Tough battle in confectionery

by Josh Sosland
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Even as certain of the industry’s top players struggle to regain their footing in the U.S. confectionery market, optimism reigns. Despite the weakening U.S. economy, strong ingredient costs and competition that intensifies by the day, the industry’s top management sees growth ahead.

Acknowledging that no business is completely insulated from an economic downturn, the confectionery industry is well positioned, said William Wrigley Jr., chairman of the William Wrigley Jr. Co., Chicago.

"First, we deliver products that meet both functional needs and emotional desires," he said March 12 at the company’s annual meeting. "Second, our products deliver small moments of delight, which are particularly important to people when times get tough. And third, we sell those small moments of delight at prices that are highly accessible to a growing percentage of the world’s population. And while no business is recession proof, those three characteristics do help make us more recession resistant."

While external factors may not dent the outlook for confectionery companies, three of the industry’s largest companies are in the midst of major corporate transitions, including Wrigley.

Eighteen months after naming William D. Perez chief executive officer, the company has chalked up impressive financial results. Net income in the year ended Dec. 31 was $632,005,000, up 19% from 2006. Sales were $5,389,100,000 up 15%.

The degree to which the Wm. Wrigley Co. performed well in 2007 was much more a reflection of the company’s success outside the United States.

"We are far from satisfied with our performance in 2007, and we’ve already begun to reassert ourselves competitively," Mr. Wrigley said of U.S. results.

Sales in North America at $1.76 billion were unchanged versus a year ago. A 7% decline in volume was primarily due to U.S. trade inventory adjustments and the impact of higher pricing.

At his first annual meeting a year earlier, Mr. Perez identified innovation as an area he said would receive attention, and he reviewed progress made on the new product front, particularly "ideas and products that really move the needle that build sustainable business."

He spent considerable time on the launch of the 5 brand.

"5’s quality, unique packaging and premium positioning set it up as a big idea with big potential," Mr. Perez said. "Leveraging our go-to-market strategy 5 exceeded not only all of Wrigley’s internal records but a few industry benchmarks as well. In the convenience channel 5 had the fastest distribution build we’ve seen on any confectionery items since we subscribed to ACNielsen (now known as Nielsen). 5 share gain on a time-aligned basis was almost twice that of a recent competitive launch."

Also in 2007, the company worked to build its Life Savers and Altoid franchises, acquired from Kraft Foods Inc. While Wrigley has enjoyed considerable success with its Life Savers brands, Mr. Perez said Altoids did not fulfill expectations in 2007.

Within the Altoids line, sours, gums and small products failed to meet targets while chocolate-dipped Altoids performed well.

Mr. Perez said Wrigley has identified exactly what contributed to share losses in 2007 and what will be needed to correct the difficulties. He said the company has innovations in the pipeline for its Wrigley traditional brand and Extra, a portfolio that represents 30% of the company’s U.S. gum business.

As has been experienced among many of the giants of the food industry, international business has been the growth engine at Wrigley, and no slowdown is expected, Mr. Perez said.

"China is one of the fastest growing economies in the world, and we’re not just riding that growth wave," he said.

He noted that gum consumption in China is about 22 servings per person per year, versus U.S. per capita consumption of 180 servings.

"Clearly, there is significant upside," Mr. Perez said. Commenting on Wrigley’s strong position in China, he noted that 9 of the top 10 stock-keeping units in China are Wrigley products.

One man’s pain, another’s gain

The weak spot for Wrigley and other companies has been the sweet spot for Cadbury Schweppes P.L.C., London. Driven largely by inroads the company has made in the U.S. chewing gum market, including dramatic market share gains, the company said its Americas growth in 2007 was its best in a decade.

In addition, the company was able to widen the margins in its confectionery business despite sharply higher commodity costs. Todd Stitzer, chief executive officer, celebrated the success of 2007 in a Feb. 19 conference call with securities analysts.

"For the Chinese, 2007 was the Year of the Pig," Mr. Stitzer said. "For Cadbury Schweppes, it was the year of the gorilla."

