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2011 Capital Spending Outlook: Benjamins for Bricks (and Mortar)

April 5, 2011
Our annual Capital Spending Report foresees a 20 percent increase.

For two years in a row, capital expenditures in the food processing sector have recovered … big time. Following a dismal 2009, in which a 15 percent drop in expenditures reflected the global economic crisis, companies budgeted 19.5 percent more for physical growth in 2010 (and actually spent 27 percent more) and have allocated a 20 percent increase for 2011.

To put a finer point on the recovery, our group of 33 companies rebounded last year with actual spending of nearly $14.7 billion, nearly $1 billion higher than they had budgeted. And for 2011, they're planning to spend 17.6 billion. In light of the $13.5 billion the same companies spent in 2008, this impressive bounce-back appears to be more than a mere rebound to pre-recession levels.

To be fair, we surveyed 32 companies in 2010 and 33 for 2011 (Pilgrim's Pride, in the midst of bankruptcy reorganization, did not respond last year). But even if we remove the $179 million Pilgrim's Pride spent in 2010, the remaining companies' actual expenditures total $14.48 billion, which is still 6 percent higher than what they budgeted.

While 33 companies is an admittedly small representation of the food & beverage industry, these are 33 of the largest companies in the U.S. and Canada. We look at the same group for this report each year.

Back to the future: The sustained levels of capital spending planned for 2011 almost perfectly match our Manufacturing Trends Survey report in January. That story, based on a survey held last fall, found that of those privy to their company's capital spending budget, 64 percent foresaw at least some increase in capital spending this year.

Capital Expenditures for 2011

"Food processing is the biggest part of our manufacturing industry in Georgia, and we've seen an increase in the number of those companies seeking locations or expansions over the last three years and the jobs they're creating," says Chris Cummiskey, commissioner of the Georgia Dept. of Economic Development. "That's a good indication to us that the industry is in an expansion mode."

Capex as a cost-cutter
There are various reasons for the sustained, strong comeback of capital expenditures, or capex, in this low-margin industry. Some companies simply may need to update aging facilities, while others are closing plants to consolidate under fewer, newer roofs.

"Most projects being considered are those that have been 'pipelined' for quite some time," says Bob Graham, vice president of the food and consumer products group at The Austin Co. Those who delay past a certain point reach a point of "bottoming out" and can no longer put-off production, maintenance or other projects.

Graham says his firm has "a number of projects in the food/consumer products sector -- which we have worked on for site selection and preliminary engineering/cost estimating [but] have been on hold for 12, 18, 24 months -- which are now showing signs of life after a period of dormancy."

In domestic U.S. projects, Graham sees adaptive reuse or repurposing existing structures or facilities as the trend, winning out over ground-up greenfield projects. That's "due [in part] to a large inventory of empty structures available in the marketplace at present."

Since the 2009 dip, spending attention has decidedly turned from just getting by to investing in future savings and new revenues. It's impossible to ignore the strategic nature of multi-year initiatives to reduce waste and boost efficiency in a competitive, low-margin industry.

Such initiatives are most prevalent among the largest companies. Examples include Hershey's Project Next Century, General Mills' global Holistic Margin Management (HMM) initiative and Kraft's Integration Program related to its Cadbury acquisition. For every penny spent by a leading global company, there's a reason, and it's probably linked as closely to the CFO's office as it is to the conference room where goals and shared-values exercises are carried out.

"There's not a lot of growth in packaged foods at the end of the day," says Bryan Hunt, senior analyst covering the food industry for Wells Fargo Securities.

"So for these companies to show improvements in cash flow and shareholder value, one of the big mechanisms for generating increasing returns or at least stable cash flow is to extract efficiency gains, through capex either in manufacturing or technology."

Kraft Foods' $1.8 billion capital spending budget includes systems investments and its Integration Program focused on Cadbury, for which it paid $9.8 billion last year. Costs for that program were $657 million last year, and the company foresees "total integration charges of approximately $1.5 billion in the first three years following the acquisition to combine and integrate the two businesses." In exchange for the spending, the company expects cost savings of at least $750 million, accompanied by new revenues resulting from expected synergies.

Top Capital Spending Projects in 2011

General Mills' $700 million budget for fiscal 2011 is slated for initiatives to increase manufacturing capacity for cereals and Yoplait yogurt and to expand international production capacity for Wanchai Ferry and Häagen-Dazs products. Additionally, the company is continuing its HMM initiative to root out waste and costs across all operations and throughout the supply chain.

Most savings to date have come from the U.S. retail businesses, but General Mills says the program also is bringing state-of-the-art manufacturing processes and global sourcing of packaging and ingredients to its international business. The company sees HMM as a way to protect margins as commodity and energy costs increase. "Our goal is to capture a cumulative $1 billion in supply chain HMM savings from fiscal 2010 through fiscal 2012, and we are targeting $4 billion in cumulative savings worldwide over the decade to 2020," states the annual report.

Hershey's Project Next Century requires extra investment this year in order to realize cost benefits in the long run – an estimated $60-80 million a year starting in 2014. But it also earmarks $200-225 million to upgrade the Key West Hershey production facility, thereby explaining a big part of the company's 89 percent budget increase for 2011.

