09 January 2014 Americas/United States Equity Research Packaged Foods (Food / Agribusiness (US)) / MARKET WEIGHT
2014 Packaged Food Preview Research Analysts SECTOR REVIEW Robert Moskow 212 538 3095 [email protected] Valuation Multiples Are Higher And Growth Is Rachel Nabatian 212-325-2131 Slower? Doesn't Sound Promising [email protected] Clay Crumbliss, CFA Our outlook for packaged food stocks in 2014 is more bearish than usual. 212 538 1076 Sales growth is decelerating, consensus expectations for EPS growth are [email protected] overly-exuberant, and valuation multiples are two turns higher than they were a year ago. This does not sound like a good formula for stock price appreciation. We forecast stock price appreciation of only 0-5% on average in 2014 with EPS growth decelerating to 5% (compared to consensus of 9%) and a modest contraction in valuation multiples. Gross margin benefit from ingredient deflation will prove disappointing. The bull case on packaged food stocks is that the depressed operating margins of companies like Kellogg, General Mills, ConAgra, and Campbell can return to their historical averages now that the prices of major ingredients like corn, sugar, and cocoa have fallen. The problem with this theory is that these companies have a lot of exposure to big categories with declining volume and huge fixed costs. As a result, we expect gross margin expansion to be held back by price discounts and supply chain inefficiencies as companies adjust to the "new normal" of weaker volume. Food companies have been shifting their marketing away from advertising and into trade merchandising, which reduces gross profit dollars and puts the long-term health of their brands at risk. Our EPS estimates for Campbell, General Mills, Kellogg, and ConAgra are modestly below consensus. We forecast mid-single digit EPS growth instead of the high single-digit pace factored into consensus. We are lowering our 12- month target price on Smucker to $108/share to reflect a P/E multiple of 16x, which is in-line with U.S. food peers. Hershey and Mead Johnson are our top large cap picks. Outstanding top- line growth, competitive advantages, and a high probability of positive earnings revisions differentiate Hershey and Mead from the rest of the pack and justify their valuation premiums. We are raising our 12-month target price on MJN to $92 to reflect a higher P/E multiple of 22.5x. We lowered our rating on Mondelez to Neutral earlier today. Mondelez has the best self-help potential in our coverage, but is trading at a hefty valuation premium to U.S. food peers. It is also trading at a premium to global peers like Nestle and Unilever, which arguably have stronger emerging market platforms. All material changes are summarized on page 3 of this report.
DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
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09 January 2014 Table of contents
Our Favorite Stocks For 2014 3 Quick 2013 Review 4 P/E multiples returned to peak levels in 2013 4 Sales growth decelerated more than expected 6 More earnings misses than beats in 2013 6 Consensus for 2014 is Overly Optimistic 7 Themes for 2014 10 Persistently weak top-line sales 10 Benefits from ingredient deflation will prove disappointing. 11 The definition of a "lean" cost structure will take on a new dimension. 15 Large caps will continue to make tack-on acquisitions 16 Private label market share will continue to stagnate 17 Performance in Emerging Markets will diverge 18 More innovation at the low end 18 Campbell Soup 20 ConAgra 24 General Mills 27 Hershey 33 Hormel 38 Kellogg 42 Kraft Foods 44 Mondelez 46 McCormick 50 Mead Johnson 52 Smucker 55 Our Thesis: More Headwinds Than Tailwinds 61 Lack of emerging markets exposure 61 Weak economy = weak volume, despite trading down 62 Emerging market opportunities are limited 65 Marketing effectiveness is declining 65 Most processed food companies are poorly positioned on health and wellness 67 Private label is still expanding 67 The result of all these headwinds is market share erosion 67 Commodity volatility continues to reduce visibility 68 The Bull Case 71
2014 Packaged Food Preview 2 09 January 2014 Our Favorite Stocks For 2014
■ We expect Hershey to grow sales 7% and EPS 12%. In an environment where just about every food company is cutting advertising, Hershey keeps accelerating its investment and keeps driving volume higher. We forecast another 100 bps of gross margin expansion for Hershey from operating leverage even though cocoa prices are ticking higher. ■ We expect Mead Johnson to grow sales 7.5% (ex FX) and EPS 10%. We expect Mead's market share gains in China at Danone's expense to be a significant driver of top-line growth. In addition, we expect Mead to benefit from gradual improvements in the U.S. birth rate and continued strength in Latin American and non-Chinese markets. ■ We expect Hormel to grow EPS 16% in FY 14. Hormel is a high-quality company that is poised to benefit from two big factors: 1) We expect a significant rebound in the commodity elements of the portfolio to boost margins to the high end of the company’s normalized range, especially in turkey; 2) We believe the Skippy peanut butter acquisition is likely to exceed its accretion targets.
Here we provide a summary of the earnings and target price changes were are making in conjunction with this report. Price Price Rating* Target Price Year EPS EPS FY1E EPS FY2E EPS FY3E Company ccy 08 Jan 14 Prev. Cur. Prev. Cur. End Ccy Prev. Cur. Prev. Cur. Prev. Cur. Campbell Soup Company US$ 42.59 — N — 41.00 Jul 13 US$ 2.48 2.47 2.61 2.60 — (CPB) ConAgra Foods (CAG) US$ 33.62 — N — 35.00 May 13 US$ — 2.36 2.55 2.54 2.79 2.77 General Mills (GIS) US$ 48.57 — N — 51.00 May 13 US$ — 2.87 3.07 3.06 — 3.28 J.M. Smucker Co. (SJM) US$ 98.17 — N 115.00 108.00 Apr 13 US$ — 5.80 — 6.30 — 6.85 Mead Johnson Nutrition Co. US$ 84.26 — O 90.00 92.00 Dec 12 US$ — 3.37 — 3.71 — 4.07 (MJN) *O – Outperform, N – Neutral, U – Underperform, R – Restricted [V] = Stock considered volatile (see Disclosure Appendix). Source: Company data, Credit Suisse estimates.