Mr. Stitzer was referring to a television spot run by Cadbury in the United Kingdom featuring a gorilla playing a drum set. Not only did the commercial achieve 91% awareness and become the most watched ad on-line, he said Cadbury Dairy Milk sales grew 9% in the United Kingdom.

While making considerable progress in the U.S. confectionery market, Cadbury results in 2007 were not an unqualified success. The company’s earnings per share declined 4% while revenues gained 7%. But the confectionery business was strong.

"Our confectionery business had an excellent year with strong commercial execution and tight control of costs driving 7% revenue growth and a good margin performance in the second half," Mr. Stitzer said. "These results reflect the benefits of restructuring initiatives undertaken between 2003 and 2007 and continued investment behind our brands. Although the economic outlook for 2008 remains uncertain, we are encouraged by the good trading momentum we have seen in the new year and our continued progress on cost-reduction initiatives. We expect meaningful margin progression in 2008."

For the company, a dramatic culmination of a four-year strategic restructuring looms. On May 7, Cadbury Schweppes P.L.C. is scheduled to be split into two businesses: a confectionery business (to be named Cadbury P.L.C.) and a beverage business (Dr Pepper Snapple Group, Inc.).

Commenting on the commodity environment, Mr. Stitzer reminded analysts of a promise he made last June to "take robust pricing" to recover higher commodity costs.

"Over the intervening months we’ve been working with our customers to effect these pricing initiatives and will continue to do so over the next several months," he said.

Looking specifically at the company’s Americas region, Mr. Stitzer described results in 2007 as "outstanding."

"Overall revenues were up 11%, 9% in developed markets and 15% in emerging markets," he said. "In the U.S., results were driven by a combination of strong pricing and market share gains. Our overall gum share increased in the United States by 310 basis points, with Trident continuing to perform strongly, and Stride’s share of the market increasing from 3% at the beginning to 6.3% at the end."

Chocolate revenues gained 6%, versus growth of less than 2% over the previous two years. He said 20% growth in Cadbury’s premium Green & Black’s brand largely derived from increased market penetration.

Ken Hanna, Cadbury’s chief financial officer, said the confectionery business has strong momentum in the Americas.

"While the U.S. economic outlook remains a little uncertain, economic growth in Latin America is very robust," he said.

Mr. Stitzer said confectionery sales growth will be limited somewhat by portfolio rationalization but still projected revenues to grow at the upper end of the company’s global range.

"Our confectionery business has a significant under-exploited potential and a motivated team focused on realizing that potential," he said. "Revenue growth will continue to benefit from our advantaged brands and our focus on geographic participation and increased investment. But the greatest opportunity is margins where we have already begun to deliver a step change by reconfiguring our business model."

Uncertainty evident at Hershey

Perhaps the greatest difficulties of any of the major confectionery companies were experienced by The Hershey Co., Hershey, Pa. The company abruptly changed course in October with the departure of Richard H. Lenny as c.e.o. Since he succeeded Mr. Lenny, David J. West has yet to lay out publicly a comprehensive plan of how the company will move forward.

Against this backdrop, the company’s achievements have been anything but dazzling. Net income of $214,154,000 in 2007 was down 62% from $559,061,000 in 2006. Sales of $4,946,716,000 were virtually unchanged from $4,944,230,000 in 2006.

In a January conference call, Burt Alfonzo, senior vice-president and c.f.o., projected a rebound in Hershey market share in 2008 "as we continue to increase core brand investment and launch new products." In particular, he said the company’s Hershey’s Bliss, Starbucks and the Signatures lines are aimed at helping Hershey compete more effectively in the "on trend premium and trade-up segments."

More generally for this year, Mr. Alfonzo said the company’s first objective is to "stabilize U.S. marketplace performance." He projected net sales growth of 3% to 4% for the year.

With input costs expected to rise in 2008 at the same pace as in 2007, Mr. Alfonzo said gross margins would be under pressure again.

"Despite the inflationary cost environment that is pressuring margins, we are committed to investing behind our brand and expect to stabilize our U.S. marketplace trends in 2008," he said.

Mr. West echoed the sentiments about the difficulties created for Hershey by the rising commodity costs. But the company faced other major challenges as well.

