Single-serve coffee jolts TreeHouse Foods

by Keith Nunes
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Aggressive pricing by Keurig Green Mountain has disrupted the coffee pod market for TreeHouse.

OAK BROOK, ILL. – On the surface it may appear as if TreeHouse Foods’ second-quarter earnings were positive. But struggles with a volatile single-serve coffee market combined with the rising costs of eggs due to an outbreak of highly pathogenic avian influenza were two factors that forced the company to lower its full-year guidance.

“As we look out towards the balance of the year, we face some challenges and uncertainty, and as a result we are lowering our full-year adjusted earnings-per-share guidance to a range of $3.00 to $3.15," said Sam K. Reed, chairman and chief executive officer. “Coffee is the largest driver of our downward revision, as competitive pricing pressure has intensified further and margins have eroded beyond our earlier expectations.

“Secondly, the Canadian exchange rate, currently at 77c, has moved below our original expectations of an 81c average for the year. Lastly, egg prices and availability issues related to the avian flu have altered our forward outlook for our dressings category, which makes up over 13% of our total company sales. This revised guidance incorporates what we believe to be the most conservative case for coffee, exchange rates and egg availability.”

Mr. Reed said aggressive private-label pricing by “the brand leader,” Keurig Green Mountain, has resulted in a roughly 20-percentage point year-over-year decline in prices.

Sam K. Reed, chairman and c.e.o.

“We had not expected this level of competitive pressure, most of which is being driven by the brand leader,” he said. “Despite the price competition, we have made progress in expanding distribution that will manifest in 2016 as our customers see that we are committed to customer brands and custom products.”

In a conference call with financial analysts on Aug. 6, Mr. Reed expanded on his perspective of what has led to such a challenging situation in single-serve coffee.

“Our initial success, however, has recently soured as the marketplace for both pods and machines has undergone a fundamental transformation,” he said. “Product innovation based on consumer benefit has given way to a failed lockout technology. Consumers and customers alike remain confused and frustrated over the failed promise of new and better.

“Household penetration of machines has stalled as price has become the principal barrier to consumer entry. Balanced marketing of licensed and owned brand of K-Cups at comfortable margins has given way to bundled selling of national brands and private label. The national brands incursion into the customer brands has doubled private label's market share but eroded its margin structure as prices have fallen.”

Despite the difficulties, TreeHouse Foods managed to post net income of $31,362,000, equal to 73c per share on the common stock, and an improvement when compared to the same period of the previous year when the company earned $21,759,000, equal to 59c per share.

Sales for the quarter, ended June 30, were $759,208,000 compared with $627,960,000 the previous year.

“Overall our sales were lower than we had expected primarily due to a shortfall in coffee sales and generally lower sales in most of our other categories,” said Dennis Riordan, chief financial officer. “Part of the lower sales was due to the very difficult comps that we had resulting from a very good quarter last year. In fact, last year's second quarter represented one of the largest organic sales growth rates in our history with North American Retail Grocery sales alone showing a volume/mix growth of 6%.

“In addition we have become more focused on simplification which means selling the right products and eliminating complexity and waste in our manufacturing process. While this had a minor effect on total sales, it resulted in better-than-expected margin improvement.”

Compared to a year-ago, Mr. Riordan said TreeHouse’s coffee business is off approximately 12% in volume.

“Last year we estimated that we had approximately two-thirds of the private label market while we now believe our 52-week share is down to less than 50%, and we believe all of our share erosion went to the brand leader,” he said. “As we entered 2015 we knew we had lost certain coffee business based on the usual six- to nine-month notification process that takes place in private label. However, we felt the lost business would be offset by higher overall sales to retained accounts based on our expectations of growth in the broader single-serve coffee market.”

The lowering of the company’s guidance is directly related to the single-serve coffee market, Mr. Riordan said.

“ … We are now expecting that private label coffee prices at retail will not improve this year, and what we thought was a temporary margin structure for coffee is now a new reality,” he said. “This means that our coffee margins have reverted to a range that is consistent with our company average and down significantly from the average over the past two years.

“Our new estimates for coffee margins over the back half of the year have caused us to reduce our full-year guidance by another 28c to 30c. This large change is due to the heavy seasonal shipments in the third and fourth quarters being made at lower-than-expected margins.”

While much of management’s focus was on the single-serve coffee market during the discussion on its quarterly results with analysts, it was clear the egg market did not help. Mr. Riordan said eggs are used in the manufacture of cream-based salad dressings and mayonnaise, and that the company has experienced a 300% increase in the cost of eggs.

“Shortages of egg whites and whole eggs will result in lower-than-expected sales for the third quarter,” Mr. Riordan said. “We expect those shortages to continue into the fourth quarter while egg laying flocks are replenished. We have estimated that we will see an earnings shortfall of approximately 5c to 7c based on lower second-half sales and inefficiencies at our salad dressing plants due to the lower volumes and inconsistent deliveries.”

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