2014 Packaged Food Preview 3 09 January 2014 Quick 2013 Review P/E multiples returned to peak levels in 2013 As was the case across the consumer staples sector, the market shrugged off bad fundamental news and bid up P/E multiples by more than two turns on average. This was a result of increased flow of funds into equities and increased interest from private equity bidders in the space. The low interest rate environment and the willingness of experienced and highly respected acquirers like Berkshire and 3G to pay a big premium for Heinz was a positive signal for the market. Barring a radical change in expectations for interest rates, we think valuation multiples will contract only modestly over the next 12 months.
Exhibit 1: Forward P/E Multiples Now Average 18x, Up From 16x Last Year 2008 2009 2010 2011 2012 2013 2014
CAG 14.9 11.2 12.9 11.9 14.0 13.6 13.6 CPB 16.5 13.7 13.3 13.5 13.7 13.4 16.4 GIS 15.7 14.8 14.9 13.7 14.8 14.4 16.7 HSY 18.3 18.8 15.4 17.0 19.8 20.1 23.6 K 1 17.7 13.9 15.0 14.8 14.3 15.0 15.2 KRFT NA NA NA NA NA 15.1 17.1 MDLZ 16.8 13.6 12.5 13.6 14.8 16.1 20.2 MKC 17.9 14.5 14.4 16.6 16.3 18.8 20.0 SJM 16.0 13.2 13.9 13.5 14.5 15.6 16.5 MJN NA NA 18.4 23.4 22.0 19.9 23.0
Average ex MDLZ, HSY, MJN 16.5 13.6 14.1 14.0 14.6 15.1 16.5
Average 16.7 14.2 14.5 15.3 16.0 16.2 18.2 1. Kellogg's P/E multiple rerates 1.0x lower beginning 2014 due to pension accounting change Source: FactSet Consensus estimates as of 1/7/14 After outperforming in the first half of 2013, food stocks went out of favor in the back half when a spate of companies cut guidance. The large cap food stocks finished the year up 22% on average, quite a bit below the S&P 500 but essentially in-line with consumer staples peers. Valuation multiples compressed from their mid-year highs, but remained elevated due to the expectation that falling commodity prices will lead to an earnings rebound in 2014.
2014 Packaged Food Preview 4 09 January 2014
Exhibit 2: Food Stock Rose Significantly In 2013, Essentially In Line With Staples Peers Food CS Rating 12/31/2012 12/31/2013 % Change ConAgra Neutral $ 29.50 $ 33.70 14% Campbell Neutral $ 34.89 $ 43.28 24% General Mills Neutral $ 40.42 $ 49.91 23% Hershey Outperform $ 72.22 $ 97.23 35% Kellogg Underperform $ 55.85 $ 61.07 9% Mondelez Outperform $ 25.45 $ 35.30 39% Kraft Outperform $ 45.47 $ 53.91 19% McCormick Neutral $ 63.53 $ 68.92 8% Mead Johnson Outperform $ 65.89 $ 83.76 27% Smucker Neutral $ 86.24 $ 103.62 20% Average 22%
Household Products Church & Dwight Outperform $ 53.57 $ 66.28 24% Colgate Outperform $ 52.27 $ 65.21 25% Clorox Underperform $ 73.22 $ 92.76 27% Estee Lauder Outperform $ 59.86 $ 75.32 26% Kimberly Clark Underperform $ 84.43 $ 104.46 24% Procter & Gamble Neutral $ 67.89 $ 81.41 20% Average 24%
Beverage Coca Cola Enterprises NA $ 31.73 $ 44.13 39% Dr. Pepper/Snapple Neutral $ 44.18 $ 48.72 10% Pepsico Neutral $ 68.43 $ 82.94 21% Coke Outperform $ 36.25 $ 41.31 14% Molson NA $ 42.79 $ 56.15 31% Average 23%
S&P 500 1,426 1,848 30% Source: Company data, Credit Suisse estimates Food stocks now trade at an 8% discount to the staples peers, which is essentially in line with historical trends.
Exhibit 3: Forward P/E Jan 2007-December 2013 22x
20x
18x
16x
14x
12x
10x
Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13
Apr-08 Apr-11 Apr-07 Oct-07 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13
Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
Pkg Food HH Beverage Source: Factset
2014 Packaged Food Preview 5 09 January 2014
Exhibit 4: Consumer staples one-year forward P/E Average P/E Multiples Pkg Food (ex HSY, HPC/Bev CPB CAG DF GIS HSY K MDLZ KRFT MKC HSH SJM MDLZ, DF) SPX HPC Bevg Avg 20 yr avg 17.2 15.0 14.0 16.6 20.2 17.8 16.2 17.3 15.6 16.2 16.7 16.9 20.0 22.0 20.8 10 yr avg 15.5 14.6 14.4 15.4 20.3 16.2 15.7 17.7 15.5 15.4 15.8 14.5 17.4 17.6 17.5 5 yr avg 14.0 12.9 12.6 14.6 19.7 14.7 15.0 17.7 16.7 15.9 14.7 14.7 13.6 16.0 15.9 16.0 Current 16.8 13.6 14.8 16.6 23.6 15.1 20.6 16.8 19.8 18.8 17.0 17.0 15.7 19.0 18.1 18.5
Food P/E Premium / (Discount) to Other Sectors Pkg Food Food vs (ex HSY, HPC/Bev CPB CAG DF GIS HSY K MDLZ KRFT MKC HSH SJM MDLZ, DF) SPX HPC Bevg Avg 20 yr avg 3% -10% -16% -1% 21% 6% -3% NA 4% -7% -3% - -1% -16% -24% -20% 10 yr avg -2% -8% -9% -2% 29% 3% -1% NA 12% -2% -2% - 9% -9% -10% -10% 5 yr avg -5% -12% -14% 0% 34% 0% 2% NA 14% 9% 0% - 8% -8% -8% -8% Current -1% -20% -13% -3% 38% -11% 21% -1% 16% 11% 0% - 8% -10% -6% -8% Source: Factset. Multiples are based on consensus EPS for next 4 quarters Sales growth decelerated more than expected The biggest negative surprise for the industry in 2013 was that volume did not return to positive territory as inflationary pricing eased. Consumers remained very cautious and emerging markets slowed down. Average organic sales growth of 1.7% in our coverage was well below our initial forecast of 3%. We expect sales to remain muted in 2014.
Exhibit 5: Organic sales growth in our coverage averaged 1.7%, well below our initial forecast of 3%.
