The 2005 OC&C Top 150 Index found the large branded players on a winning streak, with big own-label producers losing out. Glynn Davis reports
The doom and gloom that has been besetting the retail industry has not fully translated to the food and drink manufacturers.
Their fortunes have been varied, however, according to The Grocer 150 Index compiled exclusively for The Grocer by OC&C Strategy Consultants.
The most marked difference was in the performances of the large branded players, who fared pretty well, and the big own-label producers, who continued to have a torrid time.
The index shows that branded manufacturers with sales over £500m enjoy operating profit margins of 13.6%, compared with only 4.4% for the same-size company producing own-label goods.
The numbers for return on capital employed (ROCE) also show the same divergent fortunes, large branded manufacturers seeing a ROCE of 33.4% compared with only 14.7% for own-label companies.
Luke Jensen, director at OC&C, says: “In branded you can create scale advantages - such as through marketing - but in own label the larger companies are failing to create scale benefits.
“They suffer from a transparent situation with the retailers and from consolidation such as Morrisons taking over Safeway.
“Although there have been cases of retailers going to a single supplier for own label, which creates value, this is largely taken by the retailer.”
Among those having difficulty in this part of the market are Northern Foods, Uniq and Geest - with the latter being bought recently by Bakkavör Group. Northern’s turnover fell for the year to April 2004 and the company continues with its ongoing strategic review.
These companies’ difficulties are highlighted by their declining operating profits. At Northern they dropped 9.6%, Uniq suffered a fall of 5.5% and Geest declined 3.8%. This compares with an average decrease of 0.2% for the total index.
Jensen says: “Ranges, particularly in chilled prepared foods, have increased in breadth and become more sophisticated, so these large suppliers have suffered as runs have got smaller.”
This has played into the hands of smaller fleet-of-foot operators such as Inter Link Foods, Glisten and Finsbury Foods, which now owns Memory Lane Cakes. The former enjoyed sales growth of 35.5% and a ROCE of 29.7%, placing it in the top 10 performers for companies with less than £100m of sales.
Jeremy Hamer, deputy chairman of Inter Link Foods and chairman of Glisten, says both companies have delivered on a strategy of organic growth and acquisitions, operating predominantly in own-label territory supplying cakes and sweet products to major retailers.
“They both understand that in own label you have to combine low cost with innovation.
“I’m not sure if cakes are in a sweet spot, but it is an important category to retailers as they have put a lot of focus on it. While there are many price pressures, there are also many consolidation opportunities,” explains Hamer.
On a different scale, Grampian Country Food Group is also playing its part in the continued consolidation of the food sector and this has helped it to become the big winner among the UK’s largest operators.
Its sales growth of 16.6% easily outstripped the average of only 1.8% for the rest of the top five manufacturers.
Roger Partington, board member at Grampian Country Food Group, says the company is benefiting from both its position as the recognised low-cost producer in its existing product areas, including the likes of chicken fillets, and from its move up the value chain with value-added products such as barbecue ranges.
“The company has been doing well against the competition.”
Helping the company progress up The Grocer 150 Index from position seven last year to the number five spot is its ability to make decisions quickly. Partington does not believe this is down to its private status, but more to its fleet-of-foot operational structure and ethos of delivering what the customer wants.
Evidence that private status - away from the glare and short-term views of the City - does not ensure success could be clearly seen in the index as companies in private equity hands performed significantly worse than average. Private equity-backed companies had sales growth of only 2.5% compared with 5.2% for the total index, operating margins of 6.5% compared with 8.8% for the total index, and ROCE at 17.4% against 21.4% for the total index.
Jensen believes this poor performance is down to the fact that private equity houses have only managed to get their hands on spin-off brands and private-label businesses, which have not been the best of assets to buy in the sector.
This is in contrast to the retail industry, where private-equity funds have succeeded in earning impressive returns by snapping up premier under-valued assets and improving their performance.
