A return of focus

by Josh Sosland
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As the 20th century transitioned to the 21st, the nation’s largest food companies were on an acquisition tear. Positioning themselves for growth in the new century, the companies grew with one mega-acquisition after another. Kraft/Nabisco, Kellogg/Keebler, General Mills/Pillsbury, PepsiCo/Quaker, Unilever/Bestfoods and Sara Lee/Quaker are among the familiar transactions consummated during this period.

For many of the buyers, the intervening years have hardly met expectations. With the century’s first decade entering its twilight, the industry’s large diversified companies have continued to struggle. The difficulties have not been limited to companies that made major acquisitions in the 1999-2001 period. Even companies like Campbell Soup Co.; ConAgra Foods, Inc.; and H.J. Heinz Co. continue to struggle in an effort to gain their footing.

Measured by share price performance, many of the largest companies in the Food Business News Diversified Food Products index stumbled in 2007, and the performance has worsened this year. Through March 7, the index was down 6.8% in 2008, the weakest performance of any of the food industry segments tracked by the publication.

"There has been debate over the years over which business model works best — diversification and scale or focus," said Rob Moskow, an analyst with Credit Suisse in New York. "It’s clear that over the last several years focused food companies have been more successful after the large round of consolidation in 1999-02."

The development has not been lost on the industry’s largest companies, Mr. Moskow said. He cited Credit Suisse research indicating U.S. food companies divested businesses with aggregate annual sales of $14 billion in 2004-06 in an effort to fine tune their portfolios. During this same period, acquired companies had aggregate annual sales of $2 billion.

More recently, the decision of Cadbury Schweppes, P.L.C. to split its confectionery and beverage businesses into separate companies also was consistent with this trend (see story on Page 11).

The importance food company management is placing on focus has been evident in their actions as well as in the comments of industry leaders in recent conference calls and at the recent annual meeting of the Consumer Analyst Group of New York, held in late February in Boca Raton, Fla.

For instance, the H.J. Heinz Co., urged along by activist investor Nelson Peltz, significantly narrowed its range of businesses. By April 2006, Heinz completed several divestitures worth more than $1 billion, including a poultry business in New Zealand, seafood businesses in Europe and Israel, a vegetable business in The Netherlands, an ethnic foods business in the United Kingdom and a stake in the Hain Celestial Group, Inc. in the United States. Since then, the company has emphasized the benefits of its narrower portfolio.

In a Feb. 26 conference call, Art Winkleblack, Heinz executive vice-president and chief financial officer, trumpeted a 17% jump in sales for the company’s top 15 brands in the third quarter ended Jan. 30. He noted the top six brands grew by 20% or more.

"We posted strong double-digit increases in each of our three core categories," he said. "Our ketchup and sauces, and meals and snacks categories each rose by almost 14%, while infant nutrition led the way, growing by 17%."

Mr. Winkleblack added that the company made double-digit increases in marketing spending in six of the last seven fiscal quarters. Still, one analyst noted Heinz marketing spending was still only 3.5% to 3.7% of sales, a level that lagged its peers.

Mr. Winkleblack responded by saying that while further increases may be forthcoming, the lower spending levels were a benefit of the company’s restructuring.

"I think the beauty of the Heinz portfolio, now that we’ve done the hard work of pruning the portfolio over the last number of years, is that we have a very focused portfolio," he said. "Those top 15 brands represent about 70% of our sales, and so our spending can be quite focused. As you say, we have increased marketing significantly. We would look to continue to increase marketing going forward, but only to the extent that we have the ideas and the people to effectively spend the money. And you’ve seen that where we’ve spent the money, we’ve gotten very good returns. We do anticipate continuing to step up marketing going forward."

Similar language popped into the Feb. 22 CAGNY presentation of Doug Conant, president and chief executive officer, Campbell Soup Co.

"We have slimmed down to improve our strategic focus with the divestitures of the businesses in the U.K. and Ireland and shortly in Godiva," Mr. Conant said. "Campbell is now focused worldwide on just three business areas: simple meals, where we are heavily anchored in soup; healthful beverages, where we are heavily anchored in vegetable-based beverages; and baked snacks, where we are heavily anchored in biscuits."

With the changes, Mr. Conant said innovation will be the principal engine for growth moving forward. Toward that end, the company launched a major sodium reduction initiative for its soups in 2007, an effort it is expanding in 2008.

For Wall Street financial analysts, moves by companies like Heinz and Campbell Soup make investment analysis easier, said Mitchell B. Pinheiro, senior vice-president of Janney Montgomery Scott, Philadelphia.

"They are easier to cover if they are more focused," Mr. Pinheiro said. "There are fewer moving parts to watch. We have seen over the last couple years Sara Lee Corp. slim down, getting rid of Coach and apparel. Campbell just sold off Godiva. That was their one piece that was off center of their core snack foods, baking, and simple meals focus. They have had Godiva for many years. You could have made the argument 10 years ago that it should have been sold. They sold several other non-core businesses at that point. Today, they are focused on core competencies rather than being everything to everyone."

