UK: The Deloitte Consumer Products M&A Survey - Feeling The Pinch

Last Updated: 6 February 2013
Article by Deloitte Consumer Business Group

Most Read Contributor in UK, August 2017

FOREWORD

Feeling the pinch ...

This is our fifth survey of prevailing M&A trends in the European Consumer Products sector, which covers insights gained from 36 leading companies and investors.

Our last survey, issued in July 2012, highlighted continued uncertainty and pessimism regarding future prospects for both the economy and the Consumer Products sector. The Chancellor's autumn statement signalled a prolonged period of austerity for the UK and, combined with limited expected European growth in the short to medium term, offered little in way of festive cheer to improve customer confidence. Against this backdrop, it is perhaps unsurprising that some companies, directors, shareholders and investors are cautious about organic growth and undertaking M&A. Nevertheless a review of European deal activity in 2012 indicates that a number of companies continue to deliver growth through acquisition.

Many of the respondents to our survey continue to be cautious about financial prospects over the next 12 months. One of the key themes highlighted is the challenge faced by companies in the Consumer Products sector in passing through raw material price increases to their customers. Around half of all respondents indicate that profitability had been significantly impacted by rising raw material prices. Tight cost control together with renegotiation of prices with suppliers and direct price through agreements with customers are seen as key to mitigating risk.

In addition, product reformulation and product specification changes are being carried out to respond to the reduced spending power of consumers and commodity price pressure. Increasingly, companies are looking to find ways to engage more directly with consumers and the survey highlights a trend in the development of social media strategies to achieve this, potentially circumventing major retailers.

From an M&A perspective, respondents are slightly more optimistic on the future outlook for acquisitions over the next 12 months. Tellingly, distress-driven deals are seen as one of the primary drivers of this activity alongside market consolidation to achieve further economies of scale. In addition, international expansion in pursuit of improved growth prospects is the other key driver. Whilst price expectation gaps between buyer and sellers appear to be closing slightly, ongoing director/shareholder caution and, noticeably, financing constraints were identified as barriers to increased activity.

Despite the ongoing economic uncertainty, deals continue to be done. Premier Foods has continued to offload non-core businesses successfully with the divestment of its sweet spreads business (including Hartleys, Gales and Sun-Pat) to US buyer Hain Celestial, as well as its vinegar and sour pickles business (Sarsons, Branston Pickle, Dufrais and Haywards) to Japanese investor Mizkan.

In the same period, Britvic and AG Barr came to the altar offering the potential to create a major European drinks player whilst delivering attractive costs synergies, reflecting further consolidation in the drinks market.

Most recently there are clear examples of strong strategic imperatives overriding the potential inertia that economic uncertainly can impose, particularly in terms of major investments in high growth markets. Diageo's proposed acquisition of United Spirits offers it a major presence in the fast growing Indian spirits market; Heineken's acquisition of Asia Pacific Breweries consolidated its previous joint-venture position in the Asian market; whilst Barry Callebaut's acquisition of Singapore based Petra Foods gives it a leading cocoa production position and offers it greater security of supply to service Asian and Latin American markets.

Such major investment has not just been one way. There is increasing overseas interest in acquiring European consumer products businesses as attested by transactions completed by Chinese, Indian and Japanese buyers. Key transactions include: Bright Foods with the acquisition of Weetabix; India Hospitality Group with Adelie Food Holdings; Japan's UCC purchasing United Coffee; Mizkan (as above); as well as most recently Li & Fung's acquisition for Lornamead.

Respondents expect average valuation trends for the next 12 months to be broadly unchanged, but trophy assets will continue to attract high prices in competitive auctions, whilst more challenged performers come to the market with lower deal multiples. Interestingly one area that does stand out clearly, in terms of heightened valuations, is the personal care sector. This perhaps reflecting the staple nature of some of the products within this sector, but also the opportunity for further margin improvement by premiumisation of such products.

In summary, the overall outlook for the next 12 months continues to remain challenging, and avoiding operational inertia and heavy discounting appears critical. Invariably the ongoing pinch of squeezed consumer spend coupled with retailer price pressure and high levels of raw material input prices is likely to polarise the performance of consumer product companies. Those businesses with clearly defined growth ambitions and capable of demonstrating cost leadership together with brand relevance to consumers remain the likely winners.

Once again, my thanks to the 36 respondents who contributed to our survey and we look forward to updating you again in July 2013.

Kind regards

Conor Cahill
Partner, Corporate Finance

ECONOMIC OUTLOOK – UK

The backdrop

  • Some minor respite for consumers as real growth in post tax wages recovered to (0.6)% in September 2012, but levels remain in negative territory.
  • CPI inflation broke from its previous downward trend in July 2012, reaching 2.7% in December 2012, making it three years since it was last below the Bank of England's 2% inflation target.
  • Better than expected UK unemployment (claimant count) levels continue to puzzle economists despite lacklustre GDP levels (even allowing for some of the declining contribution of North Sea oil), with some attributing this to declining productivity levels. Others (notably R3 an insolvency industry trade body), highlight that as many as 1 in 10 British businesses are being maintained by low interest rates and the reticence of banks to write down loans. That said, recent events in the retail sector highlight the fragility of this position.
  • On a more positive note private sector jobs created continue to outstrip public sector job losses.

