial preservatives with ingredients that allow clean label claims without sacrificing shelf life.
It is not all plain sailing for functional ingredients companies, though. Brand owners are rightly precious and consumer testing of changes can last years. With any change likely to attract negative headlines, brand owners are being increasingly strategic about reformulations. For example, when Kraft Heinz relaunched its Macaroni & Cheese with natural colours it started selling the new recipe without telling consumers. It was only when it could be sure its new recipe had been accepted that it advertised the change.
In addition to strong growth, the margins made by functional ingredients companies also tend to be higher than those of traditional food manufacturers. Ad spend is minimal, too, though R&D tends to cost more.
We are seeing the best functional ingredients companies being able to pick who they work with and target higher-growth sectors. This means their growth is increasingly outpacing that of the food sector in general.
Warren Ackerman is head, global staples research, at Société Générale