Big spenders
Most of PepsiCo's year-over-year rise in spending is related to recent acquisitions. Its capex budget includes about $150 million related to the integration of its two largest bottlers, Pepsi Bottling Group and PepsiAmericas, acquired in 2009. Additional capital spending will be earmarked for the company's $3.8 billion majority acquisition of Wimm-Bill-Dann Foods OJSC, in February. This is a company incorporated in the Russian Federation, a "fast-growing, strategically important market offering abundant opportunity," according to Indra Nooyi, PepsiCo chairman and CEO. She said the company's dairy operations will help capitalize on "a huge, untapped potential to bridge snacks and beverages. We see the emerging opportunity to 'snackify' beverages and 'drinkify' snacks as the next frontier in food and beverage convenience."

Pepsi's rival Coca-Cola, too, upped its capital expenditures to integrate a major bottler -- which explains why its capex budget is up a whopping 40 percent to $1.1 billion for 2011. Last October, Coke acquired the North American business of Coca-Cola Enterprises (CCE). Beyond integration, the budget will include investments "to further enhance our operational effectiveness." Expenditures specific to the added bottling business accounts for an estimated $1 billion of its 2011 capital expenditure program, the company reports.

Anheuser-Busch Inbev plans to spend $2.7-2.9 billion for 2011, targeting building capacity to meet demand in key growth markets "and to drive our commercial innovation pipeline." This is consistent with last year's capital spending, which was "primarily related to higher investments in the growth regions of Brazil and China," the company reports. Of total spending, 53 percent went to improvements at production facilities and 38 percent went to logistics and commercial investments.

J.M. Smucker's 72 percent spending hike comes partly from restructuring. Production consolidations and its Folgers acquisition occupied spending in 2010. This year, the company continues consolidating coffee, fruit spreads, syrups and topping production, closing four plants while expanding three. Some $150 million will be spent to complete a new plant in hometown Orrville, Ohio.

Seaboard Corp. budgets a 105 percent increase and, while the pork segment gets a nice bump to $33.5 million (from just $9.6 million in 2010), the big increases are in the diversified company's nonfood Marine segment ($51.4 million in total) and Power segment ($87.4 million).

TreeHouse Foods' 113 percent increase in capital spending to a budget of $85 million this year includes safety, quality and productivity improvements, upgrades at its San Antonio, Texas, salsa and North East, Pa., salad dressing facilities – both facilities acquired in 2007. The company also plans to invest about $10 million for a new enterprise resource planning system following a roughly $25 million system investment last year.

Lancaster Colony is planning a plant expansion at its Kentucky frozen roll facility, reflected in a major bump in spending from $13 million to $43 million.

Reductions & reasons

This year, six companies have reduced their capital budgets, compared to three last year. Only Imperial Sugar has reduced spending both years in a row, with the biggest decrease in our group, a 68 percent reduction. Why? The company completed repairs to its fire-ravaged Port Wentworth, Ga., refinery, and also finished kicking in its share for the new Gramercy, La., plant. The latter is the result of a three-way joint venture with Cargill and co-op Sugar Growers and Refiners. The plant is expected to be complete midyear and will replace Imperial's current facility to reach an estimated 50 percent increase in capacity in 2012.

The next-largest capex reduction in our group belongs to Sanderson Farms. The poultry company trims capital spending by 54 percent as it nears completion of a new Kinston and Lenoir County, N.C., poultry complex, which accounted for $108 million of $145 million spent last year. Sanderson's dip in capital expenditures could be temporary, however. While not in the budget for 2011, another new 1.25-million bird-a-week plant, possibly for Goldsboro, N.C., is waiting in the wings if Sanderson can get approval.

On the heels of a capex reduction in 2010 from a budgeted $350 million, Campbell Soup earlier this year announced it would spend $300 million, but since has adjusted that figure down to $275 million as it struggles with low margins, earnings and cash flow.

Pilgrim's Pride, Del Monte and Flowers Foods also reduced spending plans, as did Smithfield Foods. Some, including Smithfield, Pilgrim's Pride and Tyson Foods were pushed into high-yield bonds in large part due to the volatility of doing business with livestock, according to Wells Fargo's Hunt.

High feed costs and excess supply in the pork market hurt profits for animal protein companies, but there's been a "significant turnaround" in the past 18 months, says Hunt. Tighter hog supplies and rising pork prices make pork packing "amazingly profitable right now," he says, hitting weekly records not seen in more than a decade. Healthy profits, which Hunt sees continuing through 2011, "will give Smithfield the wherewithal to pay off their debt, but also the latitude and the fortitude to spend more money on capex."

Maybe Smithfield bit off more than it could chew with its restructuring program, now in its third year. But after spending more than $80 million on processing and manufacturing operations, the company will move upstream to streamline its raw material inputs to retain its role as a low-cost producer.

Asked for the lesson Smithfield teaches, Hunt says it's important to mind internal operations even when growing and consolidating in the good times. "Capital is precious. At any given point in time you never know when capital markets are going to turn away from you or not in your favor. And when acquisitions are made or consolidations occur, you need to turn the juicer and extract every possible dime at every possible moment," he adds.

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