Happy New Year to you all from the Eversheds Food and Drink Sector Team. Last year was a challenging year for many in the food and drink sector; a year which saw the grocery landscape change. Grocery share figures for the 12 weeks ending 9thNovember 2014 showed, for the first time since Kantar Worldpanel records began in 1994, that the British grocery market had fallen into decline, with sales down 0.2% compared with the same time in the previous year. The increased pressure from retailers to be more competitive on pricing had a knock on effect on manufacturers margins and profitability. We also saw a significant increase in the number of insolvencies of food and drink manufacturers. Consumer habits changed from the traditional big weekly shop to more frequent visits to convenience outlets and a willingness from customers to visit more than one store. Professor Elliott issued his report on food fraud, which was warmly received but disappointingly little progress has been made on implementing his proposals. Campylobacter was heavily debated and expect it to be a continuing issue in 2015 as the retailers work with manufacturers to reformulate packaging and educate consumers. Healthy eating continues to gain headlines.
As we look forward to 2015, Parmjit Singh, Head of Eversheds’ International Consumer Sector with responsibility for food and drink (FAD), was recently asked to address a number of questions in relation to the key legal and business issues to be faced by the sector this year.
What are your thoughts on the key challenges faced by the UK’s major supermarkets and their suppliers in 2015?
This year has already seen televised adverts for Sainsburys’ price cuts and Asda’s January 50p rollback campaign, and there will undoubtedly be increased pressure upon the major supermarkets to drive down prices throughout the year. I would expect the institutional markets to accept a revised profitability benchmark for the major supermarkets over the next three years. The pressure on pricing will inevitably lead to the squeezing of margins for FAD suppliers and the lengthening of payment terms. We would expect the number of FAD suppliers in significant financial distress to increase from the current figure of almost 1,500 per annum. Accordingly, supermarkets and suppliers throughout the sector should be alive to the approach they take when contracting to cover against the risks of insolvencies, both from a commercial and legal perspective.
Price promotions, whilst helpful in increasing sales volumes and customer buy in, will be used with more care – not only for their commercial cost to the suppliers, but also for the reputational risk to the retailers. Already this year, the media has been swift to scrutinize the value of many promotional campaigns.
A key characteristic of 2014 was the rise of the discounters, not just Aldi and Lidl but Poundland, 99p Stores and B&M Retail. The success of these retailers has been put down to them all having their fingers on the pulse and meeting consumer demand. We expect to see an increased focus on consumers from all the supermarkets but especially Tesco as the new Chief Executive tries to re-engage with Tesco’s substantial consumer base. A recent BBC Panorama programme emphasised the value of customer trust.
The utilisation of omnichannel selling has also been successful for many companies, particularly those selling new and niche products. The challenge for the rest of the market will be to list wisely and diversely in advance of consumer spending trends and to crack the conundrum of how to trade profitably online.
Do you expect significant levels of corporate activity in the sector in 2015?
The FAD sector witnessed significant corporate activity in 2014. Some of the transactions which Eversheds has been involved in include acting for: Dairy Crest on the proposed sale of its dairies operations to Müller UK & Ireland Group, Raisio on their acquisition of the Benecol business in the UK, Ireland and Belgium, Greencore on the disposal of Ministry of Cake, Aimia Foods on the sale of Aimia to Cotts Ventures Limited; as well as acting for Belgian based private equity firm Verlinvest S.A. on its investment in gluten free food manufacturer Genius Foods, and advising multinational food company Wessanen on the acquisition of Abafoods, a European expert in organic vegetal drinks and a leading brand in Italy. We expect to see a continued interest in western food and drink brands from Asian businesses and other companies from emerging countries. The purchase of United Biscuits by the Turkish conglomerate Yildiz Holding is a perfect example of what we can expect to see more of over the coming years.
From our perspective, the FAD sector has a number of qualities which have proved to be attractive to international and domestic investors and acquirers alike (both trade and private equity). Characteristics that have continued to draw investment and promote growth in the FAD sector are:
- Strong brands with an international, if not global relevance, are prolific within the sector. This is very attractive from an M&A perspective, as is the cash generative nature of FAD businesses and the fact that they tend to be stable businesses with resilience to withstand changing market conditions.
