Talking Points: Good Soup, Denise
In this month’s Talking Points, we highlight some key themes from two recent food events in North America: the Consumer Analyst Group of New York (CAGNY) conference for large public food companies and the awesome Natural Products Expo West.
CAGNY: Same Venue, Same Problems
In late February, many of the leading food & beverage companies in the U.S. presented at the annual CAGNY conference in Boca Raton, Florida. As one would expect with public companies speaking to an audience full of their principal shareholders (institutional investors such as pension and insurance funds), their CEOs tried their best to give a Panglossian spin on how well they are doing, while at the same time fessing up that they were “not satisfied” or “disappointed” in their performance and need to spend more time cultivating their own garden. In terms of headlines from the event, it was going to be hard to top the developments of the preceding week, which is a time when companies typically drop any bad news to avoid being grilled on it at the conference. This year however, the week was dominated by Kraft Heinz’s sensational, but quickly abandoned, USD 143bn bid on Unilever. Notwithstanding this pre-CAGNY high drama, here are five takeaways:
1. Pressing all the Growth…
The fundamental problem Big Food is facing remains the negative to flat growth in their core food categories resulting in a flat-lining top line. As an industry, top-line sales averaged just 1% per year over the past five years and a miserable 0.3% in the last year. Declining sales, which have worsened further during Q1 2017, were attributed to shrinking volumes—with fewer folk buying their stuff, volumes have been down 1% to 2% for the last couple of years and about 5% so far this year—and lower prices as a result of heavy discounting through price promotions, as companies fight among themselves for a greater share of the consumer’s packaged food dollar.
As if reading from the same menu, companies have responded to this challenging environment with the same solution: frantically pressing the usual growth levers of innovation (mainly through product renovation) and acquisitions, from acquiring equity stakes in emerging brands (such as Kellogg’s venture fund investing in Kuli Kuli Foods) all the way to billion dollar deals (such as Danone’s purchase of WhiteWave). But to date, all this has had a limited effect. Interestingly, many companies are now categorizing their portfolios into growth and foundation brands (the latter being about 20-33% of sales, depending on the company). Foundation brands are viewed as cash cows with little growth prospects and possibly one step away from divestiture, as companies ultimately concede defeat on these brands. Truth be told, these companies probably have more foundation brands than they are prepared to admit. In 2017, should your breakfast cereal or canned soup business really be your top priority? Yes, says General Mills and Kellogg’s. No, says Campbell Soup.
…and Cost-Cutting Levers
Without revenue growth, cost-cutting is left as the principal tool for companies to hit their margin targets and grow earnings as they become leaner and meaner. Once again, companies are following a similar strategy, each with their own version of zero-based budgeting (ZBB) or other cost-cutting programs, such as Danone’s Project PROTEIN to make EUR 1bn in savings by 2020. We discuss DSD as a new and more profound cost-cutting initiative below. In this no-growth environment we expect the pressure for cost-cutting to continue as it is the only way for companies to meet their commitments around operating margin expansion. General Mills is aiming for 20% and Kellogg’s for 18% by next year in an attempt to match the knife-wielding that Kraft-Heinz has done so successfully to the delight of their shareholders.
2. Consumer First? Sometimes
Companies have been talking about the changing tastes of consumers for some time now and touting their ability to respond effectively. With snacking—which is both a category and lifestyle choice—clearly companies have gotten the message. Companies lined up to discuss their snacking initiatives. Kellogg’s reiterated their ambitions to become a “global snacking powerhouse”, PepsiCo talked about a renewed focus on the euphemistic ‘better-for-you snacks’ such as low-calorie ready-to-eat popcorn, and Snyder’s Lance, a pure-play snacking company, announced it is moving closer to its goal of having half of its portfolio as ‘better-for-you snacks’ by 2019. And whereas Campbell Soup was more about the consumer of the future moving from ‘mindless munching’ to ‘purposeful snacking’, Hostess reminded us of the perennial desire for indulgent snacking: chill guys, not everything has to be about health & wellness. Even Tyson threw its hat into the ‘on-demand’ eating ring with plans to build a modern growth portfolio including Hillshire Snacking, an adult snacking brand, quoting Hartman data that less than 10% of U.S. adults did not snack on something in the last 24 hours.
