A nice fit

by L. Joshua Sosland
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GLENDALE, CALIF. — The Kraft Foods Co. frozen pizza business represents “a very compelling acquisition” for Nestle, said Brad Alford, chairman and chief executive officer of Nestle USA.

Mr. Alford participated in a conference call Jan. 7 to discuss the transaction with investment analysts. Also on the call for Nestle was Jim Singh, chief financial officer of the parent company, Nestle S.A., Vevey, Switzerland.

The call followed the Jan. 5 announcement that Nestle has agreed to acquire Kraft’s frozen pizza business in the United States and Canada for $3.7 billion. Brands included in the transaction include DiGiorno, Tombstone, California Pizza Kitchen, Jack’s and Delissio.

For the parent company, the transaction “satisfies Nestle merger and acquisition strategies on all metrics,” Mr. Singh said. These targets include having No. 1 or No. 2 category presence with strong, leadership brands; to be in value-added categories; opportunities for integration and synergies; ongoing internal growth, cash flow and earning enhancing potential; and not imperiling Nestle’s credit rating or financial flexibility.

Drilling into the logic behind the deal, Mr. Singh said the $3.7 billion Nestle will spend partly will be offset by $500 million in tax benefits (present value). The purchase price equates to 10.6 times 2009 EBITDA, after accounting for the tax benefit, Mr. Singh said.

The frozen pizza EBITDA margin was 14.9% in 2009, and Nestle has identified synergies totaling at least $147 million, he said.

Asked by analysts to elaborate on the synergies, Mr. Alford said Kraft’s current annual frozen foods business, including ice cream, generates $8 billion in sales.

“It’s a large business that is going through primarily a dedicated distribution channel,” Mr. Alford said. “When we look at opportunities, the cost for frozen distribution is obviously higher than ambient. We will spend $900 million to $950 million on distribution. We think there is an opportunity to cut that back. There are different ways these businesses get to market, touching different points of distribution. We think if we take the best of all the ways we go to market, we can dramatically expand distribution across all our products.”

In addition to distribution synergies, Mr. Alford said the complementary nature of some of the company’s frozen brands offer a different kind of synergy potential.

Mr. Singh noted that Nestle is No. 1 in the frozen prepared meals category with a 36% share and No. 1 in frozen sandwiches and snacks with a 23% share.

The company’s current brands include Stouffer’s, Lean Cuisine, Hot Pockets and Lean Pockets.

“With the range of brands in frozen foods we have, there are some interesting brand stretching opportunities that we can take advantage of,” Mr. Alford said. “Can you take the DiGiorno brand into sandwiches? There is a lot of opportunity to play our brands across one another.”

Mr. Alford was very hopeful about prospects for growth in the frozen pizza category, noting that supermarket pizza sales of $7 billion ($4 billion in frozen sales) are a reasonably small part of the total $37 billion U.S. pizza market. He said 95% of U.S. households consume pizza and 71% buy frozen pizza. The spread offers opportunities to gain share, he said.

“There is a large advantage for frozen pizza when you consider the price of a home-delivered pizza,” Mr. Alford said. “There is better economic value for the consumer.

“In our due diligence, we did product testing of frozen pizza against delivered product. One of the things that sets DiGiorno apart from others is the rising crust technology brought to market with DiGiorno. We think we have a product that’s pretty good — as good or better than delivered. The consumer is looking for a nice way to trade down.”

Beyond the specific potential for growth in pizza, Mr. Alford was upbeat about prospects for frozen foods generally.

“From what we hear from retailers, the frozen food section is a critical part of the store for them,” he said. “Fewer and fewer people know how to cook, and frozen products are a good solution for the consumer. We see that continuing and becoming more advantageous, as do our retailers. They are making more investments in frozen food in their store or within their systems.”

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