Wall Street's Perspective
Analysts Alexia Howard and April Scee divulge how consumer goods companies can build profitable brands and meet optimistic growth goals in the face of shifting consumer preferences and complex market pressures.CGT: What are the main opportunities to drive growth for consumer goods manufacturers?
Howard: In U.S. food, the overarching growth theme is around health and wellness. In particular, consumers are looking for less heavily processed foods and want authentic foods where they understand all the ingredients. So, fresh fruit and vegetables, butter and honey are all doing well, while frozen meals, dry dinners and Jell-O are in decline. We’ve had a few years where consumers have favored proteins over carbs, and the gluten-free diet has taken off. There are a few signs that this may be slowing down. Snacks are doing particularly well, which may seem to run counter to increased interest in health and wellness. It seems that the health and wellness trends are really hitting meal-based categories most directly, where moms are the main decision maker. At the same time, other consumer groups are giving up three square meals a day in favor of more frequent snacking.
Scee: Significant macro headwinds, higher competition and lower entry barriers are threats to consumer goods growth, but opportunities remain in:
- Frontier markets, where sustainable advantages accrue for those who build route-to-market and consumer awareness early;
- Buying/developing niche growth and divesting slow-growth or commoditized categories;
- "Real" innovation, which goes beyond typical brand updates to introduce new technology or utility; and
- Elevating brands by standing for something and being authentic.
CGT: The consumer goods industry has seen an explosion of small, niche brands. Why is this occurring? What are the implications for the larger, more established brands?
Howard: We are indeed seeing the rise of new niche brands in U.S. food — a sector that has historically had very high barriers to entry. Chobani Greek yogurt broke the mold, KIND snack bars are taking off, and we are seeing this phenomenon of premium products with simple ingredients gaining share in many categories. This phenomenon seems to have a number of root causes. The rise of the Internet has cast a spotlight on a range of food ingredients that have been called into question — food apps, blog sites and social networking sites have all amplified the online conversation about food. Although it’s hard to separate the scare mongering from the science, perception is becoming a hard reality for the industry. Moms of young children and millennials seem to be leading the shift into less-heavily processed foods. We are seeing some companies renovate their established brands to simplify their ingredient lists — Philadelphia Cream Cheese underwent a makeover earlier this year to add more fruit and vegetables and reduce artificial flavors and colors in some varieties. Oscar Mayer has also launched a line called Oscar Mayer Selects that have no artificial preservatives, flavors or colors. However, it may be tough going for some large, established brands that cannot easily be reformulated in this way.
Scee: Barriers to entry have reduced meaningfully in recent years due to the convergence of consumer, retail and technology trends, which have given rise to a consumer who is more brand promiscuous. Entry barriers are breaking down as:
- Narrow-casting and digital make advertising more affordable,
- The rise of e-commerce eliminates the need to obtain shelf space,
- The rise of outsourcing and asset-light barriers reduce fixed costs,
- A sharing economy (think crowd funding, crowd innovation) continues to lower barriers over time.
The resulting explosion of small, niche brands is being well received by consumers. For example, millennials between the ages of 19 and 36 want to be special and demand differentiated (niche) products. Also, access to ubiquitous and instantaneous information, especially user-generated content, promotes brand promiscuity, helping consumers identify what new products others in their demographic have endorsed.
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CGT: Can you share predictions for 2015, particularly with regard to M&A activity?
Howard: In U.S. food, we have seen a number of spin offs and splits in recent years. Sara Lee’s break up, Mondelez International’s sweet snacks business separation from Kraft Foods Group’s grocery business, the Post cereals spinoff from Ralcorp, and WhiteWave’s spin off from Dean Foods. Going forward, it seems more likely that we’ll see some consolidation. U.S. Food remains a much more fragmented industry than other consumer goods sectors in the developed world. The last time sales growth slowed in the late 1990s, we saw a wave of consolidation across the industry (Kraft bought Nabisco, Kellogg bought Keebler, General Mills bought Pillsbury). As sales slow once again, we may see increased deal-making to give companies access to faster-growing markets, like healthier brands in the United States, as we saw with the recent announcement that General Mills plans to buy Annie’s. We could also see a roll up of the snack foods industry, since this remains a growth area, and we may well see more acquisitions in emerging markets over time. Who wins and who loses really depends on what price is paid. With very high multiples announced for several recent deals (Hillshire Brands, Annie’s, D.E. Master Blenders in Europe), it may be hard to recoup an adequate return, but with interest rates so low these deals are accretive to earnings even at these prices.
Scee: Over time, we believe M&A will prove most beneficial to owners of small, niche brands, as larger, multi-national consumer goods companies acquire growth. Additional beneficiaries will be acquirers of the orphaned brands that these same multi-nationals spin off given attractive valuations, strong cash flow characteristics and opportunity to resuscitate the brands, just as Paper Partners did when it rolled Procter & Gamble’s White Cloud brand (orphaned in 1993) into Walmart in 1996.
We believe increased brand proliferation overall is negative for consumer goods companies as it becomes more difficult (and expensive) for an individual brand voice to be heard amidst an increasingly noisy competitive environment. Strong brands that truly stand for something and non-traditional media providers will likely benefit as marketing spend increasingly shifts away from traditional media — and as return on investment on non-traditional media proves out and non-traditional media providers raise prices and grab a larger share of the pie.