But for other categories it was a little surprising to see how some companies are still blindsided by changing tastes, even if we acknowledge that trends are moving at a much faster rate than before. Take General Mills and their USD 1.5bn U.S. yogurt business. Do companies not realize ‘low-calorie’ and ‘diet’ are no longer a thing? After two decades of 6% CAGR growth, the U.S. yogurt market has soured, despite relatively low household penetration compared to Europe. For General Mills, their low-calorie brands have been particularly hard hit, with sales down by almost 15% over the last twelve months. No doubt pricing was an issue—theirs went north when competitors went south—but, as the company admits, they were hit hardest by being ‘out innovated’ and not ’well aligned’ to where the growth is, such as premium yogurts. Like Nestlé with Lean Cuisine, General Mills has been slow to respond as new brands with exciting formats, such as Siggi’s, Noosa and Chobani’s Flipcups, run rings around Yoplait, which is totally misaligned with today’s consumer trends. Given the company’s lateness to the premiumization party, it needs to step up the renovation story and do a major rebranding the way Coca-Cola seems to be heading with its ‘beverages for life’ make-over campaign or learn the lessons from Nestle’s Lean Cuisine turnaround (see October’s Talking Points.)
3. Catch Me if You Can
As any shrink will tell you, it is often what goes unsaid that is the most interesting and revealing. Despite dominating headlines in the build-up to the conference, there was barely a mention of 3G Capital during the proceedings. Ever since 3G’s Valentine’s Day acquisition of Heinz in 2013 and merger with Kraft in 2015, U.S. food companies have been engaged in a rather complex relationship with this potential suitor. On the one hand, the unwelcome attention has forced these Rubenesque companies to slim down and boost margins by scouring through their own business operations for savings and adopting their own versions of ZBB to become a less attractive target. But at the same time, 3G’s advances and the endless Wall Street rumor mill around ‘Who will be next?’ has helped bolster company valuations relative to the S&P, despite poor earnings.
So for U.S. food companies, 3G’s move on Unilever must have caused alarm as it suggests an intent to not only look for an overseas bride, but that their love affair with food maybe coming to an end, as Unilever’s household and personal healthcare non-food business is about 60% of sales after almost a decade of divesting of food brands. In the same way that Kraft Heinz’s bid of Unilever has forced the Anglo-Dutch company to undertake an urgent strategic review by April, so too U.S. food companies might want to consider if they too have mishandled their relationship either by being a little too aloof or too successful at cutting costs, as they calculate 3G’s waning interest on their valuations.
4. We Want No Truck with DSD
Although we have highlighted the commonality in the approach of many food companies to cutting costs, one area of difference that emerged during CAGNY was Kellogg’s announcement to follow in the footsteps of companies like Hostess, and ditch its own direct-store delivery (DSD) infrastructure for its USD 3.2bn U.S. snack business in favor of using an outsourced warehousing model (see Paul Bosch’s article Food Distribution: A New Logic to Logistics?).
Given the proliferation in routes to the consumer from traditional supermarkets, through to dollar and convenience stores, to online shopping via the likes of Amazon and Instacart—where food can be delivered with a few clicks on a cell phone—food companies have the option of adopting a variety of go-to-market strategies. In the case of Kellogg’s, 40% of their snacks business (mainly Pringles) was already serviced by warehousing, so this is not a complete leap of faith. It is possible that the company has been influenced by the success of Hostess in cutting costs to free up funds to reinvest back into the business. At the conference, Hostess claimed to have achieved huge savings by abandoning DSD in favor of warehousing as they turned around the company’s fortunes. For Hostess, using the warehouse distribution model has given them a competitive cost advantage and provided greater access to distribution channels that were previously hard to reach with their DSD network, such as drugstores and dollar stores. Kellogg’s hopes to benefit from similar savings and, as an opportunity to raise margins, service some of the channels such as convenience stores and other smaller formats in urban areas that are growing faster than traditional retail groceries (and play well with their push into snacking) as well as clean up the portfolio.
While recognizing the significant costs of owning a DSD system, other companies felt it was justified keeping it and like Snyder’s Lance were “proud” of their DSD network as they built out their national distribution. For PepsiCo there was “nothing like it”, but even they use warehousing for their Quaker brand. Here are some of the more persuasive arguments we heard in favor of retaining DSD:
- Store-level relationship. To many, ditching DSD means losing muscle in the store and the ability to cultivate a relationship and build trust with store managers. This is unquantifiable but clearly highly valuable asset.
- Better merchandising. DSD, we were told, was essential for managing and executing in-store promotions, such as making the products on the shelf look appealing and readily available.
- Category dependent. DSD has a particularly strong foothold in categories such as salty snacks, where the relative fragility of the product and the high velocity lend itself to a DSD system.