- Linked to the branding of a business is intellectual property more generally. In evaluating businesses in which to invest, the potential acquirer clearly needs to consider how the business can grow (i.e. how it can make a “return” on its investment). A business’s intellectual property and its ability, or potential ability, to invest in research and development are two key catalysts of potential growth for a business, and FAD businesses typically evince both characteristics. For example, the UK FAD sector introduces around 10,000 new products each year and worldwide there are over 3.6 million published patents in the agri-food sector.
- Niche brands and products are often attractive to potential acquirers because of their growth potential and there are numerous examples of these in the FAD sector.
In addition to the qualities set out above, the sector has the benefit of operating against a backdrop in which private equity houses currently have significant uninvested capital to deploy and debt markets which have recovered to an extent that new providers are entering the market.
The appetite for investment, consolidation and acquisition in the sector is growing, indicated alone by the speculation published on the potential sale of SABMiller and the potential IPO of Moy Park.
In light of all of the above our expectation is that the FAD sector will enjoy continued momentum in the corporate arena during 2015.
Ensuring safe and high integrity supply chains was a key conclusion of Elliott’s report. What practical issues should the industry be considering?
Last year’s difficulties arising from the provenance of ingredients, recent high profile arguments about supermarket contracts and the increasing activity levels of the Groceries Code Adjudicator all indicate that retailers as well as producers and manufacturers will be taking a closer look at their supply arrangements this year.
Where no written contracts exist, the parties having simply relied on years of informal arrangements, this will be the year to eliminate the uncertainty and formalise the relationship by way of a written contract. Where contracts are not performing as anticipated, businesses will need to examine closely the terms of their agreements, to determine what options are available to improve performance or to take action against the other side. Given the increasing pressures to shave costs, many companies will be looking for ways of getting out of their less profitable contracts and look for a better deal elsewhere. Any terminations will need to be handled very carefully, otherwise there is a risk of being in breach of the contract and having to pay compensation.
Big businesses will also want to have greater control over the supply chain as a whole. With some companies coming under criticism for the working conditions and pay levels of their work force in developing countries, it is becoming increasingly important for the business to have contractual mechanisms in place for taking direct action to protect workers further back along the chain. However, such action could easily lead to disputes and will need to be handled carefully.
In relation to food hygiene and safety, there are now proposed sentencing guidelines and consultation is running until mid-February as part of the wider consultation about health and safety sentencing generally. We expect that businesses, and larger businesses in particular, can expect significantly higher fines if convicted of relevant offences once the guidelines take effect. This may be as early as this summer, though many commentators think that 2016 is the more likely implementation date.
In your experience, how has the sector responded to the recent changes in labelling?
Our experience so far suggests that most businesses have used the long lead-in time for the Food Information Regulation wisely.
Notwithstanding the above, this will be the first full year of implementation of the regulation, and we expect that we will see in the coming months precisely how well the new requirements have been embedded by food businesses. Cases of complaints concerning alleged breaches will also assist in providing some insight into the approach that the authorities will take.
Further updates to FAD labelling regulations may also be on the horizon, pending the outcome of the General Election. By way of example, Labour have suggested they will set limits on the fat, sugar and salt levels on products marketed to children.
Aside from changes to the regulatory scope surrounding labelling, I expect to see the continued heightening of consumer sensitivity to components of FAD products, and the industry will need to consider its approach to consumer demands. Cadbury’s decision in relation to the reformulation of its Creme Egg constitution is one such example currently in the public arena.
2015 will be challenging for many in the sector with pressure on pricing by retailers to continue to combat the discounters and the knock on effect on the profitability of manufacturers. A bright point for manufacturers is that although input prices for most commodities will increase, the increases will remain below the record levels seen in the past three years. We may see tougher regulation with the voluntary codes of conduct being questioned as to effectiveness. Consumer awareness of health trends will be high on the agenda in 2015 from weight wellness, increased protein, good v. bad carbs, frozen products to advantages of dairy, trans fats v. natural fats, as well as sugar and salt content. There is evidence that some consumers are starting to move away from main meals and towards snacks – can this become more mainstream? Consumers may prefer to have a little of something they really like rather than a lot of something they don’t, suggesting portion sizes may reduce. The rise in craft beers is a very good example of this change. We do expect to see more opportunities for expansion and growth through corporate activity moving away from relying on organic growth and cutting costs.