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A mixed hamper for food producers

SECTOR FOCUS: Supermarkets are often blamed for the woes of food producers, but the reality is that strong suppliers are still able to thrive
December 21, 2010

It's been almost a year since Cadbury succumbed to the unsolicited advances of plastic cheese-maker Kraft, but still the animosity rages on. In the months since the deal completed, the buyer reneged on promises to keep factories open and jobs in the UK, but its latest crime is, to many worse still - it plans to shrink the size of the iconic Dairy Milk bar, from 140g to 120g, as well as increasing the price of other products by a whopping 7 per cent.

In short, Kraft's move is the latest manifestation of the return of food inflation, just in time for the UK's annual Christmas binge. With cocoa prices soaring again as a result of political instability in the Ivory Coast, it wants to reduce the pack size so that it continue to promote the item at the magic £1 mark, and has even been working with discount retailer Poundland to make a budget Toblerone.

Inflation back on the menu

While it's easy to point the finger at the nasty American corporation, it won't be alone in tinkering with pricing and pack sizes to protect its profits. The most recent UK data shows that food prices climbed from 1.7 per cent in July to a whopping 4.9 per cent. Many have argued that the current food price is a mere temporary blip, but according to analyst Clive Black at Shore Capital, it's likely to remain a feature of UK food industry for the foreseeable future. "The global population is rising, they're more affluent, and eating better," he says, adding that the rising oil price has meant inflation has been stronger then thought.

So far, though, Mr Black believes inflation is "manageable". And although he believes that, with grain supplies tight, there is scope for poor Northern Hemisphere harvests in 2011 to add to upward pressure. So far, though, there's no indication that there will be a return to the levels during the 2007 soft-commodity bubble, which prompted a rash of consumer down-trading.

Last supper for households?

Certainly, households haven't yet felt the full effect of inflation in the run up to Christmas. With the snowy weather wreaking havoc and shopper struggling to simply get out of their houses, retailers - including supermarkets - have been doing everything they can to lure people into stores.

Indeed, Tesco recently said that inflation had remained low in its latest quarter, possibly the result of continuing promotional activity. However, while supermarkets have undoubtedly been involved in driving promotions, Mr Black believes that it is the manufacturers who have been the main culprits by chasing volume. "Supermarkets have a responsibility to pressurise suppliers, and where they see overcapacity or inefficiency they will be quite ruthless in driving value for their shareholders," he says.

Christmas crackers and festive turkeys

So, while Tesco was painted as the bad guy in a recent high profile spat with supplier Premier Foods over the pricing over Hovis - with the supermarket threatening to withdraw its products after the manufacturer planned price increases to cope with the soaring cost of grains - Mr Black argues that over-supply in the bread market that made price increase untenable. Similarly, he says, the recent upheaval in the dairy industry, which saw the country's leading liquid milk supplier Robert Wiseman issue an ugly profit warning, was the result of its own indiscipline.

And pork processor Cranswick provides ample demonstration that the relationship between supermarket and supplier is not as one sided as popular opinion suggests. The pork producer has been able to recover costs and drive new business thanks to investment in more efficient factories and "savvy" management. "Where there is undercapacity or suppliers can demonstrate efficiency, the retailers will bow to economics and accept price increases," says Mr Black.

However, Mr Black concedes that it is generally more difficult for private label suppliers to claw back rising input costs. Unlike branded suppliers that, theoretically, can push through price increase unilaterally, those producing own-label products must wait for their customers to agree to hikes.

Chilled ready meal supplier Northern Foods is a case in point. Failure to agree terms with customers saw it shut several factories this year, but analysts are confident that a proposed merger with Irish rival Greencore to create a new company Essenta, will help restore a semblance of balance. As well as ticking the efficiency box with £40m of synergies, the deal will also, in the words of Alex Sloane at broker Evolution, "provide the company relatively more leverage when dealing with the major retailers".

Price (p)Market capitalisation (£m)Forecast PE ratio1-year price change (%)
ANGLO-EASTERN PLTNS.693273.5na88.57
ASSOCIATED BRIT.FOODS11288930.114.640.21
CRANSWICK861.5409.611.811.88
DAIRY CREST396527.88.716.95
DEVRO250.1409.21591.28
HILTON FOOD GROUP250174.111.524.84
NORTHERN FOODS61.5288.210.5-5.09
PREMIER FOODS18.08433.63.7-47.93
REA HOLDINGS767.5256.512.895.82
ROBERT WISEMAN DAIRIES358253.19.7-31.42
TATE & LYLE535.52496.312.727.59
UNILEVER (UK)196925271.315.82.29

Source: Datastream

FAVOURITES...
Although food inflation is raging across cereals, grains and oils, ongoing expansion of the UK pig-herd means pork prices are relatively steady. That's good news for our perennial favourite in the sector, Cranswick, the UK's largest pork processor, which won't have to battle to push through price increases, and will benefit from continued consumer demand for the low-cost protein. Heavy investment in processing facilities has paid off, with volumes rising sharply and enough capacity to support £100m of incremental sales over the next few years. Debt is low and a forecast PE ratio of 11 means the shares are a buy.

OUTSIDERS...
Robert Wiseman Dairies has had a horrible year, with its shares crashing by a third as it warned that profits this year and next would fall £7m and £16m below expectations respectively as a result of intense competition in the liquid milk industry. Some suggest the development represents a structural change in industry profitability and could seriously hamper Wiseman's ability to generate the required returns from major investment in its 500m litre Bridgwater dairy. However, the falls also mean the shares offer a well-covered dividend yield of nearly 6 per cent from a lowly-geared business with a large family shareholding.