Capital Spending: Seizing the Moment

by Dan Malovany
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Unlike school, life provides experience first and teaches lessons later. Not long ago, baking and snack manufacturers discovered this fact after they learned a few tough lessons about fad diets from the low-carb craze. A few years later during the commodity crisis, they received a painful education about how to manage costs during a time when they couldn’t raise prices fast enough. If that weren’t enough, most recently they had to navigate through a market driven by deep discounts and value-conscious consumers. Conventional wisdom states that the food industry is recession-proof, but everyone now knows that was never the case.

Recent history has turned most executives into better students of the industry. As a result, many of them are throwing away manuals that preach how businesses need 3- and 5-year planning strategies to thrive in the long haul. Rather, long-term survival today requires quick reactions to a changing market. Instead of pulling back in tough economic times, a greater number of them are assessing the market, identifying opportunities and seizing the moment.

For Oakrun Farm Bakery, a proactive strategy means investing today to remain competitive tomorrow. “We’re not holding back due to the recession. We’re still looking at investment, and if you want to compete — our finances are sound — you continue to invest about the same levels as in the past,” said Tony Tristani, senior vice-president and general manager of the diversified baking company based in Ancaster, ON. “Today, it’s more competitive than we’ve ever seen. With US bakeries getting more competitive in Canada and the strengthening Canadian dollar, we need to protect our business. We plan to do that through investments that will increase throughputs and reduce waste. You need to continue to invest in automation and in equipment to maintain a lower cost of goods and remain competitive with these larger bakeries.”

Mr. Tristani is one of a cross-section of key baking and snack executives interviewed by Cypress Research Associates, Kansas City, MO, which conducted Baking & Snack’s 18th Annual Capital Spending Survey. The interviews provided anecdotal support and interpretation for the survey that showed that a majority of companies plan to maintain or boost investments in 2011. This year, the survey indicated capital spending is expected to be at or beyond what the industry spent during 2007 pre-recessionary levels, despite a number of headwinds affecting the industry.

For most companies, capital spending never stops, but the level of investment depends on its business model. During the past two years, for instance, Tasty Baking Co., Philadelphia, PA, made one of the bigger bets on its future. It closed its historical Hunting Park plant and spent $75 million to open up its new highly automated production facility for producing its line of iconic Tastykake snacks as well as a variety of healthful and private label products that all sell for less than $5 for a family pack.

With ongoing depreciation and the pressures of opening of a new plant completed, Tasty Baking now has a decreased cost structure that should result in $10 million in annual savings, noted Autumn Bayles, senior vice-president of strategic operations. Although volatile commodity costs might eat into those savings, the company also is benefiting from lower labor costs, greater capacity and streamlined operations. With this huge investment completed, Ms. Bayles naturally expected the company to have a reduced level of spending this year. She added Tasty Baking will continue investing in ongoing efficiencies and new products for its customers, although the company has experienced some widely publicized financial challenges earlier this year.

“We now have a smaller, more efficient factory to produce the same products with half of the number of lines that produce the same output,” she said. “We may have a lower level of capital spending in 2011, but this is going to be investing in ongoing efficiencies and new products for our customers.”

For some businesses like Oak State Products — the Wenona, IL-based contract manufacturer of cookies, bars and other baked sweet goods — investing in the any economic environment requires responding to customer demands and staying the course. “No, we didn’t alter our capital spending during the last several years,” said Dave Van Laar, the company’s president. “With customer demands, we might have to spend more in some areas. By no means is this a strong time in the baking industry. We are solid and continue [to be] so, but revenue isn’t what we anticipated.”

Custom Foods, a frozen dough manufacturer based in De Soto, KS, also finds its capital spending patterns generated by customer demands. “If our customers want something new, we’ll do it,” said John Khoury, its president. “All of our growth fits under our roof. Right now, we’re at incremental growth, but sometime in the future, we’ll expand. When we buy equipment, we buy more capacity in our equipment so we can grow into it.”

In 2010, for example, Custom Foods installed a high-capacity cookie line for one of its customers. “The ROI from that investment is covered directly by this customer,” Mr. Khoury observed. “So it gives us potential and secures new cookie customers.”