But there have been some successes and Jensen points to Young’s Bluecrest, owned by Capvest, which over the past year has pushed up sales by 18.7%, operating profit by 5.8% and increased margins from 5.2% to 6.1%.
He also cites United Biscuits - owned by PAI and Cinven - as an example of how the private equity companies are increasingly “playing the industrial game” of pursuing efficiency gains through synergistic acquisitions, as signalled by its acquisition of Jacob’s Biscuits from Groupe Danone. Next year’s numbers will show whether this move has paid off and helped turn around UB’s declining profits.
UB is not alone in having its margins come under pressure and this is a major theme of this year’s index. This key metric fell for the first time in seven years, down to 8.8% compared with 9.3% last year.
Jensen says this is down to the realisation that, as marketing spend has increased and cost-cutting has been undertaken for the past few years, many manufacturers have now reached the point where the negative effects of retailer pressure and increasing marketing spend exceed any possible efficiency gains.
Despite this fall, Jensen says manufacturers have been holding their own against the retailers. Indeed, the operating margins of Tesco stayed consistent over the year at 6.2% and Sainsbury fell from 4.3% to 1.6%. “If manufacturers have seen a decline in margins, does that mean retailers are gaining more of the pie? This does not appear to be the case. The main winner has been the consumer, as the retailers have been fighting a price battle.”
The index shows that it is the largest companies that have taken the biggest hit on margins: the top three fell from an average of 13% to 12.3%; companies with sales greater than £500m, excluding the top three, suffered a drop from 9.7% to 9.1%; while those with less than £500m of turnover dipped by a much more modest 0.1% to 5.7%.
Against this backdrop, it is no surprise to find that the larger companies are in the midst of shifting their emphasis to producing more value-added products. This is certainly the case for Tate & Lyle with Sucralose, which trades under the Splenda brand.
Splenda enjoyed sales of £115m and delivered hefty profits of £52m, which helped maintain margins across the whole group at 9.2% (down from 9.3% last year).
Needless to say, the plan for Tate & Lyle is to continue to boost the percentage of its value-added activities, because while commodities represent the largest percentage of sales, they have only limited growth prospects.
Ferne Hudson, head of media at Tate & Lyle, says: “Sales is not a key number of ours because we have a large commodity business. It is the percentage of profit from value-added products that is most important, such as Sucralose, which has driven growth and sales in this area.”
Jensen says that although commodity products have the disadvantage of low margins as well as exposure to EU price controls and international trading regulations, they do have the benefit of providing food manufacturers with high levels of sustainability and relatively predictable consumption rates.
Another major player that has been following a similar strategy of moving the emphasis away from its commodity-focused business (industrial sugar) and up the value chain is Associated British Foods, where margins have crept up from 8.9% to 9.3% over the past 12 months.
Geoff Lancaster, the head of external affairs at Associated British Foods, says: “Five years ago, the group was in commodity-type products and own label, but it has moved to value-added brands such as Ovaltine, Mazola, and recently Blue Dragon, and is building up its margins.
“Playing in the bottom end is a dangerous place to be.”
He says that the group has benefited from brands being sold off by other manufacturers. “We are seeing the advantage of brands being sold off as global operators thin out their portfolios. And where we can leverage our presence, we will acquire.”
While such purchases have brought additional sales for the big operators, most of the mergers and acquisitions (M&A) activity has been undertaken by the smaller players. Evidence of this activity among the lower tier is obvious.
Take the top three, which only increased sales by 2.2%, whereas a 5.3% jump was achieved by those companies with revenues greater than £500m, excluding the top three, and an impressive 7.4% leap was achieved by those with sales of less than £500m.
Such was the performance of those outside the top three in growing sales that the year-on-year growth for the total index exceeded 5% for only the third time in the past 10 years (the previous years being 1997 and 2002) - with sales growth increasing from 4.2% to 5.2%.
Although Cadbury Schweppes recorded a sales uplift of 2.6% in the index, the company prefers to measure its performance on a constant currency basis (that strips out the effects of movements in the US dollar), which shows an increase of around 5%.