- An expensive but necessary fixed cost. It appears companies will weigh up the costs and benefits of DSD on a regular basis from now on. In some categories, such as frozen foods, there is probably not enough warehousing capacity, so some companies have no choice but to stick with their own DSD network.
5. The Bigger Picture
For public companies who have to report their earnings every quarter and respond to Wall Street analysts who often seem obsessed with asking questions that focus on the minutiae, which provide data points allowing them to tweak their models, it must get a little frustrating to not be able to address the bigger picture. Three companies at CAGNY rose above the chaos of the quarter and the soundbites of delivering ever-higher shareholder returns and attempted to address the longer-term direction of the industry and the role they wanted to play. Then a fourth brought us back to earth:
1. The circular economy. Danone’s CEO, Emmanuel Faber, discussed the bigger picture with their Strategic Resource Cycle, in which the full life cycle of their ingredients is viewed through the lens of the circular economy. This approach promotes greater efficiency through minimizing waste. He even envisaged a time when Danone uses more recycled plastic than virgin PET. The company is also planning, once Whitewave and Danone U.S. have merged, to turn it into a B-Corp because “consumers are increasingly requesting evidence that companies behave properly.”
2. Sustainably feeding the world. Tyson Foods, with its new CEO and shiny new company logo, is shaking up the conservative protein sector by planning to take a leadership role, to embrace change and make “real accessible food”, and to deliver sustainable food at scale. Their investment in Beyond Meat is still turning heads.
3. Beyond five years. Campbell CEO Denise Morrison was probably the leading futurist at the event, outlining a vision for the company that went way beyond the typical five-year planning horizon. She identified four promising platforms based around: i) the ever-increasing convenience of shopping for food online, ii) the transformation of the snacking category from impulse-driven mindless munching to purposeful snacking where snacks provide functional benefits, iii) personalized nutrition with curated food options delivered to your door and, iv) locally sourced foods from a transparent food chain. (One can only imagine her frustration after she met President Trump the week after CAGNY for him to remark, “Good soup.”)
4. Back to Earth. It was only fitting for Graeme Pitkethly, CFO of Unilever, to remind everyone of the dangers of focusing too much on value creation in the long term and not focusing on the now and the “challenge to unlock more value in the shorter term”. The trick is to get the balance right between long-term goals and short-term delivery—something that is sure to emerge from their strategic review out later this month.
Anaheim: The Greatest Food Show on Earth.
In many ways, the vastness of the Natural Products Expo West caters to every taste. There really is something for everyone, but here are four observations on this year’s show:
1. Mainstreaming of Event
What started out in 1980 as the last redoubt for hippies who survived the 60s and 70s, the Natural Foods Expo has become an important showcase for established and emerging brands in the natural and organic space. Every year, and this time Rabobank was out in force, our visit to the venue in the heart of Disneyland seems less and less ironic. With about 3,100 exhibitors, of which about 600 companies were showing off their wares for the very first time, it is perhaps the greatest food show on earth.
The show attracts players from all corners of the industry, from foodies to specialty retailers, big-box supermarkets to established food players as well as the finance guys. Participants come with a range of objectives, from looking for interesting products to differentiate their store, potential acquisitions to expand their portfolios, new takes on tired categories or inspiration for private label copycat products, to the all-important networking and community building. With over 80,000 attendees, it is only a matter of time before the expo has its own dating app.
This year we noted especially the presence of many large food companies’ corporate venture capital arms with funds typically around USD 100m to USD 150m burning a hole in their pocket. These funds are not averse to writing smaller checks such as Kellogg’s 1894 Capital’s recent stake in Kuli Kuli Foods and General Mills’ 301 Inc-led investment into Farmhouse Culture. In the world of zero-based budgeting, it is easier to buy into the best new scalable ideas than to have to pay for the upkeep of a standing army of food technologists.
2. It’s the Growth Rate, Stupid
Of course, the draw for everyone is the impressive growth rates—unstoppable if you believe the hype—of consumer demand for natural and organic products, which continue to outshine the growth rates of the wider industry (see above). According to the conference organizers, sales of organic and natural foods grew by about 9% over the past year, as consumers increasingly perceive these premium products as being healthier, better quality and from an ethical viewpoint just ‘better’ than conventional foods weighed down by too many food ingredients. (There are only a few value propositions at this show, and natural and organic foods are typically 25% higher than their conventional counterparts.) And remember, most of the products on display are shelf-stable packaged goods—the only fresh fruit I saw was the apple I lifted from my hotel buffet.
