It would be shocking if the next six months didn’t reveal increased costs for food manufacturers due to the fall in sterling. ‘Marmitegate’ saw Tesco and Unilever go head to head on prices, but not all suppliers have the luxury of playing chicken with retailers. As margins become squeezed, own-label companies will come under the most pressure without the protection of high-profile brands.
The increasing market share of discount retailers has created growth opportunities for own-label suppliers. In addition to being highly profitable for retailers, which can drive hard bargains with the suppliers, own label has become a more important part of how retailers differentiate and build their own brands. The result has been an increasingly sophisticated own-label market, driving genuine partnerships between retailers and their larger suppliers, and allowing these manufacturers to earn acceptable returns by offering higher innovation and service levels. This more attractive business environment has driven an increase in investor interest in the sector, not only the UK.
Should the weakness in sterling continue over the medium to long term, with downward pressure on margins leaving own-label suppliers vulnerable, what are the alternatives to accepting structurally lower profitability?
One alternative is for retailers and own-label companies to consider product redesign, initially, for example, through further decreases in pack sizes. R&D and innovation could suffer, although product renovation and exclusive ranges are a way to protect prices. Others may look to M&A to generate efficiencies.
However, while food companies have long been a popular sector for financial investors and private equity, the stable cashflows these companies previously boasted may be under threat. Buyers without existing exposure to the sector may be reluctant to step in, and sellers risk being disappointed by the likely impact of this potential profit erosion on valuations. Nevertheless, the case for consolidation and diversification has never been stronger, so more deals are to be expected.
Michael Collinson is MD investment banking, consumer and retail at William Blair