"Throughout 2007, competitive activity intensified in the form of both innovation and spending," he said. "The activity was strongest in refreshment and the premium and trade-up chocolate segments. This came at a time when we were transitioning our portfolio with less than normal levels of innovation and higher amounts of discontinued items."

He said advertising, consumer promotion and coupons will rise nearly 20% in 2008. Mr. West also projected further Hershey progress in the "trade-up" segment in a way that leverages the company’s scale, tapping into the Hershey’s Extra Dark and Signatures brands together with its Cacao Reserve, Scharffen Berger, Joseph Schmidt and Dagoba lines.

In what it calls its refreshment business, Mr. West described competitive activity and innovation at "the highest levels since Hershey purchased the business in 2001." In that environment, Ice Breakers retail takeaway was down 10% for the year. New products, including Ice Breakers Ice Cube gums and Ice Breakers Wellness mints and gums helped improve sales trends, gains Mr. West said would be built upon in 2008.

A setback for the company, though, was Ice Breakers Pacs. While popular among consumers, Mr. West said the product’s design drew reservations from law-enforcement officers because the shape of the product could be mistaken for "illicit items." Because of this public reaction, the company has decided to withdraw the product from the market.

For 2008, Mr. West projected improved results, beginning after the first quarter.

"As we look to the longer term, Hershey has many opportunities to leverage its global brands and U.S. scale," he said. "Work is already under way as we evaluate our approach to consumer insights and innovations and further develop a consumer approach to portfolio."

Mr. West was pressed by one analyst who said Hershey was facing a disaster in view of a 270-basis-point drop in operating margins in 2007 to be followed by another significant drop in 2008.

Responding, Mr. West declined to offer specific comments on pricing.

"It is an unprecedented run-up in costs over the last couple of years," Mr. West said. "You know, we are working very hard at getting our gross margins in line among any number of levels."

Momentum for Barry Callebaut

For Barry Callebaut AG, a hitch in growth during the first half of fiscal year 2008 will not derail the company from the impressive growth momentum, said Patrick De Maeseneire, c.e.o.

"Despite strong headwinds from high raw material prices and economic and exchange rate uncertainties, we confirm our ambitious financial targets, which have been defined as averages over the four year period from 2007-08 to 2010-11," Mr. De Maeseneire said.

The targets he cited are annual top-line growth of 9% to 11%, EBIT growth of 11% to 14% and net profit growth of 13% to 16%.

In the six months ended Feb. 29, Zurich, Switzerland-based Barry Callebaut experienced flat net profit of 124.4 million Swiss francs and a 1.3% gain in net profit, to 200.4 million Swiss francs. Sales volume climbed 10%, to 612,436 tonnes while revenues surged 21%, to 2,585 million Swiss francs.

As Mr. De Maeseneire said, higher ingredient costs weighed on first-half earnings. He noted that cocoa prices climbed by almost 50% between September 2007 and February 2008. In March, cocoa powder prices declined sharply.

Also weighing on results was the startup of new international factories.

"We opened two new chocolate factories, one in Russia, one in China, which will allow us to capture growth opportunities in these emerging markets," he said. "We also integrated four new production sites in North America and Europe."

Fueling growth at Barry Callebaut has been innovation during a period of change in the cocoa market.

"The increasing demand for food that increases the feeling of well being has led us to develop a range of health-enhancing chocolates," Mr. De Maeseneire said. "During the past six months we have launched probiotic chocolate that helps maintain a healthy intestinal balance. Tooth-friendly chocolate has been endorsed by dentists.

"In our gourmet business we also launched a number of new single and plantation origins, and so we continue to have the largest assortment of single origins available on the market."

The company also has generated growth by outsourcing volume to other chocolate companies, said Victor Balli, c.f.o.

"Volumes have grown the first semester by more than 10%, about three times the market," he said. "This is the result of the phasing in of our new largest outsourcing contracts with Hershey, Nestle and Cadbury."

With new plants in Russia and China fully operational (opening delays had adversely affected financial results,), Mr. De Maeseneire said the company was positioned to rapidly gain EBIT contributions from its expanded capacity.

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