This year the company was
especially sensitive to such dollar movements because its figures included the first full-year contribution from US-based Adams, which it acquired in 2003.
Katie Macdonald-Smith, head of financial public relations at Cadbury Schweppes, says the company has been benefiting from its Fuel for Growth strategy, of which the Adams acquisition has been a part.
This deal gave it more exposure to high-margin carbonated soft drinks, medicated confectionery and sugar-free chewing gum to the extent that 30% of sales now come from gum, of which a mighty 80% is sugar-free.
With diet trends increasingly impacting on food companies, this shift away from sugar confectionery should help put the company in a strong position for the future. Jensen agrees: “Diet fads have demonstrated a real influence on the performance of food companies. Last year was a big year for the Atkins diet and meat-related products, so companies such as Grampian have done well.”
Acquisitions such as Adams have certainly moved Cadbury Schweppes away from its previous heavy reliance on confectionery and given it a broader business spread. In 1997, as much as 73% of its sales derived from chocolate, whereas in 2004 this had fallen to only 46%.
However, much more important than diet fads is the influence of the major multiples. Macdonald-Smith claims Cadbury Schweppes is, to some extent, insulated from pricing pressures from the supermarkets because only 60% of its sales come from the major grocers - with the rest derived from smaller operators and independents.
“People worry about retailer consolidation and the squeeze that they put on suppliers, but we’re protected from it,” she says.
While this might be the case for Cadbury, many manufacturers in the index have the majority of their eggs in the supermarket basket and will have grave concerns about the future pressures that they face from these heavyweight customers.
Jensen suggests this is a reality of modern-day food manufacturing and singles out Tesco as the most powerful force in the sector.
“It’s difficult to think a manufacturer can grow without knowing Tesco very well.
“This is a concern, but every one of them knows that they have to respond to this situation.”
While this might be overplaying the influence of Tesco, it is certainly something that manufacturers cannot dismiss. If they can continue to adapt, then they might be in for another ‘not too bad year’.
The doom and gloom that has been besetting the retail industry has not fully translated to the food and drink manufacturers.
Their fortunes have been varied, however, according to The Grocer 150 Index compiled exclusively for The Grocer by OC&C Strategy Consultants.
The most marked difference was in the performances of the large branded players, who fared pretty well, and the big own-label producers, who continued to have a torrid time.
The index shows that branded manufacturers with sales over £500m enjoy operating profit margins of 13.6%, compared with only 4.4% for the same-size company producing own-label goods.
The numbers for return on capital employed (ROCE) also show the same divergent fortunes, large branded manufacturers seeing a ROCE of 33.4% compared with only 14.7% for own-label companies.
Luke Jensen, director at OC&C, says: “In branded you can create scale advantages - such as through marketing - but in own label the larger companies are failing to create scale benefits.
“They suffer from a transparent situation with the retailers and from consolidation such as Morrisons taking over Safeway.
“Although there have been cases of retailers going to a single supplier for own label, which creates value, this is largely taken by the retailer.”
Among those having difficulty in this part of the market are Northern Foods, Uniq and Geest - with the latter being bought recently by Bakkavör Group. Northern’s turnover fell for the year to April 2004 and the company continues with its ongoing strategic review.
These companies’ difficulties are highlighted by their declining operating profits. At Northern they dropped 9.6%, Uniq suffered a fall of 5.5% and Geest declined 3.8%. This compares with an average decrease of 0.2% for the total index.
Jensen says: “Ranges, particularly in chilled prepared foods, have increased in breadth and become more sophisticated, so these large suppliers have suffered as runs have got smaller.”
This has played into the hands of smaller fleet-of-foot operators such as Inter Link Foods, Glisten and Finsbury Foods, which now owns Memory Lane Cakes. The former enjoyed sales growth of 35.5% and a ROCE of 29.7%, placing it in the top 10 performers for companies with less than £100m of sales.