In 2011, the company signed on additional customers that boost capacity on its frozen cookie dough line. Often, he said, an initial investment to create a unique product or increase capacity can lead to new sales opportunities. “A few years ago, when we brought on a new customer to do frozen pizza dough balls, we bought several new pieces of equipment, including dividers and rounders, with higher capacity than we needed,” Mr. Khoury recalled. “Since then, we’ve added several pizza customers.”

FACING HEADWINDS.

Not all companies are upping their investments during these uncertain political, regulatory and economic times. Ellison Bakery, Fort Wayne, IN, actually spent only half of what it initially anticipated for investments going into 2010. The cookie manufacturer did the same in 2009 and 2008 as it continues to take a more prudent approach to capital expenditures, said Todd Wallin, the company’s president. “We’re going to see our profitability dramatically lower due to the fact that commodity prices are going up, and we’re not able to pass that through in many cases,” he said. “Obviously, we have to cut back in other areas. Capital spending is low on the totem pole where spending is concerned.”

Ms. Bayles noted that the economy remains in a tough place with high unemployment negatively affecting consumer spending, prompting many businesses, such as Tasty Baking, to deliver value even though input costs have skyrocketed. Specifically, she said, edible oils, sugar and cocoa have climbed dramatically.

A less-than-optimistic Mr. Wallin sees overall sluggish growth, at best, for the cookie category this year. “My customers don’t want price increases, but my costs are extremely high right now,” he explained. “Looking ahead to the next 12 months, things aren’t as positive as they were a year ago. By some standards, the numbers tell us things are getting better. That is not the general feeling among ordinary folks or people who are buying products. There is not a general consensus that things are getting better. Things are very, very slow from an industry perspective and for consumers.”

That said, Mr. Wallin added, there are always niche areas where investment is needed. Companies need to be lower-cost producers to get price-sensitive consumers to make impulse purchases on small indulgences such as cookies. Many tight-budgeted consumers are trading down as they search for anywhere to cut costs. “Throughout the industry, in light of ingredient costs, we’re looking at how we can drive costs out of the system with things like automation,” he observed.

In such an economic environment, many opportunities may involve stealing customers from competitors or robbing the proverbial Peter to pay Paul. On a more optimistic note, companies also are discovering opportunities by becoming lower-cost producers via improved automation or by rolling out more innovative products and consumer-friendly packaging formats through the use of strategic equipment investments.

Capital spending, in many ways, is simply a numbers game. “I really think it’s about sales,” Mr. Tristani said. “I look at it from a revenue perspective and what we’re seeing from how our competitors. I look at how some of the larger baking companies are performing. They’re struggling. I think there’s a bit of optimism because you’re seeing people start to invest in capital. That shows a level of optimism. From a revenue perspective, things are still difficult, but people are starting to invest more in their operations.”

Despite today’s strong headwinds, Turano Baking Co., Berwyn, IL, remains one of those companies that will continue to spend the same amount this year on capital investment as it did in 2010 in real dollars, noted Giancarlo Turano, a principal with the company. Despite persistent high employment, he said, the wholesale baking company continues to invest to improve operational efficiencies as well as build new facilities — such as its recently opened bun facility in Orlando, FL — as it explores its long-term business strategy to further expand nationally and into new product segments for new customers. Mr. Turano noted that bonus depreciation, among other incentives, also helps the company maintain its capital spending levels during a variety of economic cycles.

Tax credits and other financial incentives also remain integral variables in the capital spending equation, Mr. Van Laar said. A clear pro-business direction from government on capital spending would go a long way in the long run. “Businesses are being asked, ‘Where’s the best way to invest our money right now?’ When we had clear incentives to invest internally, we did that,” he said. “And that strategy seemed to spur things in past years. Our industry doesn’t know what is going to affect us from a legislative and financial perspective or how. We’re just seeing a struggle in the marketplace with consumers.”

FUELING A GROWTH SPURT.