6.0
4.3 4.1 3.8 3.7 3.5 3.2 3.3
2.3 2.1 1.8 1.7 1.5 1.2
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014E Source: Company data, Credit Suisse estimates More earnings misses than beats in 2013 The weak top-line environment caused several U.S. food companies to miss consensus expectations during the course of 2013. Within the food sector, EPS growth slipped to 6% in calendar 2013 due weak sales and stagnant operating margins. But there was a significant divergence of performance within the group with most of the U.S.-centric food companies (Kellogg, General Mills, ConAgra, Campbell) barely generating any EPS growth at all and the companies in advantaged categories or emerging markets (Mondelez, Mead Johnson, Smucker, and Hershey) growing at a 9-15% pace.
2014 Packaged Food Preview 6 09 January 2014
Exhibit 6: Calendar EPS Growth Averaged 7% In 2013 2008A 2009A 2010A 2011A 2012A 2013E 2014E
CAG NA 51% (4%) 9% 16% 4% 17% CPB 1 8% 15% 1% 3% 3% 1% 9% GIS 19% 14% 3% 8% 8% 1% 11% HSY (10%) 15% 18% 10% 15% 15% 11% K 2 8% 6% 4% 3% (3%) 4% 7% KRFT NA NA NA NA NA 5% 6% MDLZ / KFT 1% 7% (1%) 13% 7% 13% 8% MKC 11% 9% 13% 5% 9% 3% 10% SJM 7% 12% 10% 7% MJN 9% 17% 9% 15% 10% 9% 10%
Average 7% 17% 5% 8% 9% 7% 1. For comparability, CY12 and CY13 growth rates adjusted to consider the sale of European business. 2. CY12 results exclude the accounting restatement for comparability. Source: Company data, Credit Suisse estimates
■ Campbell, ConAgra, and Mondelez felt the most pain from the weak consumer spending environment because all three had planned for a rebound in their categories and had budgeted higher marketing spending to fuel the growth. But all three companies ended up cutting their budgets and lowering their operating profit guidance when they realized that the advertising wasn't working.
■ McCormick issued disappointing guidance in January then reduced its forecast to the low end of its EPS range.
■ Kellogg lowered guidance for the third time in four years when cereal category sales slowed.
■ Mead raised guidance, but experienced significant volatility during the year as a result of Hong Kong's actions to limit cross-border commerce and a list price reduction in China in response to an anti-trust investigation. There were some positive surprises:
■ Hershey’s upside came from strong volume sales behind effective advertising investment and the favorable deflationary trends in cocoa input costs.
■ Smucker raised guidance during the course of FY 13 as a result of falling coffee costs. Weaker single-serve coffee sales and increased competition has held back earnings growth in FY 14.
■ Kraft raised EPS guidance when it accelerated its overhead cost reductions, but sales growth was disappointing.
■ TreeHouse reversed two years of earnings disappointments by delivering solid fundamental results, making more acquisitions, and raising 2014 EPS guidance. Consensus for 2014 is overly optimistic It is hard to believe that fundamentals in the food space are strong enough for this group to deliver 9% EPS growth. We are particularly concerned about downward EPS revisions for ConAgra, Kellogg, and General Mills.
2014 Packaged Food Preview 7 09 January 2014
Exhibit 7: Consensus Is For A Rebound In EPS Growth In 2014 Despite Multiple Disappointments Over Past Three Years
Consensus Expectations For EPS Growth at Beginning of Calendar Year
2008 2009 2010 2011 2012 2013 2014
CAG NA NA 5% 13% 10% 6% 17% CPB 12% 5% 6% 7% -2% 3% 9% GIS 10% 4% 6% 13% 10% 5% 11% HSY 3% -2% 7% 8% 11% 11% 11% K 7% 6% 13% 5% 5% 5% 7% KRFT 4% 6% MDLZ / KFT 3% 11% 7% 15% 10% 11% 9% MKC 10% 3% 7% 6% 11% 11% 10% SJM 7% MJN 10% 10% 10% 10% 9% 10%
Average 8% 5% 8% 9% 8% 7% 9%
Calendar EPS Surprise % vs Consensus at Beginning of Year
2008 2009 2010 2011 2012 2013
CAG -11% -4% 6% -2% CPB -4% 10% -6% -4% 5% -2% GIS 9% 10% -4% -5% -3% -4% HSY -13% 17% 10% 2% 4% 4% K 1% 0% -8% -2% -7% -1% KRFT 1% MDLZ / KFT -2% -4% -8% -2% -3% 2% MKC 1% 6% 6% -1% -2% -8% SJM MJN 9% 7% -1% 5% 1% 1%
Average 0% 7% -1% -1% -1% -1% Source: Factset, CS Estimates. Figures represent the difference between actual results during the calendar year and the consensus estimate as of the first day of each calendar year
■ For some reason, the street has fallen into a strange pattern of assuming that General Mills' next "big year" is just around the corner even though management adheres consistently to rather conservative EPS guidance and 2014 is no exception. Why would this company suddenly deliver 11% EPS growth in calendar 2014 after consistently delivering just 5% on average for four years? Some people are convinced that Mills is poised to benefit from grain deflation, but the company had gone to great lengths to dissuade investors from clinging to this theory. ■ Consensus for ConAgra to deliver 17% EPS growth is based largely on the assumption that the commodity deflation will boost profit margins in the first half of calendar 2014 and easy comparisons will drive the earnings growth in the back half. This sounds like a tough hill to climb in an environment where the company's low-income consumer base is struggling and the company is still in the throes of figuring out its hybrid branded/private label model. ■ Although consensus for Kellogg's EPS growth doesn't seem particularly high at 7%, the company hasn't delivered anything higher than 5% for four years and is clearly in the midst of further transition in its supply chain (closing a major cereal facility) and organizationally (shifting to global brand management and reducing management layers). In addition, it is difficult to assume much in the way of commodity deflation benefits when the management team goes to the trouble of filing an 8K (in November) warning that it expects inflationary conditions to persist in 2014, albeit at a moderate level.
