Year of living dangerously for food companies
Stock market-quoted food companies are often touted by young pimple-faced analysts as providing defensive qualities for investors in choppy markets. In 1998 that myth was consigned to the tiphead as five of the six quoted Irish food companies underperformed the ISEQ. Once again, as has been the case in each of the last ten years, share price action has been determined primarily by fundamentals and strategic decisions taken within each company.
The operating environment for most food manufacturers remains intensely competitive. Outside of Ireland, and especially in the UK, consumer demand has weakened progressively over the year. Retailers are twitchy, and the pressure to open price wars across a number of product categories is considerable. In turn, manufacturers are being asked to deliver with ever-increasing efficiency and higher food safety standards, at lower unit costs.
At a broader level, the continuing reform of international trade agreements is forcing down the price of primary dairy, cereal and meat products. The eternal jousting between farmers and the EU Commission over CAP reform continues. The only certainty is that farm output prices will decline further.
That is good for consumers. Food prices will be flat to declining in the forseeable future. For manufacturers, lower raw material prices should help margins. But retailing is now a sophisticated system, dominated by a handful of companies. These closely monitor all movements in raw material prices for their suppliers. Lower prices in, say, milk, cereal or pigs, are followed closely by demands from supermarkets for more competitive prices in cheese, bread or pigmeat. How do Irish companies tack around these problems? A variety of strategies are being employed. Scaling up to counter the power of retailers is one such route. Kerry's efforts to become the largest supplier of certain consumer foods (sausages, pies) and be the most efficient in the game has been successful. The Avonmore Waterford merger is also designed to attain scale in the liquid milk and cheese markets.
Another route is to move away from direct reliance on retailers and focus on supplying value-added ingredients to high-margin manufacturers. The classic example of this has been Kerry's well-analysed drive into global fruit, dairy and cereal-based ingredients. It has engaged in strategic partnerships with its customers to deliver key flavouring and texturising agents. In the process it gets robust margins from some of the world's largest branded food processors.
Yet another option, related to the first two, is to diversify earnings as a means of minimising risk. We have seen this adopted recently by Golden Vale, Greencore and IAWS. Golden Vale entered the frozen prepared meals market for the first time through its £16.5 million Rye Valley purchase. Greencore bought the pizza producer Paramount Foods (costing £61 million sterling). IAWS has placed a large bet on the frozen par-baked bread and confectionery market through the £50 million acquisition of Cuisine de France and a commitment to expand this business in the UK. Each of these deals offers new markets for the purchasers and faster growth rates than their core activities. Both the Golden Vale and Greencore deals are just bedded down and a judgement on their success will take another year. Cuisine de France was purchased in November 1997 and has apparently beaten its budgets in 1998.
Clearly, far from the stodgy image food manufacturing obtains, the dynamics of the industry are complex and challenging. Each of the quoted companies enters 1999 against the backdrop of ever-changing market conditions. That environment will churn out a range of investment, divestment and acquisition opportunities.
We expect the flow of deals in the sector will remain healthy. Strong balance sheets, coupled with low interest costs, provides the war chest for expansion. A slowdown in the global economy is exerting pressure on a number of sectors. That feature, plus the ongoing divestitures of assets by trans-national companies, will provide opportunities for Irish food groups to expand. In particular, we expect to see further activity by Irish groups in UK liquid milk, bread baking and flour milling.
At a more strategic level, debate continues about how Irish food processors should position themselves for the future. Some argue food manufacturing offers limited returns on investment, and companies must carefully weigh up the option of returning cash to shareholders rather than pursue acquisitions. Others see the domestic food industry consolidating, and would argue that mergers are an optimal structure in some sectors.
Joe Gill is head of equity sales at ABN AMRO Stockbrokers