KANSAS CITY — Several years have elapsed since large acquisitions triggering seismic shifts in the U.S. baking industry were completed. Still, even after integration processes have been finalized, the industry remains in a state of flux.
Underpinning the challenges faced by baking executives charged with steering their businesses toward prosperity has been persistently sluggish demand for the industry’s flagship product — fresh bread.
Unit sales of bread in the 52 weeks ended Aug. 7 were 3,841,030,454, down 1.6% from the previous year, according to IRI Market Advantages. The results from the past year represent an acceleration in the decline of bread sales, which were down 0.98% in 2014-15. In 2013-14, the category was down 0.1% and in the year before that fell 1.3%.
As reported by I.R.I., the three largest U.S. bread companies experienced sales declines while the next three enjoyed gains. Each of the “big three” bakers sustained a decline smaller than the category overall — 1.3% for Bimbo Bakeries USA, 0.4% for Flowers Foods, Inc., and 1.5% for Pepperidge Farm, Inc.
The next three largest baking companies were Aunt Millie’s Bakeries, up 2.8%; Lewis Bakeries Inc., up 1.6%; and United States Bakery, up 4.4%.
Perhaps the most dramatic shift was a whopping 6.9% drop in private label bread sales. The drop was far wider than the 1.8% drop in 2014-15 and 0.7% in 2013-14.
While extreme competitiveness across the bread market was cited by industry executives over the course of the year, bread prices overall tracked modestly upward — up 1.9% for the category overall, including 1.1% at Bimbo, 0.6% at Flowers and 0.2% at Pepperidge.
Among companies most clearly struggling to gain a clear bearing of its financial picture and to reach its business objectives was Thomasville, Ga.-based Flowers Foods.
The uncertainty at the company was highlighted by failures to achieve guidance, sometimes only a few weeks after the guidance was revised. For example, in November 2015, midway through the company’s fourth quarter, the company revised its quarterly sales forecast to $898 million to $922 million, but it ended up with quarterly sales of only $858 million.
More recently, Flowers in August revised its sales and earnings guidance significantly downward one quarter after moving in the opposite direction — raising its guidance for the year. The revised earnings guidance of 88c to 93c per share compared with the previous forecast of $1 to $1.06 per share.
Similarly, the sales guidance for the year was lowered to $3,930 million to $3,986 million from $3,986 million to $4,080 million, lopping off a large chunk of the sales gain projected from $3,779 million in 2015.
The adjustments were highly unsettling to the investment community, particularly from a company long valued for its steady, predictable growth. At the end of August, Flowers shares closed at $14.91 in trading on the New York Stock Exchange, down 35% from a year earlier. Flowers shares were trading at the lowest levels since 2012.
Beyond the company’s operational challenges, Flowers has been contending with numerous lawsuits in connection with its use of independent distributors for delivery of its baked foods rather than company-employed drivers.
Company executives were fairly quiet about the issue through the year, though D. Keith Wheeler, president of the Flowers direct-store delivery segment, elaborated on the matter at some length in April.
As of that date the company was facing legal action from 156 named plaintiffs in 20 different cases pending. The company has about 5,100 independent operators. At that time one class action suit had been certified, and one had been denied. The figures were not updated in the company’s most recent 10-Q filing with the Securities and Exchange Commission.
“Flowers has operated an independent distributor model for over 30 years,” Mr. Wheeler said in April. “From the 1980s through today the model is intended to offer opportunities for distributors beyond that of company-owned routes. Independent distributors are business partners to Flowers. Distributors have the exclusive right to sell and distribute our brands in their territories. They grow their income and their equity as they increase sales. They own their own business. They make decisions about how to operate for their products, for their customers, take responsibility for the management of their business, (and) many hire their own employees. All make their own important decisions every day.
“Flowers benefits when distributors are successful, and distributors benefit when Flowers invests in brands, new products, marketing support and improved technology. We believe this model creates an entrepreneur incentive that will deliver significant benefit for independent distributors, their customers and for Flowers.
“In the past few years, independent distributor models in general have been challenged. Those challenges have been across many industries, not just the baked foods industry. Flowers has some distributor lawsuits and so do others in the baking industry. We do not believe the lawsuits have merit, and we’re vigorously defending our independent distributor model.”