2014 Packaged Food Preview 8 09 January 2014
■ Expectations for McCormick EPS growth appear a bit high, but the company is about to enjoy a 3% benefit from lower pension expense. This would account for almost half of the operating profit growth in our model. As a result of these factors, our EPS estimates for Campbell, General Mills, Kellogg, and ConAgra are modestly below consensus.
Exhibit 8: We forecast mid-single digit EPS growth instead of the high single-digit pace factored into consensus for CPB, GIS, and K, and we are modestly below consensus for CAG
CS Estimates Consensus % Variance
Non-calendar Year Ends
FY2014 FY2015 FY2014 FY2015 FY2014 FY2015
CAG $2.36 $2.54 $2.34 $2.59 1% (2%) CPB 2.47 2.60 2.51 2.66 (1) (2) GIS 2.87 3.06 2.88 3.11 (1) (1) SJM 5.80 6.30 5.79 6.27 0 0
Average (0%) (1%)
Calendar Year Ends
FY2013 FY2014 FY2013 FY2014 FY2013 FY2014
HSY $3.72 $4.16 $3.72 $4.12 (0%) 1% K 3.75 4.00 3.76 4.04 (0) (1) KRFT 2.78 3.23 2.80 3.20 (1) 1 MDLZ 1.58 1.73 1.56 1.71 1 1 MJN 3.37 3.71 3.37 3.66 0 1 MKC 3.13 3.47 3.13 3.45 (0) 1
Average (0%) 1%
Source: Credit Suisse estimates compared to I/B/E/S estimates (Thomson Reuters)
2014 Packaged Food Preview 9 09 January 2014 Themes for 2014 Persistently weak top-line sales Several management teams have already lowered their growth algorithms pointing to a “new normal” of slower volume growth in developed markets. We actually view this as a positive for the group. The risk to maintaining overly aggressive revenue targets is that it leads to bad decisions by the business unit managers who are responsible for delivering them and it contributes to the continuous death spiral of over-promising and under- delivering. We favor the management teams who approach the year with an appropriate degree of caution. Kraft, Pinnacle, and B&G Foods have done a particularly good job of reading the environment and appropriately allocating their resources.
Exhibit 9: We expect sales to remain muted in 2014 with Mead and Hershey delivering the strongest growth and ConAgra and Kellogg the weakest
Volume 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014E Avg 09-13 MJN 0.2 (2.4) 5.8 11.3 0.1 4.6 5.5 3.9 MDLZ 1.1 3.4 2.0 2.3 HSY - 0.3 1.0 4.1 4.4 2.0 (0.9) (1.1) (5.0) 4.5 3.4 1.9 6.5 5.0 2.3 MKC - - 2.5 4.0 0.4 1.7 1.9 0.4 (1.6) 3.2 2.5 1.6 1.9 1.0 1.5 KFT 2.2 1.4 0.7 1.8 (0.5) (2.3) 1.7 (1.8) (0.8) 2.6 0.5 0.8 GIS 5.0 1.3 2.5 1.3 2.0 3.0 3.3 3.8 0.0 2.8 (2.1) (1.4) 1.0 0.9 0.0 HNZ 1.2 (2.8) 0.6 1.3 1.8 4.2 4.0 (0.3) (2.7) 1.2 (0.8) 1.7 (0.1) CPB 4.3 0.5 4.3 5.8 (0.8) 2.5 4.5 (0.5) (3.5) 1.7 (1.0) 0.6 1.5 1.0 (0.1) K (1.4) (0.2) - 2.1 4.5 3.1 2.1 0.9 (0.7) (2.1) (0.0) (0.6) (0.2) (0.0) (0.7) KRFT (2.2) 0.0 1.1 (1.1) SJM - (0.5) (0.5) (3.2) (2.2) 0.6 1.0 (1.2) CAG (1.0) 3.5 (1.5) 1.5 1.0 (0.8) (1.3) (3.1) (3.4) (1.0) (1.0) (1.9) SLE/HSH 0.1 (0.1) (0.1) (2.9) (4.5) (4.8) 1.7 (0.5) 0.1 (2.2) Average (ex MJN) 1.6 0.1 1.6 2.4 1.9 1.4 2.0 0.2 (1.8) 0.8 (0.9) (0.1) 1.3 1.1 (0.0)
Price/Mix 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014E Avg 09-13 HSY - - 1.0 1.7 2.2 0.5 (0.2) 4.0 9.7 1.9 5.9 5.9 0.5 1.5 4.8 SJM 8.0 4.0 1.0 9.6 8.4 (0.3) - 4.5 MJN 8.1 5.9 3.5 3.4 5.8 3.4 3.0 4.4 KFT (1.0) (0.2) 1.3 (0.1) 3.5 3.7 3.4 8.2 2.0 1.1 6.0 3.0 GIS 2.0 3.0 2.3 1.8 3.0 7.2 4.2 (0.1) 5.4 4.1 1.5 1.1 3.0 SLE/HSH 1.9 4.5 5.1 1.6 4.0 8.2 0.6 0.2 1.8 2.9 HNZ 1.5 3.7 0.3 (0.5) 0.2 1.1 2.8 6.2 4.8 1.0 3.6 2.2 2.9 MKC (0.5) 1.0 (0.3) 2.3 2.1 5.1 3.7 (0.4) 4.6 4.4 1.4 2.2 2.7 K 2.3 4.2 3.8 2.9 1.9 3.7 3.3 4.5 3.7 0.9 4.6 3.2 0.8 0.4 2.6 CAG 2.5 2.5 1.0 (0.6) 1.5 5.0 5.5 (0.6) 3.9 4.0 (0.1) 0.5 2.5 MDLZ 3.3 0.7 2.0 2.0 CPB (1.5) 0.3 3.5 0.5 3.3 2.8 0.8 4.3 2.3 (1.8) 2.3 1.0 (0.4) 0.9 0.7 KRFT - 2.3 (0.3) 0.1 0.7 Average (ex MJN) 0.3 1.6 1.7 1.4 1.8 1.9 2.4 5.8 4.1 0.7 4.9 3.6 0.4 1.0 2.7
Organic Sales % 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014E Avg 09-13 MJN 8.3 3.5 9.3 14.7 5.9 8.0 8.5 8.3 HSY - 0.3 2.0 5.8 6.6 2.5 (1.1) 2.9 4.7 6.4 9.3 7.8 7.0 6.5 7.0
MDLZ 4.5 4.1 4.0 4.3 MKC 2.0 5.0 0.1 4.0 4.0 5.5 2.0 2.7 7.1 6.0 3.3 3.2 4.2 KFT 1.2 1.2 2.0 1.7 3.0 1.4 5.1 6.5 1.2 3.7 6.5 3.8 SJM 8.0 3.5 0.5 6.3 6.2 0.2 1.0 3.4 GIS 5.0 1.3 4.5 4.3 4.3 4.8 6.3 10.9 4.2 2.7 3.4 2.7 2.4 1.9 3.1 HNZ 2.7 0.9 0.9 0.8 2.1 5.3 6.8 5.9 2.2 2.2 2.7 3.9 2.8 K 0.9 4.0 3.8 5.0 6.4 6.8 5.4 5.3 3.0 (1.3) 4.5 2.5 0.6 0.3 1.9 SLE/HSH 2.0 4.4 5.0 (1.3) (0.5) 3.4 2.3 (0.4) 1.9 0.7 CAG - - 2.5 1.5 4.5 (2.1) 3.0 6.0 4.7 (1.9) 0.8 0.6 (1.1) (0.5) 0.6 CPB 2.8 0.8 7.8 6.3 2.5 5.3 5.3 3.8 (1.2) (0.1) 1.3 1.6 1.1 1.9 0.5 KRFT - 0.1 (0.3) 1.2 (0.1) Average (ex MJN) 1.8 1.2 3.2 3.8 3.7 3.3 4.3 6.0 2.3 1.5 4.1 3.5 1.7 2.1 2.7 Source: Company data, Credit Suisse estimates. Estimates have been calendarized. Mead Johnson is excluded from the group average
