The food business has traditionally been an underinvested area by private equity and other big money players.
Aside from some highly public forays into companies such as Coca-Cola and Restaurant Brands International by Warren Buffett (whose mantra is buy what you know), food has often been dismissed as a slow-growth, low-margin business. But the merging of H. J. Heinz Company and Kraft Foods Group this summer shows that idea may be out of date.
Backed by Buffett’s Berkshire Hathaway and Brazilian investment firm 3G Capital Partners LP, Heinz’s purchase of Kraft creates the fifth- largest food company in the world, with annual revenues of almost US$30 billion, and eight brands worth more than US$1 billion each.
The resulting Kraft Heinz Company has North American sales that trail only PepsiCo and Nestle USA. Alicia Forry, an analyst at Canaccord Genuity Ltd. (UK), called the merger a “game-changer” when it was first rumoured in March, noting it would likely support food sec- tor valuations that had become “elevated” by historical standards.
“Food is not generally a [private equity] target, as it’s often regulated, has unionized workforces, skinny margins and low profitability,” says Darren Sissons, managing director and portfolio manager at Portfolio Management in Toronto. Sissons has spent the lions’ share of his investment career, which spans more than
15 years, in private markets.
But he says interest in food is rising, even though big food companies have already acquired many of the big assets, so most acquisitions are either small tuck-ins or the majors trading assets.
Sylvain Charlebois, a professor at the University of Guelph’s Food Institute, says the lure of “free money” will keep consolidation happening.
“We are in a zero- growth, zero-interest rate environment, so there will be more consolidation,” he says. “But I’m not suggesting distributors will be dealing with an oligopoly. It will still be fragmented at the processing level and remain so for quite some time.”
Others aren’t so sure. In a 2013 Food & Water Watch report called “Grocery Goliaths: How Food Monopolies Impact Consumers,” the food and environmental group reported that four or fewer food manufacturers controlled at least 75% of U.S. sales in 32 of 100 food categories.
But it blames grocers for consolidating first, which led foodmakers to follow suit to try to meet the bulk buying capabilities chains demand. The report said Kraft is a major manufacturer of 22 items, dominating the macaroni and cheese, processed cheese and mayonnaise categories; while Heinz is among the top makers of meat and pasta sauces, frozen appetizers and, of course, ketchup.
“Even when mergers don’t join companies that sell identical kinds of foods, they give big food-processing companies more economic power over other companies and consumers,” says Patrick Woodall, research director at Food & Water Watch. “Startup food companies would find it harder to get on store shelves because Kraft would have them surrounded on all sides.”
He adds that supermarkets are more likely to work with a conglomerate such as Kraft–which supplies products in many categories–than with lots of companies with only limited products.
Charlebois, however, expects some brands will disappear if the consolidation trend continues, as merged companies revisit the resources they dedicate to their brands. The Kraft–Heinz merger, for example, is expected to squeeze US$1.5 billion in costs by the end of 2017, and has already led to 2,500 layoffs.
Sissons says private equity generally makes such acquisitions because there’s “belief the business could be better run and, coupled with a debt, labour or plant restructuring, generate more profit.”
But Charlebois also believes opportunities will open up for new players as existing CPGs swallow each other up.
“Particularly with Canadian grocers, they are showing an interest in local products and setting themselves up differently to accommodate these smaller players more and more,” he says. “To grow the top line you really need innovative products; there is no other way to do it.”
Unfortunately, the Canadian food industry doesn’t always deliver on that front. A 2012 report by the Conference Board of Canada praised this country’s retailers for being innovative, but concluded that the food manufacturing sector “lags behind its international peers in R&D intensity and productivity.”
Even if it didn’t, J. P. Gervais, chief agricultural economist at Farm Credit Canada, notes, “the success of niche or high-value markets isn’t a slam dunk. For one thing, competition at one level of the market always finds a way to force efficiencies in the entire supply chain.”
Mega deals such as the Kraft–Heinz merger are more often found in the packaged goods industry, where margins are thin. Charlebois believes grocers looking to grow margins will keep focusing on fresh. “People aren’t going to eat more, the pie isn’t growing–or at least it’s growing less.”