NEW YORK — Because of still heavy debt loads, large scale merger and acquisition activity is unlikely in the year ahead for the packaged foods industry, according to Fitch Ratings. The agency offered its assessment of prospects for the food business in an annual report, “2014 Outlook: Global Packaged Food.”
A number of companies remain focused on debt reduction, Fitch said, and several would be subject to credit rating downgrades in the event of a large acquisition or leveraged buyout, the agency added. Hillshire Brands, Inc., a spinoff from Sara Lee Corp., was cited as an exception by Fitch and identified as a company that may make an acquisition or even become the target of one. The agency cited what it called “many attractive characteristics” of the company, including a relatively modest market capitalization of $4.7 billion, a clean balance sheet and a “streamlined protein-centric portfolio with good cash flow.”
Fitch predicted that gross leverage would remain stable or even improve modestly in the year ahead. Most merger and acquisition activity in the new year is likely to be bolt-on transactions, the agency said.
Larger companies identified by Fitch as potential takeover targets included Campbell Soup Co. and ConAgra Foods, Inc. Fitch noted any action on Campbell may be subject to the founding Dorrance family going along.
“ConAgra has recently had volume declines in its core consumer foods and lost significant food service business,” Fitch said. “Also, ConAgra’s margins are among the lowest in the sector, implying that it still has more cost cutting that could be done and brand strengthening to command a premium.”
With economic growth in emerging markets slowing, the sluggish rate of growth in the United States and other developed markets will come increasingly into focus in 2014, Fitch said.
“While ramping up promotions is a quick short-term fix, it generally is not sustainable and does not enhance brand equity,” the agency said. “Fitch expects the near-term low inflationary environment to remain promotional, but companies will also beef up their innovation pipelines and support new product launches and core product categories with advertising to support long-term brand equity. Advertising will continue to shift toward digital and social media, as companies try to assess the best way to reach today’s young consumers.”
Health and wellness is likely to hold center stage when it comes to areas of innovation, with features such as high protein, gluten free, omega-3 and Greek yogurt having fueled growth for certain products/categories.
“Private label is growing faster than brands,” Fitch added. “ConAgra acquired Ralcorp to take advantage of this faster growing segment. However, it has encountered hiccups that have slowed Ralcorp’s growth, which could continue into 2014 before favorable trends re-emerge. According to the Private Label Manufacturer’s Association, U.S. private label supermarket sales were $59 billion in 2012, with a unit share of 23.1% and dollar share of 19.1%. Since 2009, private label sales in the supermarket channel have increased at an annual rate of 2.6%, versus 0.9% for national brands.”
While not quite a bright spot, Fitch said the European macroeconomic picture will not be as great a drag in 2014 following recession in most countries in 2012 and 2013.
“However, the recovery is still fragile — and particularly so in Southern Europe — as austerity measures are still displaying their effects,” the agency said. “Fitch expects unemployment to remain above 12% in the region until 2015. The perspectives of growth in France, Germany and the U.K. growth are likely to remain modest.”
A concern for the coming year in Europe is the possibility of continued food price deflation, Fitch said. They noted a cut of 1.4% by Nestle in its Zone Europe in the first three quarters of 2013.
“Industry players will therefore need to continue focusing on innovation and affordability while their pricing power is limited,” Fitch said. “One bright spot which is growing in the region seems to be pet care. The out-of-home channel remains adversely affected while discount stores continue to increase share of food and grocery sales reflecting consumers’ pursuit of more affordable products. Fitch’s central scenario for the region in 2014 is for a very mild pickup only later in the year.”
While the sluggish U.S. economy generally represents a challenge for U.S. food companies, this cloud is not without its silver lining, Fitch said. Interest rates are expected to remain low in the year ahead, creating an attractive environment for debt refinancing. The agency noted debt maturities in the coming year or so totaling $4.1 billion for PepsiCo, Inc.; $700 million for General Mills; $1 billion for Mondelēz (admittedly a small part of a debt load aggregating approximately $18 billion); and $1.3 billion for Unilever.
Cost cutting initiatives also are likely to be a prominent feature of the packaged foods industry in 2014. Fitch said the industry was caught off guard by the $29 billion takeover of H.J. Heinz Co. in 2013.
“U.S. companies need to streamline their cost structures or risk being publicly criticized by activist investors, acquired by private equity firms or strategic buyers who will drastically cut costs,” Fitch said. “Activist investors also typically focus on rewarding shareholders and increasing leverage.”
Reviewing an effort in July 2013 by Trian to spur a merger between PepsiCo and Mondelēz, Fitch said there is little reason to expect pressure to diminish in the new year.
“Food companies are implementing their own cost-cutting plans to support or enhance margins, drive efficiency and reinvest in the business,” the agency said. “They are trying to do this by implementing their own plans in order to get ahead of activist investors who will do it for them. However, cost-cutting plans, particularly for Kellogg with the magnitude of its recently announced plan, will adversely affect cash flow in 2014 as cash costs, likely from severance, flow through before cost savings emerge.”