2014 Packaged Food Preview 10 09 January 2014
Benefits from ingredient deflation will prove disappointing The bull case on packaged food stocks for 2014 is that the depressed operating margins of companies like Kellogg, General Mills, and Campbell can regress back to their historical means now that commodities are falling. For example, corn prices are down 40%, and the price of corn is correlated to other food ingredients – like meat, soybeans, and sweeteners. But we think the benefits of grain deflation in 2014 are going to be diluted by a multitude of factors.
■ The cost deflation next year isn't substantial enough to matter. Over the past ten years, there was only one (2009) where packaged foods' gross margins expanded materially as a result of commodity deflation. That was a year where every cost input – packaging, energy, food – deflated all at once. The deflation in 2014 is going to be a mere fraction of 2009, because packaging and distribution costs are still high. Exhibit 10: Since 2002, the packaged foods group experienced deflation-driven gross margin expansion in only year, 2009, when deflation hit 6%. 12% 1200 bps
10% 1000 bps
8% 800 bps
6% 600 bps
4% 400 bps
2% 200 bps
0% 0 bps
-2% -200 bps
-4% -400 bps
-6% -600 bps
-8% -800 bps
3Q04 4Q11 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 1Q11 2Q11 3Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13
4Q 08 4Q 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 3Q10 4Q10
4Q14E 4Q13E 1Q14E 2Q14E 3Q14E
PPI y-o-y change (left axis) GM y-o-y change (right axis)
Source: Company data, Credit Suisse estimates
■ Declining capacity utilization puts more pressure on manufacturers to drive volume. Many believe that the grocers and manufacturers have finally learned their lesson that deep price discounts don't create any economic value. But as volume continues to disappoint, vendors and grocers will get more desperate to leverage their fixed costs, particularly in the categories that have suffered big volume declines and now have excess capacity. ■ We view breakfast cereal, chewing gum, and canned soup as the categories most vulnerable to price compression in 2014 due to the fact that category volume has declined substantially over past four years. In fact, Kellogg recently announced a plant closure in cereal and Campbell announced a plant closure for soup. Mondelez and Mars reset their chewing gum offerings to increase the value proposition. ■ The chart below indicates that canned pasta and popcorn (ConAgra), powdered soft drinks (Kraft), and shelf stable juices (Campbell and Kraft) are also vulnerable to price compression.
2014 Packaged Food Preview 11 09 January 2014
Exhibit 11: Over Past Four Years, Consumption of Ground Coffee, Yogurt, Peanut Butter, and Chocolate Has Increased; While Breakfast Cereal, Chewing Gum, Canned Soup, Popcorn, Canned Pasta Have Declined Significantly 25% 19% 20% 14% 15% 11% 10% 5% 4% 5% 2% 0% 0% 0% -1% -5% -1% -3% -4% -5% -10% -7% -7% -9% -10%-10%-11% -15% -20% -16% -19% -25%
Source: Company data, Credit Suisse estimates
■ Food companies shifting marketing dollars out of advertising and into trade promotion. General Mills, ConAgra, Kellogg, and Campbell all cut their advertising budgets in response to weak sales trends and shifted their spending to short-term marketing vehicles such as in-store merchandising. This reduces the pool of gross profit dollars for manufacturers, thus pressuring their gross margins and reducing their flexibility. It also could negatively impact the long-term health of the brands. Exhibit 12: Most Food Companies Have Reduced Exhibit 13: Hershey now spends the most on advertising Advertising Spending As % of Sales Over Past 3 Years as a percentage of sales. 2.0% 9.0% 8.3% 1.4% 7.6% 1.5% 8.0% 1.0% 1.0% 7.0% 6.0% 0.5% 5.2% 5.2% 5.2% 5.0% 0.1% 5.0% 0.0% 4.0% 4.0% -0.5% 2.9% -0.3% 3.0% -1.0% 2.0% -1.1% -1.1% -1.5% 1.0% -1.5% -2.0% 0.0%
Source: Company data, Credit Suisse estimates. All companies Source: Company data, Credit Suisse estimates. Campbell and represented on a FY 13 vs FY 10 basis except for CPB (FY 11) ConAgra include consumer promotion expense
■ Tack-on acquisitions have diluted gross margins. Kellogg, Campbell, and General Mills acquired assets in emerging markets and early-stage entrepreneurial businesses to jumpstart their growth rates. These businesses do not yet operate with sufficient scale to match the profit margins of their acquirers.
