Food companies cut costs in bid to offset high energy prices

By Ahmed ElAmin

- Last updated on GMT

Related tags Free cash flow

Most of Europe's consumer goods companies, including food
processors, will likely succeed in cutting enough costs out of
their operations to offset the impact of the high energy prices,
Standard & Poor's says in a new analysis.

The analysis provides a quick snapshot of how individual food companies are expected to fare in Europe's tough trading environment.

Rising energy and packaging costs caused by higher global oil prices have cut into the margins of many food processors, and the pressure continues. Crude oil prices rose to about $69 a barrel over the weekend, approaching the record high of $70.85 reached on 30 August last year.

As a result many food companies have had to pay more for their plastic packaging while at the same time dealing with rising energy costs.

While some manufacturers have raised the prices for their products, Standard & Poor's believes they have limited ability to do so in Europe's competitive market.

The firm's ratings services expects increased energy costs to reduce profitability, although marginally, for most consumer goods manufacturers. Cost cutting measures will offset most of the impact. Forthcoming full-year results will likely clarify the impact of energy and raw material cost increases on profitability.

"We do not, however, expect this to have direct implications for the ratings,"​ S&P stated. "Although the actual cost increase may be significant and the ability to pass this on to customers remains very limited in Europe, cost-reduction efforts already being implemented should offset most of the negative effects."

Danone estimates the effect of packaging and other oil-related cost increases on its profitability margin at 0.75 per cent of sales, S&P reported. Household goods company Reckitt Benckiser estimates the impact at 0.10%.

"We nevertheless expect both these companies to improve their overall full-year profitability, reflecting the benefits of sales-mix increases and cost-cutting," ​ S&P stated in its report.

One other trend that could possibly impact profitability is the rise of private-label products. Private-label products continue to gain at the expense of branded goods, according to marketing research company ACNielsen.

The trend is in line with the increasing fragmentation of consumer demand and concentration of retailers. Private-label products are now available at all price points, offering differentiated products. The quality of the private-label offering is also increasingly important as a differentiating factor for retailers.

Globally, the private-label share of food sales was up to 17 per cent and grew by five per cent in the year to July 2005. Europe, the most concentrated retail market and the most price-competitive consumer goods market, has the largest share of private-label sales, at 23 per cent.

S&P cited its ratings downgrade of Greek yogurt manufacturer Fage Dairy Industry to 'B' from 'B+' in the fourth quarter as due in part to the rise of private-label products.

"The rating action was driven mostly by weaker operating performance, prompted by increased private-label competition focused on the value segment of the local yogurt market,"​ S&P stated. "Thanks to the increasing retail concentration in Greece, a previously unknown foreign competitor took a significant 10 per cent market share -- and pricing power -- away from market leader Fage in less than six months."

Overall however S&P continues to remain positive about the fortunes of Europe's consumer goods companies, including food companies. Rating changes have been positive overall, but the proportion of negative outlooks remains high.

Other rating actions taken in the quarter have been positive, although linked more to corporate activity than operating performance, or to improved performance in non-mature markets.

The agency cited the particularly difficult trading environment in Europe as the main reasons behind any negative ratings. Corporate activity -- whether in terms of increased returns to shareholders or debt-funded acquisitions -- continue to underpin the high proportion of negative outlooks and forecasts.

Among the European consumer goods companies rated by Standard & Poor's, 25 per cent have negative outlooks or forecasts. The ratio is down on the previous quarter, and is now in line with the other industries the agency covers in Europe.

The ratio indicates that companies benefit from mitigating factors, such as geographical diversification, or have strengthened their financial profile, S&P stated.

In the food and non-alcoholic beverages sector S&P gives negative outlooks to Nestlé, Croatian-based Agrokor, Fage Dairy and Foodcorp.

Stable ratings were assigned to Unilever, United Biscuits, Cadbury Schweppes, Danone, Coca-Cola Hellenic Bottling, JFC Group and Wimm-Bill-Dann Foods.

