Three Paths to a Better Bottom Line

Consider acquisitions, emerging markets and energy efficiency to increase your competitiveness.

By Chris Nay, GE Capital, Corporate Finance

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These are challenging days for companies in the North American food processing industry. Overall growth is slow, with most categories tied to incremental population growth in the low single digits. At the same time, profits are being squeezed by escalating commodity costs, which food processors can't easily pass along to price-sensitive consumers. What's more, some retailers are holding the line on price increases and forcing processors to absorb extra costs.

Of course, low growth and difficulty in passing along costs are not new developments, but they are becoming the new normal for the industry. To outperform, companies will need to find creative ways to step up growth, gain pricing power and reduce their own costs to improve margins. These are ambitious goals, but they are achievable. In fact, some companies are already pursuing several pathways to improve their bottom lines, including making strategic acquisitions, entering emerging markets and improving energy consumption.

Strategic acquisitions are particularly compelling today given the ample liquidity in the market. Bankers like the stability of the food and beverage industry and are willing to offer relatively aggressive financing — e.g., higher multiples of EBITDA (earnings before interest, taxes, depreciation and amortization) — to facilitate deals.

In fact, M&A among food processing companies ticked up in 2011. Among food and beverage processors, 63 mergers were completed in 2011, according to the Food Institute. That's higher than the 58 in both 2009 and 2010, but below the 110 recorded in the three consecutive years from 2006-2008.

Strategic acquisitions are a way to grab market share and boost growth. But they are also an avenue to high-growth niches with more pricing power, such as the gluten-free market, which has swelled to $6 billion thanks to 27 percent growth since 2009.

The recent acquisition of Bolthouse Farms for $1.55 billion by Campbell Soup is a case in point. With the purchase, Campbell, which pioneered "shelf stable" products such as soup, is making a foray into the packaged fresh-food category. The $12 billion category is growing at nearly 7 percent — much faster than traditional grocery staples. The deal is also evidence of the ample liquidity in the market. Campbell is paying 9.5 times Bolthouse's EBITDA.

A second growth strategy for food processing companies is to look overseas to grow organically or through acquisitions — specifically to the faster-growing emerging markets where a nascent middle class is driving dramatic changes in food preferences. For instance, spice maker McCormick & Co. made several emerging market acquisitions in 2011 that helped boost sales by 11 percent to $3.7 billion: Kamis SA, a Polish company that makes spices, seasonings and mustards, and Kohinoor Foods Ltd., an Indian company that sells basmati rice and other foods.

McCormick and other companies are enticed by a growing middle class that is improving its diet by adding more protein (meat) and vegetable oils. It's also consuming more processed foods, as women move into the workforce and have less time to prepare meals at home. These long-term demographic trends bode very well for food processing companies. Consider this statistic from McKinsey: by 2025 China's upper middle class will comprise 520 million people with a combined disposable income of $2.1 trillion.

But increasing revenue through acquisitions and forays into the emerging markets are not the only levers to improve the bottom line. A third pathway is reducing costs and vigilantly driving efficiencies wherever possible. One cost center that many food processing companies are paying particular attention to is energy consumption.

In most manufacturing processes, food processors need both electrical and thermal energy that they purchase through public utilities. To better manage these costs some companies are taking a closer look at Combined Heat and Power (CHP), which allows the processor to improve thermal efficiency.

CHP is not a new technology, but its adoption has been held back by the capital expense of building these facilities on site and the slow payback. But some companies — such as Unilever — are now avoiding this major capital outlay by partnering with an energy services company (ESCO) or independent power producer (IPP). These companies build the power facility on site for the food processor, which then buys the cheaper energy and reduces greenhouse gas emissions without spending its own capital. This frees up capital to drive the business side.

Making strategic acquisitions, entering emerging markets and improving energy efficiency are just three possible pathways to a better bottom line. What's critical — given the exceptional challenges in today's global business environment — is that executives think creatively about both the cost and revenue sides of their operations. Only in this way can they hope to outmaneuver competitors, create a sustainable advantage and improve the bottom line.

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