2014 Packaged Food Preview 12 09 January 2014
■ The management teams of General Mills and Kellogg have been quick to point out that they are still experiencing inflation in their cost structure. Certainly it is not in their best interests to reveal too much information about their cost structure publicly, but we don't think they are being disingenuous about what they are facing. Recall that grains represent only 5-10% of COGS for the likes of General Mills and Kellogg. Distribution, sales, and overhead represent the bigger cost of getting products on store shelves. Exhibit 14: Management teams are guiding to lower but persistent inflation in 2014 FY12 FY13 FY14 Notes
CPB 6% 4% 2-3% per 4Q conference call
CAG 10% 2-3% <2% lowered on 1Q conference call
GIS 10% 2-3% 3% per 2Q conference call
HSY 0% 0% NA
MDLZ 3-5% NA per 3Q conference call
KRFT 5% 2-3% NA
SJM 16% NA NA expect deflation
K 7% ~5% Moderate per 8-K dated 08 November
Source: Company data, Credit Suisse estimates That said, ingredient deflation will help ConAgra, TreeHouse and Smucker to a larger degree than their peer group, but we expect these companies to give back a good portion of these benefits to consumers in the form of deeper promotions.
Exhibit 15: We expect 2% COGs deflation for the packaged foods group on average in 2014 1% 0% 0% 0% -1% -1% -1% -2% -2% -2% -3% -3%
-4%
-5% -5% Campbell Hershey General Kraft Foods Kellogg Mondelez ConAgra Smucker Mills
Source: Company data, Credit Suisse estimates We are forecasting 90 bps of gross margin expansion for the group to take these factors into account.
2014 Packaged Food Preview 13 09 January 2014
Exhibit 16: We Expect U.S. Packaged Foods Gross Margins to Expand 90 bps on Average in 2014
37.7% 37.7%
37.1% 36.9% 36.9% 36.9% 36.6% 36.3% 36.2%
35.6% 35.7%
34.8%
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014E
Source: Company data, Credit Suisse estimates (calendarized)
Exhibit 17: We Expect Hillshire and Mondelez's Gross Margin To Expand The Most In 2014 and ConAgra's To Expand The Least
Cal GM 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014E CAG 21.8% 21.0% 24.0% 24.8% 25.3% 25.9% 22.1% 24.6% 24.3% 22.1% 22.6% 21.6% 21.9% CPB 43.2% 42.0% 40.1% 41.2% 42.2% 40.6% 39.5% 40.9% 40.5% 39.5% 38.0% 36.9% 37.4% GIS 39.5% 41.3% 37.7% 35.7% 35.8% 35.9% 35.6% 38.8% 39.0% 37.9% 36.9% 35.6% 36.5% HNZ 36.1% 37.1% 36.2% 36.7% 37.2% 37.0% 35.8% 35.9% 36.7% 36.0% 35.9% HSY 37.9% 38.9% 39.5% 39.1% 37.7% 35.5% 35.8% 38.9% 42.9% 42.4% 43.8% 46.3% 47.3% K 45.0% 44.4% 44.9% 44.8% 44.2% 44.0% 41.9% 42.9% 42.7% 41.3% 40.1% 39.0% 39.7% KFT 40.4% 39.3% 37.1% 36.1% 36.2% 34.5% 33.1% 36.2% 37.7% 36.6% MDLZ 37.4% 37.6% 39.0% KRFT 31.8% 32.3% 33.5% SJM 34.9% 34.0% 36.4% 37.3% SLE/HSH 38.7% 38.7% 38.5% 36.6% 37.0% 33.5% 24.0% 29.4% 28.6% 30.9% Average (ex HSH) 37.7% 37.7% 37.1% 36.9% 36.9% 36.2% 34.8% 36.9% 37.7% 36.3% 35.6% 35.7% 36.6% Source: Company data, Credit Suisse estimates We expect operating margins to rise 100 bps in 2014 as the food companies maintain discipline on administrative and marketing expenses. Most of the food companies took restructuring charges in 2011 and 2012 to adjust their footprints to the lower volume environment. They also cut advertising and reallocated it to trade promotion. Not a good recipe for long-term success.
2014 Packaged Food Preview 14 09 January 2014
Exhibit 18: We Expect U.S. Packaged Foods Operating Margins to Expand 100 bps on Average in 2014
17.3%
16.1% 16.0% 15.9% 15.9% 15.6% 15.7% 15.4% 15.1% 14.9% 14.7% 14.3%
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014E
Source: Company data, Credit Suisse estimates (calendarized)
Exhibit 19: We Expect Kraft and Hillshire's Operating Margin To Expand The Most In 2014 and Kellogg and Campbell's To Expand The Least
Cal EBIT 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014E CAG 14.5% 13.0% 15.7% 12.8% 10.9% 13.6% 13.7% 10.2% 10.4% 9.9% 10.6% CPB 17.4% 16.0% 15.2% 15.8% 16.4% 15.6% 15.7% 18.6% 17.0% 16.4% 15.6% 14.7% 15.2% GIS 17.5% 18.9% 18.0% 17.7% 16.7% 16.1% 16.0% 17.2% 17.5% 17.1% 16.8% 15.9% 16.8% HNZ 16.8% 16.6% 15.4% 15.5% 16.1% 15.9% 14.9% 15.0% 15.2% 14.4% 14.3% HSY 18.1% 19.5% 19.9% 20.2% 20.3% 17.6% 15.0% 16.2% 17.7% 17.9% 18.5% 19.4% 20.3% K 18.2% 17.5% 17.5% 17.2% 16.2% 15.9% 15.2% 15.9% 16.1% 15.0% 14.1% 14.7% 15.1% KFT 21.0% 19.2% 16.5% 15.3% 15.3% 13.7% 12.3% 13.7% 13.8% 13.7% MDLZ 12.1% 11.9% 12.7% KRFT 14.6% 16.3% 18.5% SJM 16.4% 16.2% 17.3% 18.0% SLE/HSH 9.1% 9.1% 8.1% 7.4% 7.2% 6.9% 7.6% 9.9% 9.0% 9.3% 9.5% 8.0% 9.5% Average (ex HSH) 17.5% 17.3% 16.1% 15.6% 16.0% 15.4% 14.3% 15.7% 15.9% 15.1% 14.7% 14.9% 15.9% Source: Company data, Credit Suisse estimates, Calendarized The definition of a "lean" cost structure will take on a new dimension Aggressive cost-cutting by 3G at Heinz and Ambev at Budweiser definitely got the attention of struggling staples peers. Board-level discussions looked deeply into the prices that PE firms paid and the steps they took to cut costs to see if they are missing any synergies that someone else could capture. If they don't cut costs, someone else might do it for them. Just about every U.S. food company trimmed headcount or restructured their organizational footprints to reduce costs. The management teams all vowed to plow these savings back into the business to stimulate growth. But we have yet to see much in the way of payback from these “investments,” and, in the case of Campbell, the “investments” were paradoxically accompanied by cuts to advertising. At the end of the day, we think these programs provide a cushion to near-term earnings outlooks by “hiding a lot of sins.” But they don’t do much to drive longer-term shareholder value.