Nestlé's performance gives evidence of the resilience and predictability of its operations. However the company's financial position limits its ability to fund large debt-financed acquisitions, S&P stated.

By contrast Cadbury Schweppes's sale of its European beverages business for £1.27 billion will provide the group with some financial flexibility. S &Ps expects the money headroom to be used up over time through acquisitions.

The company's underlying sales growth in 2005 is expected to have increased toward the top end of the company's three per cent to five per cent goal range. Cost pressures are expected to continue into the first half of 2006 will not lead to margin expansion, S&P stated.

Danone also gained from its disposal of its loss-making US water joint venture in November for a limited cost. As a result the group is expected to report a debt level at December 2005 significantly below S&P's expectations for the ratings.

The group is likely to spend any excess cash gradually over the medium term through acquisitions or increased shareholder returns, S&P believes.

"At seven per cent, sales growth over the quarter remained above most peers, despite the weak consumer environment and the progress of generic dairy brands in the European market,"​ the agency stated. "This trend is expected to persist in the coming quarters, underpinning steady free cash flow generation."

Coca-Cola Hellenic Bottling has reacted to increased costs by improving the efficiency of its supply chain management. Profitability was held back by rising raw material prices.

The company's strategy of strengthening its portfolio of non-carbonated beverages will prevent any debt reduction in 2005, given the €193 million already spent on acquisitions during the year, S&P stated. The company is one of Coca-Cola's major bottlers in Europe.

Unilever has reacted to the changing market through improving its financial profile, mainly its working capital profile.

S&P believes Unilever will not be able to restore its financial profile to levels that are fully in line with the ratings before 2006. Sales growth remains below that of its peers despite the improvement in the company's results to September.

Profitability is down on the previous year, reflecting intense price competition in Europe and Asia and increased advertising expenses.

Despite the gloom, S&P gives a stable outlook to the company's 'A+' rating as market share losses have narrowed, with improved performance outside the EU market.

"In addition, we expect the group's free cash flow generation to remain stable for the full year and into 2006, underpinning the stability of the ratings,"​ S&P stated.

UK-based United Biscuits also received a stable rating due to cost-saving measures. The company also increased the prices of its products in the first quarter of 2005.

Cash flow generation is expected to increase due to lower restructuring costs. The position should allow the group to meet higher mandatory debt repayments in 2006, S&P stated.

The UK's retail environment is expected to remain competitive in 2006 due to the large retailers continuing to focus on price. The growth of discount retail formats across Northern Europe will also affect the market, S&P stated.

In the alcoholic drinks sector S&P maintains a negative outlook on Scottish & Newcastle's "BBB" rating. The company is reacting to the market through an ongoing cost-cutting programme.

The group is still too financially leveraged for the ratings and is expected to continuously improve its financial profile, applying all its free cash flows to debt reduction, S&P stated.

The group's trading performance in the UK remains satisfactory, as it managed to gain share and improve the mix of products at constant prices. The group's performance in its other main markets remained lackluster over the last quarter, however.

S&P maintains a positive outlook on Allied Domecq's "BB" rating. The ratings are now aligned with the ratings on its parent, Pernod Ricard. The parent has a positive rating due to strategic disposals and the seven per cent growth in the company's branded sales.

The group has agreed to dispose of its Quick Service Restaurants for about €1.4 billion. The transaction, which follows the unexpected disposal of Pernod's stake in Britvic for about €200 million and of three whisky brands for €130 million, compensates for the disposal of Montana wines that was expected but did not take place

The group's debt levels are also slightly below S&P's initial expectations at the closing of the Allied Domecq acquisition. The integration of Allied's brand portfolio into Pernod's offering is ongoing. The group has yet to achieve any of the planned synergies, S&P noted.

S&P has stable outlooks on the ratings for Central European Distribution Corp., Diageo, Rémy Cointreau and SABMiller.

Related topics Processing & Packaging

Related news

Show more

Follow us


View more