Strategic moves in capital spending

by Dan Malovany
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For years, old Hostess Brands and its defiant unions played a high-stakes game of chess that had the producers of Wonder bread and Twinkies in and out of bankruptcy court for years.

For thousands of workers in the baking industry, however, Nov. 16, 2012, will forever live in infamy. That’s when then Hostess Brands officially filed papers in bankruptcy court to shut down 33 bakeries nationwide and began liquidating the business, which had an estimated $2.5 billion in annual sales when it closed its doors.

Throughout the recent history of baking business, only a handful of major events dramatically altered the shape of the industry as much as the demise of the old Hostess Brands. During the past year, the industry divvied up Hostess assets and returned many if its iconic brands to the market under new owners. For many competitors of the old Hostess Brands — not to be confused with the new Hostess Brands that reintroduced Twinkies and other sweet goods last summer — 2013 was a banner year as they scrambled to fill the void and pick up potentially hundreds of millions of dollars in new business.

That was especially true in the bread aisle, where several of the largest regional baking companies saw sales rise significantly, even as high as double-digits, according to IRI, a Chicago-based market research firm. In response, many wholesalers reported adding new production lines and additional shifts to meet capacity. The health of the industry appeared especially robust during the 2013 International Baking Industry Exposition, which many touted as one of the most successful shows in a long time. From a capital spending perspective, many companies are wondering if 2014 might be the big breakout year.

Not so fast

Well, the big breakout year just doesn’t work that way when it comes to investing, according to Marjorie Troxel Hellmer, president of Kansas City, MO-based Cypress Research Associates, which conducted Baking & Snack’s 21st Annual Capital Spending Survey.

“From the capital investors’ perspective, ‘breakout’ is not a way of speaking for them,” she said. “When they go into investment mode, they’re still very pragmatic.”

In other words, she noted, bakers may be cautious, calculating, strategic and even opportunistic. As in a chess match, they want to make sure that all pieces are covered before they make their next move.

“What we see is that they’re increasing their capacity where necessary and where they have immediate growth opportunities,” Ms. Troxel Hellmer explained. “The idea of ‘build it and they will come’ is not a general trend anymore. They are responding to immediate and near-term growth opportunities. They’re definitely making investments, but it’s because they see that growth opportunity right in front of them.”

That’s especially true when it comes to return on investment (ROI), where the vision for capital spending has become increasingly nearsighted over the years. In the survey, completed in late December, nearly 68% of respondents indicated they see an ROI of two years or less — a trend that has been steadily shifting since 2011, when 46% of executives noted their companies’ ROI ­cycle was three years or more.

“When it comes to expectations for capital projects in 2014, the payback must be short term and very real for executives to commit to making an investment,” Ms. Troxel Hellmer noted.

More in the black

A short-term outlook isn’t necessarily a bad thing. Rather, it reflects the risk-averse philosophy that many baking and snack companies adopted over the years since the Great Recession decimated the economy — and capital investment, in many cases — from 2008 through 2010.

“If you look at our previous surveys and what companies are projecting from a capital spending standpoint in 2014, the data show that it’s been all positive since 2011,” Ms. Troxel Hellmer said. “The movement can be best described as ‘slow and steady,’ but that reflects positively on the industry. It’s saying the baking industry is doing well. Investments are being made where they need to be made. It’s just a new way of approaching investment. There’s not that cavalier attitude that there may have been in the past.”

The strength of the industry can be seen in the survey question that asks executives to describe their company’s financial position.

This year, 41% noted their businesses are “firmly in the black,” compared with 20% of respondents in 2012 and only 15% in 2011. Likewise, 57% in 2013 said their companies indicated “Our profits have taken a hit, but we’re on solid ground,” compared with 70% in both 2012 and 2011. Moreover, only 2% reported their financial condition as “Unstable: Our profits are turbulent these days,” down from 10% in the 2012 survey and 15% in 2011.

“Our industry executives in the data are telling us they’ve moved through the financial instability that resulted initially from the recession,” Ms. Troxel Hellmer said. “More companies are ‘firmly in the black’ than in the previous two years. They’re feeling no ill effects from the economy, and far, far fewer reported financial instability than in the previous two years.”

Shifting tactics for 2014

Overall, the survey reveals continued cautious optimism for 2014. In fact, 89% labeled their outlook for the baking industry as “positive” for this year. That’s similar to the past two years.

To delve deeper into the psyche of the industry, Baking & Snack asked executives to compare their general outlook for 2014 with 2013. “Half of the respondents feel better going into 2014,” Ms. Troxel Hellmer said. “A little less than half feel it’s more of the same, but even ‘more of the same’ is generally a positive outlook when you compare all of the data. When you look year to year, our cautious optimism continues to hold definitely coming out of this recession.”

But how does such cautious optimism translate into investing? Around half (47%) of companies plan to increase their capital spending budget in 2014 while only about a quarter (24%) plan to reduce investments, according to the survey. As a general trend line, that’s good news, according to Ms. Troxel Hellmer. “Many businesses have continued to expand their capital spending budgets year after year or kept them steady — even after making a major investment,” she said.

Capacity remains one of this year’s biggest motivators for retooling their operations. In fact, 46% are expanding operations for existing products and 28% for new products, while 26% are making non-­capacity-related investments.

Perhaps more importantly, 50% of companies listed new and existing products as the primary driver for spending during the past two years, and they will continue to prompt further growth in 2014. While ­financing on initiatives to reduce changeovers and drive efficiencies remains constant at 18%, the data indicated employee-related costs, food safety/security concerns and high commodity prices — a concern in previous years — will play less significant roles in 2014.

Likewise, survey respondents also suggested they’re primarily investing to improve product quality and consistency, decrease labor costs, expand capacity for existing products and bolster production speed and capacity.

The survey, however, did indicate a potential decline in new building and greenfield initiatives for 2014, according to Ms. Troxel Hellmer. That said, companies continue to expand their facilities or shoehorn in additional production and automation within their existing footprint.

“They’re going to break down a wall and use the former warehouse space for production,” she said. “The land they own may have been sitting there for years. They’re ready to ‘pull the trigger’ if their expected plans come to fruition for their businesses.”

Most bakers plan to spend money on maintenance and replacement parts (74%), followed by new processing equipment (63%), systems improvement to enhance automation (61%) and new packaging equipment (60%). The emphasis this year is on getting the most out of existing equipment and making strategic moves that drive efficiency to percolate profitability.

 “The bakers are working with such tight margins, and coming out of this recession, they have to decide, ‘Is it finally time to buy new equipment  or replace their aging equipment or limp by another year?’ Where is the tipping point? The tipping point is different for every company,” Ms. Troxel Hellmer said.

Overall, the focus is on the fundamentals. Bakers and snack producers are determined to make the right moves and following specific, predetermined strategies that allow calculating companies to act decisively when an unexpected opportunity finally knocks at their door, according to Ms. Troxel Hellmer.

“It’s all about ‘we make investments where we need to make them, and we don’t add anything on that’s unnecessary,’ ” she concluded. “They’re saying, ‘We’re investing where we know it’s going to be a benefit to our short-term profitability.’ ”                                                
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