The FINANCIAL — London/Chicago-26 September 2011: Fitch Ratings believes that as the latest consumer confidence readings retreat from the levels achieved early this year, food producers heavily exposed to mature economies will suffer from cash-strapped consumers trading down to more staple food products, reduced wastage and protracted promotional activity and margin squeeze from delays in passing through cost inflation.
While poor consumer sentiment affects the demand of discretionary goods first and foremost, it will also undermine the "defensive" nature of certain packaged food issuers across Europe and North America.
"Fitch acknowledges that as food is a necessity, packaged food companies tend to display relatively stable operating results under various economic conditions. However, since 2008 consumers have been adjusting their purchasing decisions, first in response to the last recession and, more recently, to the prospects of high structural unemployment, public sector austerity, curtailed lending from banks and declining asset and equity prices – thus translating into negative wealth effect," says Pablo Mazzini, Senior Director at Fitch's European Corporates group.
Recent data indicates that the proportion of the population living in relative poverty is edging 20% in the UK higher than the EU27 average (17%). In addition, over the past decade, personal debt reached record levels, and UK household debt is among the highest of any developed country mainly affecting the middle classes. Furthermore, the number of Americans living in poverty rose to 46.2 million in 2010, translating into a poverty rate of 15.1%, the highest rate since 1983. These factors have prompted consumers to remain cautious regarding spending and seek out the best deals when making food purchase decisions.
Consumers are allocating a larger share of a shrinking real disposable income to staple food products and retail private labels, the latter increasingly in North America where own labels were not as highly present as in Western Europe. According to AC Nielsen, in the 52 weeks to 14 May 2011, the private label food category grew 1.7% in USA vs. overall food at 1%.
Moreover, promotional activity in most developed markets is as high as it has ever been precisely when food companies have been attempting to pass through high input prices in H111. On 22 September 2011, Tesco, the UK largest food retailer stated a plan to invest GBP500m (USD770m) and cut the prices of more than 3,000 essential products, in particular, on its own label products. This will likely introduce additional competition at the low end of the pricing spectrum for branded food manufacturers.
Companies such as Premier Foods in the UK ('BB'/Negative) or Campbell's Soup ('A'/Stable) have reported a decline in sales in recent periods in certain grocery categories and even more staple products such as bread (for Premier). Campbell's operates in the mature and highly competitive US soup category, which did not respond favourably to Campbell's high levels of promotion in H111 (ending 30 January 2011). The company has recently pulled back on promotions and shifted more toward advertising and innovation in an effort to revitalise soup sales.
Evidence also suggests that consumers are wasting less. The UK's Department for Food, Environment and Rural Affairs (Defra) states that the average residual waste per person has declined by 76kg since 2006/07 to 275kg/person/year in 2010 (21% decline). Part of this is due to higher recycling efforts, but also consumers making more efficient use of their food purchases.
These trends are less of concern if companies are able to take pricing initiatives in other product categories and continue to extract cost savings in manufacturing/procurement efficiencies, thereby protecting profit margins in a timely manner. Large food groups continue to benefit from innovation, diversification and by pursuing conservative financial policies as demonstrated by Nestle ('AA+'/Stable) which suspended its share buy-back programme last month.
However, for those entities heavily biased towards the mature economies, evidence of negative organic sales along with continuing weakening pricing power could lead to negative rating actions in the packaged food sector, particularly if combined with aggressive financial strategies.
Discussion about this post