Jeremy Hamer, deputy chairman of Inter Link Foods and chairman of Glisten, says both companies have delivered on a strategy of organic growth and acquisitions, operating predominantly in own-label territory supplying cakes and sweet products to major retailers.
“They both understand that in own label you have to combine low cost with innovation.
“I’m not sure if cakes are in a sweet spot, but it is an important category to retailers as they have put a lot of focus on it. While there are many price pressures, there are also many consolidation opportunities,” explains Hamer.
On a different scale, Grampian Country Food Group is also playing its part in the continued consolidation of the food sector and this has helped it to become the big winner among the UK’s largest operators.
Its sales growth of 16.6% easily outstripped the average of only 1.8% for the rest of the top five manufacturers.
Roger Partington, board member at Grampian Country Food Group, says the company is benefiting from both its position as the recognised low-cost producer in its existing product areas, including the likes of chicken fillets, and from its move up the value chain with value-added products such as barbecue ranges.
“The company has been doing well against the competition.”
Helping the company progress up The Grocer 150 Index from position seven last year to the number five spot is its ability to make decisions quickly. Partington does not believe this is down to its private status, but more to its fleet-of-foot operational structure and ethos of delivering what the customer wants.
Evidence that private status - away from the glare and short-term views of the City - does not ensure success could be clearly seen in the index as companies in private equity hands performed significantly worse than average. Private equity-backed companies had sales growth of only 2.5% compared with 5.2% for the total index, operating margins of 6.5% compared with 8.8% for the total index, and ROCE at 17.4% against 21.4% for the total index.
Jensen believes this poor performance is down to the fact that private equity houses have only managed to get their hands on spin-off brands and private-label businesses, which have not been the best of assets to buy in the sector.
This is in contrast to the retail industry, where private-equity funds have succeeded in earning impressive returns by snapping up premier under-valued assets and improving their performance.
But there have been some successes and Jensen points to Young’s Bluecrest, owned by Capvest, which over the past year has pushed up sales by 18.7%, operating profit by 5.8% and increased margins from 5.2% to 6.1%.
He also cites United Biscuits - owned by PAI and Cinven - as an example of how the private equity companies are increasingly “playing the industrial game” of pursuing efficiency gains through synergistic acquisitions, as signalled by its acquisition of Jacob’s Biscuits from Groupe Danone. Next year’s numbers will show whether this move has paid off and helped turn around UB’s declining profits.
UB is not alone in having its margins come under pressure and this is a major theme of this year’s index. This key metric fell for the first time in seven years, down to 8.8% compared with 9.3% last year.
Jensen says this is down to the realisation that, as marketing spend has increased and cost-cutting has been undertaken for the past few years, many manufacturers have now reached the point where the negative effects of retailer pressure and increasing marketing spend exceed any possible efficiency gains.
Despite this fall, Jensen says manufacturers have been holding their own against the retailers. Indeed, the operating margins of Tesco stayed consistent over the year at 6.2% and Sainsbury fell from 4.3% to 1.6%. “If manufacturers have seen a decline in margins, does that mean retailers are gaining more of the pie? This does not appear to be the case. The main winner has been the consumer, as the retailers have been fighting a price battle.”
The index shows that it is the largest companies that have taken the biggest hit on margins: the top three fell from an average of 13% to 12.3%; companies with sales greater than £500m, excluding the top three, suffered a drop from 9.7% to 9.1%; while those with less than £500m of turnover dipped by a much more modest 0.1% to 5.7%.
Against this backdrop, it is no surprise to find that the larger companies are in the midst of shifting their emphasis to producing more value-added products. This is certainly the case for Tate & Lyle with Sucralose, which trades under the Splenda brand.
Splenda enjoyed sales of £115m and delivered hefty profits of £52m, which helped maintain margins across the whole group at 9.2% (down from 9.3% last year).
Needless to say, the plan for Tate & Lyle is to continue to boost the percentage of its value-added activities, because while commodities represent the largest percentage of sales, they have only limited growth prospects.
