Food suppliers were the darlings of the stock market last year, in the UK and abroad. While recession-fearing investors were driving the FTSE all-share index down 15% in the second half of 2008, shares in food producers were up a healthy 5.5%. This was despite concerns about debt sending the share price of some companies in the sector, notably Premier Foods, tumbling.

But, as the global fmcg giants reveal their performance over the past year - and their expectations for the year ahead - there are signs that all is not well. When Unilever last week refused to give any guidance on its sales or profit expectations for 2009, its share price fell 8%, making it the worst FTSE 100 performer that week.

So, with dark clouds on the horizon, what are the medium-term prospects for big brand owners, and which company is best placed to hold on to its customers and keep investors sweet?

However large the business, 2008 was hardly a straightforward year for anyone in the food sector. Almost unprecedented spikes in the price of key food commodities left producers with spiralling costs. But while some own-label producers saw their profit margins decimated, the bigger branded players generally managed to pass on their higher costs.

"Last year was the year of retail price inflation," says Anna Overton, corporate ratings director at Standard & Poor's. "Cost inflation led everyone to increase retail prices, typically by about 7%-9%. This year that won't wash, as consumer acceptance of price rises is down."

Fortunately, the prices of most food commodities have fallen significantly from their peaks - with the notable exception of cocoa - so cost inflation has stabilised for most companies. But Overton suggests the challenge has moved away from managing cost to maintaining market share and margin in the middle of a sharp downturn.

"Our base assumption is flat revenues but slightly shrinking margins - perhaps around one percentage point," she says. "Commodity prices won't come down that quickly, and some (like cocoa) are affected by weak harvests. In addition, there are likely to be fewer sales of the highest value-added products, but this will be offset by some ability to cut costs in areas such as marketing."

Overton adds that the largest companies - such as Unilever, Reckitt Benckiser and Nestlé - had "not got to where they are by being in competition with private label", and so generally operated in categories where own label is traditionally weak, such as personal care, petfood or confectionery.

But manufacturers have suggested that since the economy nosedived, own label has been gaining share in categories where previously it had been playing second fiddle. Reckitt Benckiser told analysts this week that own label had been growing in its core categories, but added that share gains had not been at the company's expense. Indeed, Reckitt said it had increased share in certain categories in the fourth quarter of 2008.

Market share at risk
Analysts believe companies - even those with strong brands - that operate in more 'commodified' categories such as tinned food or processed cheese could find it hard to maintain share versus own label in the year ahead.

Others face the prospect of consumers abandoning their key categories. Danone posted 8.4% like-for-like sales growth and a 0.5 percentage point increase in operating margin in 2008. However, much of this growth came from its emerging baby and medical nutrition divisions as consumers - particularly in developed markets such as the UK - turned away from drinking yoghurts and bottled water. The value of the UK bottled water category fell 9% [TNS 52w/e 30 November 2008], while a Bernstein research report suggested drinking yoghurt sales are also down 9%.

Agreeing that sales of bottled water in developed markets are in decline due to economic conditions, poor weather and "so-called environmental issues", Danone group communications director Laurent Sacchi says more than half the company's water sales are in emerging markets where sales are still growing - though profits are smaller. Rivals such as Nestlé, he adds, may have even greater difficulties with their water brands as they are more exposed to developed markets.

Although companies with a tight focus, such as Danone, may have problems if demand across their categories decline, broader portfolios are also a mixed blessing.

Reckitt Benckiser's already strong results were substantially boosted by sales of Suboxone, a prescription drug used in the treatment of heroin addiction, according to Investec's Martin Deboo, who says it could have accounted for as much as a quarter of Reckitt's 8% like-for-like fourth quarter sales growth. Without Suboxone, Reckitt's margins may have been slightly down in this period, he says. It will become a particular issue for Reckitt in the year ahead as it loses exclusivity on the drug from October, after which sales are expected to plummet.

Reckitt's Suboxone sales boost is a strong example of the cross-category benefits enjoyed by the largest food companies - even if sales of some products or sales in some countries suffer, strong performance elsewhere can prop up overall turnover.

However, Deboo says investors generally prefer focused companies as they believe themselves more able to assess the risk of a tightly-focused business than one operating in disparate sectors. This has prompted the trend in recent years for companies such as Unilever to refocus their brand portfolios.

However, several key elements of a company's success in the next year may be largely out of its hands, says OC&C strategy consultant Chris Outram.

Category exposure
“In trying to see who will have a good year, there are several factors,” he says. “The first is which countries a company operates in, as some will be hit harder than others. Then there’s category exposure. If you primarily work in comfort food or treats, you should be okay, but in others you might want to head for the hills. Finally, there’s your share in the categories you operate in. Big players with long histories in the field will likely do best.”

But Outram adds that not everything rests in the lap of the gods.

He says businesses confident of their footing, such as the branded giants, should look to capitalise on the downturn rather than “hunker down and ride it out”. Though protecting market share and margin might prove tricky, product innovation and good investment are likely to pay off for the big players, since those in less secure positions will be unable to keep up.

Even in recession, the stage could be set for the big players to get even bigger.