Amid the evolving environment, Flowers has in the past made significant changes to its distributor model, and Mr. Wheeler promised more such changes ahead. He also insisted the litigation has not been a distraction for Flowers management.
“It’s important for you to know that our legal team is focused on handling the litigation, and our management team is focused on running the business,” he said.
In an Aug. 10 filing with the Securities and Exchange Commission, Flowers Foods said it was notified by the U.S. Department of Labor that it has been scheduled for a compliance review under the Fair Labor Standards Act.
“The company intends to cooperate with the department, and because the review process is confidential, the company has no further comment at this time,” Flowers said in the filing.
The driver issue has indeed caught the attention of other bakers. Fred Penny, president of Bimbo Bakeries USA, commented about the issue in a February conference call with investment analysts.
“The reclassification issue is not a new one for us, and, yes, about two-thirds of our routes are independent operators,” he said. “Our legal team works hard every day to make certain that we’re treating our independent operators or independent contractors as independent contractors. And we work hard to ensure that the I.O.s are successful entrepreneurs. Successful I.O.s are less likely to challenge their classification.”
The major acquisitions of the last few years generated considerable optimism because they left the two largest U.S. baking companies under the ownership of businesses focused principally on baking. Still, in important ways the years that followed have not unfolded in ways top executives expected. For example, Allen L. Shiver, president and chief executive officer of Flowers, in 2013 was upbeat about the outlook for the company’s existing brands and markets post-acquisition of major bread brands from Hostess.
“We do feel like in our core markets we will see an increase in sales once we own the (Hostess bread) brands,” Mr. Shiver said in response to a question from an investment analyst. “Wonder is a very strong brand in some of those markets. Merita and Home Pride, as well. The growth will be important in our core markets but will be even more important in our new markets — areas we recently expanded into where our current market share is very low.”
In the three years since the acquisition soft sales in core markets have been perhaps the greatest area of weakness for Flowers. The problems were highlighted in February 2015 by R. Steve Kinsey, executive vice-president and chief financial officer.
“We continued to see strength in our expansion markets,” Mr. Kinsey said. “However, our core market sales remained pressured by a strong competitive environment.” More recently, Flowers executives said the company’s flagship Nature’s Own brand was experiencing competitive challenges.
“I would say that our Nature’s Own brand is probably the brand that has been under attack the greatest from marketplace pricing,” Mr. Shiver said last month.
In addition to making adjustments based on shifts in the competitive marketplace, Flowers announced in August the launch of Project Centennial, a business review and potential restructuring program to be conducted with the assistance of Accenture.
“We recognize that regardless of the competitive environment or changes in consumer behavior, we need to always be looking for new ways to continue to take advantage of those opportunities we have to grow and create value, not just today but over the long term,” he said. “And that brings me to Project Centennial. First, the name of the project is a reflection of our upcoming 100-year anniversary since Flowers’ founding in Thomasville, Ga., in 1919. Simply put, the project is an in-depth review of our business and operations, focusing on ways that we can grow sales, simplify our business and improve profitability. We are still early in the process, but we are excited about the potential, and we will share additional details in the coming quarters.”
While Grupo Bimbo may not have been under the same marketplace pressure as Flowers Foods, the years since its acquisition of the fresh baking business of Sara Lee Corp. have not unfolded exactly to game plan either.
Asked in 2010 how B.B.U. will be different five years in the future, Gary Prince, president at the time, said “innovation” would be the guiding principle.
“We must be a much more productive company with sharpened strategies, wherever our footprint takes us, because that’s what matters most in today’s world,” he added.
While numerous new products have been introduced by B.B.U. over the last five years, the company has not scored the kinds of blockbuster successes achieved numerous times by Sara Lee between 2000 and 2010.
Still, the company has made marked progress in its efforts to become more productive.
Earlier this year, Mr. Penny, who succeeded Mr. Prince as B.B.U. president, said steps to make the Sara Lee baking and entire B.B.U. business in the United States more productive had been considerable and were winding down. Still, he noted the road toward productivity enhancement had by no means come to an end.
“If you think about us in terms of the last four years of work since the Sara Lee acquisition, we’ve had major restructuring work, including significant bakery closures, ... some new builds, significant work around integrating the route systems of the two legacy companies, and that was literally thousands and thousands of routes that were restructured, and a net reduction of routes when it was all said and done,” he explained. “So, I think about that as a restructuring integration period. And as we came out of that in 2015, we’re now moving into what I refer to as organizational effectiveness and efficiency time frame. We still have a lot of productivity opportunity across our entire supply chain, which we’re going to get at through bakeries running better, routes running more efficiently, lower return rates, etc. That’s different productivity work than restructuring work that we’ve been doing in the past five years.”