2014 Packaged Food Preview 15 09 January 2014
Exhibit 20: Recent Restructuring Programs US Staples Companies Column Announced 1 on Charges Program Savings Contribute to their overall cost $65M over 18 months, Exit of certain manufacturing facilities, disposal of underutilized savings commitment - CAG Feb-11 including approximately manufacturing assets, and actions designed to optimize the $275M/year FY12-FY14 $25M of cash charges company’s distribution network. (consumer foods COGS)
Increase manufacturing efficiency and accelerate productivity on HNZ May-11 $160M, or $0.35/share $0.15/ share in FY13 a global scale - reduce global workforce by 800-1,000 positions
Improve supply chain efficiency and reduce overhead costs Annual savings of $60M CPB Jun-11 $75M in Q4 of FY12 across the organization and exit the Russian market - eliminate beginning in FY12, increasing approximately 770 positions to approx. $70M in FY14 $1.5 B from 2012-2014 Reduction of approximately 1,600 positions in North America with $575M for Kraft KFT Jan-12 throughout 2012, about 40 percent of which are due to the NA Foods and $925M for realignment of U.S. Sales. MDLZ Lower costs by $10B by 2016: PG Feb-12 $3.5 B over 4 years Cut 5,700 non-manufacturing jobs by end of FY2013 $3B OH, $6B COGS, $1B marketing
$383 M 4Q FY11 , $425 Optimization of operating practices and organization structure, Over $500M in incremental PEP Feb-12 M in FY12 and $100 M including a reduction in force of about 8,700 employees, about 3% cost savings in FY12, $500M from FY13 through FY15. of global workforce in FY13, and $500M in FY14
$94 M FY12 (4Q) and Productivity and cost savings plan; eliminates approximately 850 GIS May-12 NA $15 M FY13 positions globally and asset write-down $21M FY 14 and $30M by FY CPB Sep-12 $115M Closed Sacramento soup plant. Eliminated 700 jobs 16 Eliminated 1,200 jobs globally and spent $90M on severance and HNZ Sep-13 $160M in charges $150M compensation for former executives. Closed Silvo in Netherlands and centralized shared services in MKC Oct-13 $27M NA Poland
Project K - Closed cereal plants in Ontario and snack plant Cash savings of $425-$475M K Oct-13 $1.2 - $1.4B in charges Australia (expanded Thailand). Reduced worforce by 7% (2,900) per year by 2018
CPB Nov-13 $20M in charges Eliminated 250 salaried positions, mostly in HQ $40M Optimize Private Label manufacturing facilities and consolidate CAG Dec-13 $200M for Initial Plan NA mixing centers across CAG. Enhance SG&A efficiency Source: Company data, Credit Suisse estimates
Large caps will continue to make tack-on acquisitions
■ We expect Kellogg, Campbell, and B&G Foods to bid for snack companies in 2014. There are a lot of snack companies for sale, but most of them are too small to materially impact a large company's earnings. Ontario Teachers' Pension Plan outbid multiple strategic acquirers for Burton's Biscuits in the UK. Campbell and others apparently didn't think the business would generate sufficient synergies to justify a premium price (£350M). ■ General Mills, Kraft, and ConAgra are likely to spend more time optimizing what they have. Kraft Foods Group has plenty of brands that are candidates for divestiture, in
2014 Packaged Food Preview 16 09 January 2014
our view, but management sounds reluctant to absorb the capital gains tax and earnings dilution that a divestiture would create. Jell-O, Stove Top, and Cool-Wip sound like divestiture candidates down the road. ■ Hillshire Brands is eager to find a "Skippy-esque" type of deal to reduce the volatility of their pork-centric portfolio. ■ There are plenty of good, brands in the U.S. owned by private companies, (Goya, McIllhenny’s Tabasco, Tuong Ot Sriracha), but they don’t appear to be sellers.
■ The potential for a Quaker-Post Cereal is just a rumor, in our view. Current management at Pepsico remains uninterested in selling one of their few legitimate health and wellness brands. Private label market share will continue to stagnate Private label grew a tad faster than brands in 2013, but the growth rate slowed dramatically as branded competitors narrowed their price gaps and promoted more frequently. We expect this trend to continue in 2014 as branded companies use the benefits of lower commodity inputs to fund price discounts and restore volume trends. We expect private label growth to outpace brands longer term, but not in an environment where pricing is stagnant.
Exhibit 21: Private Label market share has stagnated on a value basis
20%
19%
18%
Jul-11 Jul-12 Jul-13
Apr-11 Oct-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13
Jan-11 Jun-11 Jan-12 Jun-12 Jan-13 Jun-13
Feb-11 Mar-11 Feb-12 Mar-12 Feb-13 Mar-13
Dec-10 Aug-11 Sep-11 Nov-11 Dec-11 Aug-12 Sep-12 Sep-12 Nov-12 Dec-12 Aug-13 Aug-13 Sep-13 Nov-13
May-11 May-12 May-13
Source: Nielsen’s Scantrack Expanded AOC. All categories including dairy
2014 Packaged Food Preview 17 09 January 2014
Exhibit 22: Private Label market share has stagnated on a unit basis
23%
22%
21%
20%
Jul-11 Jul-12 Jul-13
Apr-11 Oct-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13
Jan-11 Jun-11 Jan-12 Jun-12 Jan-13 Jun-13
Mar-11 Feb-11 Feb-12 Mar-12 Feb-13 Mar-13
Aug-12 Dec-10 Aug-11 Sep-11 Nov-11 Dec-11 Sep-12 Sep-12 Nov-12 Dec-12 Aug-13 Aug-13 Sep-13 Nov-13
May-11 May-12 May-13
Source: Nielsen’s Scantrack Expanded AOC. All categories including dairy Performance in Emerging Markets will diverge Investors can no longer count on developing markets to grow at the 15% rate that they have come to expect. Category dynamics are getting more complicated and competitive, thus shrinking the size of the pie for the Western competitors competing there.