Deloitte view

Ongoing concerns continue over the UK's ability to retain its AAA credit rating and, whilst the UK purchasing manufactures index for December 2012 reported a fifteen month high, the larger UK services sector reported its first decline for two years. Concerns that the UK's GDP may have contracted in the last quarter of 2012 were confirmed by an initial estimate of a 0.3% drop for the period and a subsequent further weakening of sterling. Financial markets rallied following the US's fiscal cliff deal, however the prospects for a sustained recovery in 2013 continue to appear fragile, as ongoing austerity measures continuing to bite. Any potential recovery will also have to contend with potential future economic shocks which include raw material and commodity price spikes, lingering Eurozone uncertainty as well as the next US deficit discussions (scheduled for March 2013). Such uncertainties may challenge the strength of any recovery in the UK, as it looks to avoid the prospects of a triple dip recession.

Lower than expected unemployment levels remains good news in the short term, but potential issues linger if this reflects a delay in a more fundamental rebalancing of the UK economy.

CONSUMER INDICATORS

The backdrop

  • Whilst November 2012's recorded uptick in consumer confidence reflected the highest confidence level for 18 months, such a recovery proved short-lived. December 2012's figures reflect consumer's ongoing concerns over the strength of any near term recovery.
  • Consumer spending growth is expected to remain below pre-crisis levels, with many consumers still looking to defer major purchases.

Deloitte view

Consumer confidence continues to be weak and whilst inflationary pressure particularly from cereal prices has eased in more recent months, many consumer products companies are still faced with passing through previous increases to customers.

CORPORATE RISK APPETITE HAS RECOVERED

The backdrop

There has been a general recovery in financial markets risk appetite, even before the announcement of the interim resolution on the US fiscal cliff, which has also been mirrored by a general recovery in equity markets.

Deloitte's separate Q4 2012 CFO survey (amongst a broader pool of 112 UK CFOs) indicated a rebound in confidence in the third quarter of 2012, which was maintained in Q4 2012, albeit 40% of those surveyed indicated that they expected a continuing or renewed recession in the next two years.

Deloitte view

Deloitte's broader UK CFO survey indicated that ongoing economic uncertainty and weak growth prospects in the Euro area were the key constraints to ongoing investment with companies adopting defensive strategies to conserve cash. This first point is entirely consistent with our survey of Consumer Products companies, however we continue to see strong drivers for undertaking M&A over the next twelve months primarily in terms of market consolidation and distress driven deals.

OUTLOOK ON TRADING ENVIRONMENT

  • There has been a noticeable retrenchment in respondents views on consumer confidence levels over the next twelve months, and a similar question about the financial prospects for consumer products companies also indicated increased pessimism.
  • The potential exists for consumer products companies to be caught in a vicious cycle of short term heavy discounting and promotion, lower volume growth, margin pressure on pricing on retailers and increased raw material costs. This in turn then reduces the ability to undertake more fundamental cost reduction action and growth strategies.
  • Sector players are having to carefully address key pricing points, whilst maintaining brand innovation as product lifecycles potentially became shorter, promotion and a clear focus on the provenance of products (as this is likely to come under increasing scrutiny).

"More focus on buying products on promotion. Looking for greater value (not necessarily lowest cost)."

"Lower value products mean lower turnover, and tighter margins. This in turn slows investment and expansion."

"Consumers are polarising into value and premium ends of the scale. Covering both ends of the market represents a differentiation challenge."

"Trend for wanting something new appears to be accelerating, brand lifecycles getting shorter."

"It forces you to become smarter on your product offering and pricing i.e. perception of value, portion control and 'must have' products."

  • Whilst these factors highlight a challenging business environment, it is driving new opportunities for some companies looking to harness social media to get closer to consumers and potentially by-pass retailers by going direct to consumers.

"More direct route via internet to counteract margin loss. More focus on overheads and performance controls."

"Address the changing retail landscape to internet based selling."

  • The ability to pass through cost increases continues to be a significant issue for many companies in the sector. Cost base reduction remains a key area for most customers, but our survey also indicated that companies are looking at a broad range of options to manage this margin squeeze whilst also keeping on the shelf pricing levels attractive.
  • Clearly discussion with suppliers and customers is the first port of call for many. Anecdotally, more constructive outcomes to such negotiations with customers may be achieved, particularly if requested price increases are supported by product innovation and awareness of key pricing points.
  • On this latter point, the reformulation of products and re-engineering of pack sizes was a common theme amongst many respondents.

"Consumer and trade engagement; don't compromise medium to long-term goals to hit short terms targets."

"Ruthless cost management. Keep up innovation."

"Reformulation (if possible) away from the most likely volatile commodities. More volume discount based agreements."

"Pricing pressure on the materials chain will continue. Packs will be reformatted to achieve acceptable consumer price points."

"Smaller pack sizes to hit key price points, efforts to keep the product categories exciting in terms of NPD. More innovation in marketing through social media to ensure that companies address their target consumers."

"Product range changes, ingredients/pack architecture changes and pass through to consumers."

"Increased 'backward' vertical integration & diversification of supply where materials are still sourced externally."

"Downsizing products and changing product specifications."

Please click the link to read "The Deloitte Consumer Products M&A Survey: Feeling the pinch" in full.

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