While various segments of the baking industry struggled during the recession, many companies in the salted snack industry reported substantial growth during the past two years as consumers turned to smaller indulgences and spent more money on home meals instead of eating out at restaurants. One such beneficiary, Inventure Foods, Phoenix, AZ, had a banner year in 2010 and increased its capital spending from previous years as a result, said Terry McDaniel, president and CEO.

To support the snack producer’s snacks, convenience foods and other products sold under the Boulder, T.G.I. Friday’s and Burger King labels, the company installed a state-of-the-art line for stand-up pouches and a new twin-screw extruder, which replaced a single-screw one, to produce better-quality snacks and create whole-grain and other innovative snacks. The company also expanded its kettle-cooked chip capacity for its lines, led by the Boulder brand, that have shown record growth. With sales and its bottom line growing, Mr. McDaniel said, “we haven’t been holding back.”

“But one thing,” he added. “The cost of capital is the lowest it’s been in years. Secondly, we reinvested back in our business because we have been growing from our top line and profit.”

Mr. McDaniel, however, put forth one major caveat that explains why many executives have tempered their enthusiasm and remained cautiously optimistic, even during the best of times. “If we hadn’t seen such growth, I would be very hesitant to invest right now because of the current conditions and so many unknowns on the horizon,” he observed. “Unknowns like the recent increase in grain costs and all variables associated with grains, transportation costs in the industry and more — those are all concerns. With that, companies generally look at price increases, but consumers can’t take on much more. So how does that affect consumption if you bring pricing into the mix to offset commodity prices?”

That’s a good question, and the answer depends on a company’s customer base. Businesses that focus on branded products in the retail arena face both customer and consumer pressure to reduce prices and pinch margins. Bakers who supply the food service channel are experiencing healthy growth with quick-service chains and lower-priced casual dining establishments, while those serving fine-dining customers are still struggling. Low-cost producers of private label brands have seen a boom in sales, but pricing remains a challenge as their branded counterparts offer even deeper discounts.

Meanwhile, contract man­ufacturers are finding new opportunities because major players in the food industry as well as retailers want to roll out new products but do not want to invest in capital. If these customers provide a long-term commitment at an appropriate price to warrant investment, the growing number of bakers and snack companies serving this ultra-quiet segment of the industry indicate they’re willing to invest no matter what the economy does.

“We are product-driven by our customers. We’re a contract manufacturer,” said Mr. Van Laar of Oak State Products. “That decision to invest is determined by our customers. [On] things under our control, we’re spending the same or slightly more. We’ve automated more over the past five years, so some of the upkeep is a little more, but our labor costs also have gone down.”

Specifically, Oak State is budgeting this year for a greater amount of automation that targets food safety and employee safety. Case packing, enhanced material handling and other equipment upgrades of older systems, Mr. Van Laar noted, can reduce labor and enhance all forms of safety. “There are some infrastructural things we’ll do for food safety like refrigeration to fully meet the standards for food ingredient specifications,” he said. “Finally, always a big chunk of what we capitalize is ongoing, major capital maintenance items, including repairs and upgrading of equipment.”

Being customer-driven, Custom Foods also can’t predict 2011 or 2012 capital spending with certainty, but the company still plans to invest in strategic projects that drive down costs. “We’re upgrading equipment for 2011, but no big projects are planned unless we bring on a new customer that needs equipment or an existing customer that requires improvements to our lines,” Mr. Khoury said. “This, however, can change in a week if something hot comes through. We’ll move on it. Otherwise, we’re pretty conservative. That’s why we’re financially stable.”

For new product development, innovation often requires spending on equipment to create products with unique textures, different seasonings or a more healthful nutritional profile, Mr. McDaniel noted.

Such innovation, he added, continues to fuel sales in the salted snack industry despite a host of economic, regulatory and business hurdles. “In our industry, snacks tend to be a competitive category,” he explained. “You’ve got to make sure you’re reinvesting in your equipment to remain competitive from a cost standpoint and from an innovative standpoint. Our industry has been very fortunate. I’ve talked to equipment manufacturers that have verified that [the salted snack] industry has done well, and that the investments have good returns.”

Download the charts from the survey (includes extras not featured in print)

Read more on the subject:


Capital Spending On the Rebound
Companies demand a fast payback

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