As we never tire of saying, we maintain the future of packaged food is bright; it is just not necessarily the type packaged foods we are used to eating. This is not as scary as it sounds. We generally have an optimistic view on the outlook for most food categories. Breakfast cereals may be down, but not if you are using ancient grains as an ingredient or have innovative products, like Back to the Roots, The Soulful Project’s hot cereal and Sherpa’s barley cereal. Similarly, yogurt is a growth category if your products are targeting the premium end of the category. Even the much-maligned soup category has pockets of growth, you just have to call it bone broth (see below).
3. Emerging Trends 1: Our Readers Were Right
Our readership can give themselves a collective pat on the back for successfully identifying future trends in our 2016 end-of-year survey that asked folk what emerging trends and fads (we are not brave enough to differentiate) they will be following in 2017. Turns out three of most popular responses were all on display at the show:
- Plant-based everything. Plant-based foods and proteins are thriving as Americans become more flexitarian in their approach to food. This was on display for all to see, from the long lines at Beyond Meat’s burgers (probably the busiest and hippest booth we saw), to Sir Kensington’s vegan Fabonaise mayo, to MALK’s Nut Malk (that’s not a typo, they dropped saying milk), Milkadamia, Mooala banana milk, Ripple’s pea milk and, possibly a world’s first, Veggemo’s veggie milk.
- Clean labels. If you haven’t yet got the memo that consumers want shorter, more transparent ingredient lists with recognizable and familiar ingredients, you really need to get with the program. This show is all about clean labels. Less is more.
- Gut health. Our love for friendly bacteria is moving beyond yogurt and dairy drinks, with products such as Goodbelly juice shots, Farmhouse Culture Kraut Krisps, Luke’s probiotic sprouted grain tortilla chips, Vegan Rob’s probiotic kombucha popcorn, Pressery probiotic soup, FlapJacked probiotic smoothie mixes, etc. However, the scientific evidence has yet to catch up with the level of interest by consumers who are already sold on their importance of promoting gut health.
4. Emerging Trends 2
In addition to the three trends just described, beyond the too-many-to-count chia, jerky, turmeric, popcorn, premium chocolate, ice-cream, yogurt, nut-butter and gluten-free options, here is an eclectic list of products that my colleagues and I found particularly interesting at this year’s expo. Not all of them are brand new, but that’s ok:
- Bone Broth. Soup is back! We saw a few broth companies last year, but it seems everyone is boiling bones these days, as the collagen protein craze goes to the next level. Companies we saw include Pacific Foods, BruBroth, Bare Bones, Numo broth and EPIC.
- Bars galore. We said it before and we’ll say it again: we are always impressed how new products continue to enter the snack bar category. Notables included: Pamela’s Ambition bars made with tea or coffee, ReGrained bars upcycling spent grain from the craft beer industry, Wilde Boldr meat bars (not jerky), FODY Food bars to alleviate the symptoms of irritable bowel syndrome, Good! Green bars with fruit and veggies (and probiotics), Mediterra bars based on the Mediterranean diet, and last but by no means least, an impressively renovated plant-protein Power Bar (the snack bar that created the category). Our personal favorites were the Truth Bar as well as last year’s nut-butter bars from Clif Bar & Co.
- Chips everywhere. When it comes to snacking, chips and tortillas seem to dominate. In addition to the bounty of potato chip companies with novel flavors and on-trend points of differentiation such as Dieffenbach’s Uglies using ‘rejected potatoes’ and Deep River’s Honchos, veggie and pulse chips are on the rise and rise. Other chips we crunched on included: Terra’s plantain chips, Snack Factory’s veggie chips, Saffron Road’s ChickBean chips, Rhythm Superfoods beet chips, Simply 7’s lentil chips, Hippeas’ chickpea puffs and Beanfield’s bean and rice chips.
- Coconut Grove. Maybe it was all the palm trees outside, but we saw coconut everywhere: coconut waters, coconut oil (Jackson’s Honest chips are cooked in it), and coconut flavors in yogurt, ice cream, cookies and candy. There was even Cocoburg’s coconut jerky
- Mealtime. Not every booth was a snack company. Some stand-out meal options included True Food innovations with entrees for the private label market, Chefs’ Menu and Modern Table Meals.
- Sustainable seafood. Similarly, a number of companies have emerged to shake up the rather boring frozen fish category. Two we spotted promoting sustainable seafood meals were Salty Girl and Love The Wild.
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Nicholas FeredaySenior Analyst - Consumer Foods Read more