Still under way were efforts to integrate the assets of Canada Bread acquired in 2014. In August, the company closed a baking plant in North Bay, Ont., less than a year after closing a plant in Halifax, N.S. The company operates 18 plants in Canada.
In B.B.U.’s most recent quarter, ended June 30, operating profit of 2,063 million pesos ($109 million) for the U.S. and Canadian business was up 36% from 1,520 million pesos in the same period a year earlier. Net sales were 33,613 million pesos ($1,779 million), up 19% from 28,307 million pesos.
Daniel Servitje, Grupo Bimbo chief executive officer, said U.S./Canadian sales in dollar terms were nearly flat. The lack of growth principally reflected the abysmal trends in private label bread sales.
“While there was single-digit growth in our strategic brands across the region, these were offset by weak non-branded volumes,” he said. “In the U.S., industry data is showing that consumption of commercial and mainstream breads remain soft. However, our dollar share of the total bread category is higher year over year, most notably in mainstream and premium.”
Innovation was beginning to pay dividends for the company, Mr. Servitje said.
He said the company’s strong second-quarter results in the face of flagging private label sales reflected “continued innovation, increased and focused marketing in strategic brands and selected investments in new products.” In particular, he cited national launches of Eureka! organic and Oroweat Extra Grainy bread as examples of innovation in the category.
The emergence of organic bread prominently within the portfolios of major baking companies stands among the most notable category developments over the past two years.
Flowers has been most aggressive in this regard, acquiring both Dave’s Killer Bread and Alpine Valley Bread, both businesses specializing in organic bread, during 2015.
Over the past year, the company has been gearing up its production capacity in an effort to expand distribution and reduce its reliance on co-packing.
In December 2015, the company announced an $8 million project to convert its Tuscaloosa, Ala., plant to bake organic bread.
Still broken out separately in I.R.I. vendor data, D.K.B. had a strong year with unit sales of 20,937,119 in the year ended Aug. 7, up 32%. The price per unit charged averaged $5.30, more than double the $2.37 average price of a loaf of bread in the United States. Additionally, D.K.B. prices rose 7.6% during the year, a larger increase than taken by any other single baking company. As a standalone company, D.K.B. equated to the seventh largest bread baking business in the United States, as of August.
B.B.U.’s approach to the organic market has been far more low key. Mr. Penny first publicly commented in February on Bimbo’s entry into the organic market. At the time he said the business was small but growing and that the company intended to take its Eureka! brand into additional markets in the month ahead. In July, the company said it was taking Eureka! national.
“Historically, organic bread brings to mind the notion of being bland, boring and tasteless — a stigma Eureka! organic bread is working to change,” said Marlene Sidhu, senior brand manager of Eureka! “We believe everyone should be given the opportunity to discover great-tasting organic bread and are excited to continue to grow our fan base nationwide.”
Mr. Shiver similarly has said the upside potential for organic bread is extraordinary.
“Over 80% of American families include some organic foods in their shopping carts,” he said late in 2015, shortly after the D.K.B. and Alpine acquisitions were announced. “And the interest in organic breads in particular is broad, appealing to a wide variety of households from millennials to boomers.”
Noting that household penetration of organic bread is much smaller than of organic milk and other staples, he said limited distribution has impeded growth in the category. This situation is rapidly changing, he said.
Bread has not been at the forefront of the third largest baking company in the United States — Pepperidge Farm, Inc., Norwalk, Conn. A subsidiary of Campbell Soup Co., baking is not the company’s largest business, and bread is not Pepperidge’s leading product line (crackers and cookies are larger businesses at Pepperidge).
An extensive presentation on the Pepperidge business was delivered in July by Luca Mignini, president of Global Biscuits and Snacks (the business that includes fresh baking at Pepperidge).
While only addressing the bakery side of the U.S. business briefly, Mr. Mignini said Pepperidge was expanding distribution westward, building on its successful launch of Pepperidge Farm premium brand bread and rolls in the Phoenix market.
“We are currently evaluating additional scale market opportunities on the West coast for our next launch,” he said.