Ferne Hudson, head of media at Tate & Lyle, says: “Sales is not a key number of ours because we have a large commodity business. It is the percentage of profit from value-added products that is most important, such as Sucralose, which has driven growth and sales in this area.”
Jensen says that although commodity products have the disadvantage of low margins as well as exposure to EU price controls and international trading regulations, they do have the benefit of providing food manufacturers with high levels of sustainability and relatively predictable consumption rates.
Another major player that has been following a similar strategy of moving the emphasis away from its commodity-focused business (industrial sugar) and up the value chain is Associated British Foods, where margins have crept up from 8.9% to 9.3% over the past 12 months.
Geoff Lancaster, the head of external affairs at Associated British Foods, says: “Five years ago, the group was in commodity-type products and own label, but it has moved to value-added brands such as Ovaltine, Mazola, and recently Blue Dragon, and is building up its margins.
“Playing in the bottom end is a dangerous place to be.”
He says that the group has benefited from brands being sold off by other manufacturers. “We are seeing the advantage of brands being sold off as global operators thin out their portfolios. And where we can leverage our presence, we will acquire.”
While such purchases have brought additional sales for the big operators, most of the mergers and acquisitions (M&A) activity has been undertaken by the smaller players. Evidence of this activity among the lower tier is obvious.
Take the top three, which only increased sales by 2.2%, whereas a 5.3% jump was achieved by those companies with revenues greater than £500m, excluding the top three, and an impressive 7.4% leap was achieved by those with sales of less than £500m.
Such was the performance of those outside the top three in growing sales that the year-on-year growth for the total index exceeded 5% for only the third time in the past 10 years (the previous years being 1997 and 2002) - with sales growth increasing from 4.2% to 5.2%.
Although Cadbury Schweppes recorded a sales uplift of 2.6% in the index, the company prefers to measure its performance on a constant currency basis (that strips out the effects of movements in the US dollar), which shows an increase of around 5%.
This year the company was
especially sensitive to such dollar movements because its figures included the first full-year contribution from US-based Adams, which it acquired in 2003.
Katie Macdonald-Smith, head of financial public relations at Cadbury Schweppes, says the company has been benefiting from its Fuel for Growth strategy, of which the Adams acquisition has been a part.
This deal gave it more exposure to high-margin carbonated soft drinks, medicated confectionery and sugar-free chewing gum to the extent that 30% of sales now come from gum, of which a mighty 80% is sugar-free.
With diet trends increasingly impacting on food companies, this shift away from sugar confectionery should help put the company in a strong position for the future. Jensen agrees: “Diet fads have demonstrated a real influence on the performance of food companies. Last year was a big year for the Atkins diet and meat-related products, so companies such as Grampian have done well.”
Acquisitions such as Adams have certainly moved Cadbury Schweppes away from its previous heavy reliance on confectionery and given it a broader business spread. In 1997, as much as 73% of its sales derived from chocolate, whereas in 2004 this had fallen to only 46%.
However, much more important than diet fads is the influence of the major multiples. Macdonald-Smith claims Cadbury Schweppes is, to some extent, insulated from pricing pressures from the supermarkets because only 60% of its sales come from the major grocers - with the rest derived from smaller operators and independents.
“People worry about retailer consolidation and the squeeze that they put on suppliers, but we’re protected from it,” she says.
While this might be the case for Cadbury, many manufacturers in the index have the majority of their eggs in the supermarket basket and will have grave concerns about the future pressures that they face from these heavyweight customers.
Jensen suggests this is a reality of modern-day food manufacturing and singles out Tesco as the most powerful force in the sector.
“It’s difficult to think a manufacturer can grow without knowing Tesco very well.
“This is a concern, but every one of them knows that they have to respond to this situation.”
While this might be overplaying the influence of Tesco, it is certainly something that manufacturers cannot dismiss. If they can continue to adapt, then they might be in for another ‘not too bad year’.
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