Mr. Moskow said the consolidation surge of the late 1990s, driven in part by dramatic consolidation in the retail supermarket business, left companies somewhat ill equipped for subsequent changes in the marketplace.

"Focus is definitely the buzzword today," Mr. Moskow said. "The food industry is getting tough. By that I mean it is getting tougher to market brands, and brand value is what matters. The consumer is more fragmented than ever. There is more interest in ethnic foods and organic foods, for example. Advertising effectiveness has been declining as the media has become more fragmented. Companies that are focused on a single category, generally speaking, have done better. Kraft has streamlined its portfolio, selling brands that did not fit in, and ConAgra has sold off businesses."

Looking forward, Mr. Moskow cited General Mills, Inc. as standing out as the diversified company with the most promising prospects among the names he follows.

"After years of struggle with the Pillsbury integration, they are in the best position," he said. "I think they have the right management structure and processes internally to drive the business. For the last five years, they’ve been doing little but putting out one ‘fire’ after another. They have a legacy of marketing prowess, and the results are showing up in sales growth. They are back on track again."

Mr. Moskow also was upbeat in his assessment of the prospects for Heinz.

"Heinz has figured something out," he said. "Both General Mills and Heinz are in the ‘middle innings’ of major turnarounds. Heinz has divested its commodity businesses to focus on meals, condiments and baby food."

By contrast, Mr. Moskow said he was less upbeat about the prospects for Kraft Foods, Sara Lee and ConAgra Foods.

"I do think that Kraft will figure it out eventually," he said. "It will take a long time since they spent the last 10 years with too much focus on cost reduction, wounding their ability to differentiate their brands. Their new products were characterized by lots of little ideas that survived a year or two, rather than the fewer, big ideas you see from successful companies."

New products unveiled by Kraft at CAGNY this year did not engender confidence, Mr. Moskow said.

"As much as I think they are getting back on the right track, I was worried when they suggested their new Bagel-Fuls would become a $100 million platform," he said.

He was referring to ready-to-eat frozen bagel sticks filled with different flavors of Philadelphia brand cream cheese. Warmed in microwave ovens, the products are set to be introduced this month. Kraft said it is using proprietary technology to introduce a "broad pipeline" of products incorporating fillings in bread products.

Bagel-Fuls were not a hit at CAGNY, Mr. Moskow said.

"I know we aren’t the target audience, but the investment community was physically afraid to go near these things," he said.

While diversification in food traditionally has referred to a company’s product portfolio, Mr. Pinheiro said he watches for other ways food companies work to avoid a narrowly concentrated business.

"I look at it slightly differently," he said. "I look at diversification among channels rather than products. I don’t know what basket of products is better: soup, sauce and cookies/cracker or cereal, cookies and crackers. They all are trying to get healthier. The bigger difference in their returns is whether they are all branded versus food service versus private label.

"The companies that have 100% branded business lately have fared better than companies that do food service or private label. That’s partly because the latter segments diminish companies’ ability to control pricing. There are contracts that give food companies certain windows for changing pricing, and there is usually very tough pricing negotiations given the size of the piece of business. There is pressure on some of the customers’ customers. In food service, we know wheat prices are going up, but can you raise a hamburger a nickel? Does that throw things out of kilter? Consumers feel the pinch of energy and food inflation and lower levels of confidence."

Additionally, a small number of companies have chalked up impressive growth in recent years without an emphasis on focus. For instance, management of Nestle S.A. has celebrated the company’s complexity as a source of strength even as it has generated impressive results (albeit while increasingly focusing its business on health and wellness).

Similarly, the emphasis at PepsiCo, Inc. has not been on tightening the company’s focus. At CAGNY, Indra Nooyi, chairman and chief executive officer of the Purchase, N.Y.-based company, said the company’s compound annual growth rates have been in the double digits for revenues and operating profits since 2003.

She noted that in 1999, the company’s CAGNY presentation included its assessment of the key attributes of a premier consumer products company and how PepsiCo stacked up with those attributes.

"Recently we went back and refreshed all of these attributes of premier companies and tried to understand what the new attributes were and how we stacked up against them," she said. The older attributes included:

• Globally diverse with a broad and strong footprint,

• Leadership positions in growing categories,

• Expertise in how to drive consumption and understanding of how to enter or expand in a market,

• Innovation as a life blood of the company,

• Brand that is global in recognition and regard but local in its face,

• The ability to engage with consumers.

In reviewing the list, Ms. Nooyi said PepsiCo has added consciousness of the environment and a commitment to "do good for the communities in which they operate and a culture that promotes superior performance and develops a strong management team."

One Wall Street analyst noted that while PepsiCo has not made a show of focusing its portfolio, the company’s product line is and has been reasonably narrow.

"The power of a brand, like Frito-Lay, is greater in the snack category than in more commoditized categories like mayonnaise and cheese," the analyst said. "PepsiCo is in excellent categories and has a driven management team with very talented individuals."

This article can also be found in the digital edition of Food Business News, March 18, 2008, starting on Page 1. Click here to search that archive.

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