Exhibit 23: The average growth rate for western consumer staples companies in developing markets is slipping
Sector average developing market growth 16%
14%
12%
10%
8%
6%
4%
2%
0%
Q207 Q310 Q307 Q407 Q108 Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Q210 Q410 Q111 Q211 Q311 Q411 Q112 Q212 Q312 Q412 Q113 Q213 Q313 Q107 Source: Company data, Credit Suisse estimates. Includes Nestle, Unilever, Henkel, Kraft, Coke (volume), Colgate, L’Oreal, Danone, Reckitt The weaker backdrop has led to a divergence of performance in consumer staples that probably isn’t fully reflected in the market. The ones that are executing at the top of their game or competing in good categories will continue to perform well. But the companies that are having internal execution problems or are exposed to highly competitive categories won’t have the underlying category growth to gloss over their woes. The rising tide no longer supports all boats. More innovation at the low end Gone are the days when companies could focus their marketing efforts exclusively on "premium-ization." These days, it's all about innovating at both ends of the spectrum to
2014 Packaged Food Preview 18 09 January 2014 reach lower-income, value-oriented consumers, who represent a big percentage of branded foods consumption. These consumers suffered another blow to their spending power when their SNAP program benefits got cut in November. Our concern is that a lot of packaged foods companies (Kraft and ConAgra in particular) will find themselves "pushing on a string" as they introduce smaller packaging sizes at lower price points to cater to this group.
2014 Packaged Food Preview 19 09 January 2014 Campbell Soup Investment Highlights Incremental improvements to management and portfolio The cultural and portfolio changes at Campbell are small in scale compared to what is going on at companies like Hillshire and Kraft. But they are significant enough to merit attention and perhaps move the needle sufficiently for the business to eventually achieve its 3-4% target for top-line growth, which hasn't been met organically since 2009. The acquisitions of Bolthouse, Plum Organics, and Kelsen have added $1 billion of sales from faster-growing health-and-wellness categories and, in the case of Kelsen, emerging markets. The divesture of the struggling European soup business made sense. These moves helped reduce the exposure of the portfolio to canned soup, which is arguably in structural decline. In addition, we give credit to CEO Denise Morrison for upgrading the talent of the people around her. In total, 6 out of 11 of the top leaders are new to their roles or to the organization. Recent outside hires include Luca Mignini to run International, Raymond Liguori to run M&A, and Carlos Barroso to lead R&D. As an example of the company's emphasis on performance, Ed Carolan was promoted to run U.S. Retail after successfully driving up soup sales in FY13. Morrison strengthened the company's marketing capabilities by hiring Michael Senackerib as CMO and Yin Woon Ran. Mark Alexander was a good choice to take on the SR VP role of North America after Sean Connolly left to take on the CEO role at Hillshire. Jewels in the portfolio Pepperidge Farm in particular would fetch a premium multiple if management ever spun it off or sold it. This is not to say that Campbell is considering or ever would consider it, but the Pepperidge snacks business (cookies, crackers, and bread) would be an attractive asset for Kellogg or Mondelez if Campbell ever decided to sell. The dis-synergies for Campbell would be minimal because Campbell essentially lets Pepperidge run on its own. Strong free cash flow Campbell is a strong free cash flow generator with a higher EBITDA to FCF conversion ratio than its peer group. That said, the company's free cash flow efficiency has been declining over the past few years as demonstrated in Exhibit 25. The acquisition of faster growing, entrepreneurial businesses (like Bolthouse and Plum) and the development of more innovative packaging for soups and sauces for Millennials comes at a higher cost. Management is guiding to another year of higher cap ex spending ($350M) in FY 14 despite the fact that it has divested its European soup business.
2014 Packaged Food Preview 20 09 January 2014
Exhibit 24: Campbell's Free Cash Flow Conversion Ratio Is Above Peer Average 85% 81%
75% 70% 68% 64% Group Average: 65% 55% 60% 60% 59% 59% 57% 57% 56% 55% 52%
45% 43%
35%
25%
15%
5%
-5% Pinnacle BGS HNZ MJN CPB K GIS HSY KRFT THS MKC CAG DF BNNY (2013 e) -15% -10%
Source: Company data, Credit Suisse estimates
Exhibit 25: Campbell has higher FCF as % of Sales Than Its Food Peer Average 12.0% 11.3% 10.3% 9.7% 10.0% 8.6% 8.5% 8.5% 7.8% 8.0% 7.3%
6.0%
4.0%
2.0%
0.0% 2010 2011 2012 2013
Campbell Food Average
Source: Company data, Credit Suisse estimates. Food average includes CPB, CAG, GIS, HNZ, HSY, K, MDLZ, KRFT, MKC, HSH In addition, management is now directing more of its cash to debt reduction rather than share repurchase. This is why the divestiture of the European soup business was so highly dilutive with only $0.01 of benefit to EPS from reallocation of after-tax proceeds. Better insights into consumer needs We applaud management's decision to steer away from its Quixotic attempts to reduce sodium content across its line soups and reformulate more of its items "full taste." The reduction failed to reduce the content in a meaningful enough way to persuade lapsed users (especially older consumers) to return to the category, and a big turn-off for consumers who wanted "full taste. Management reallocated its R&D resources to needs of younger Milleniums who are looking for more sophisticated ingredients and convenient packaging.
2014 Packaged Food Preview 21 09 January 2014
Investment Risks Management was too quick to declare victory on U.S. soup What we struggle to understand is why management defined their soup business as "fixed" after just one strong year that was fueled by favorable weather, inventory loading at the trade, and (paradoxically) a 15% cut in advertising that was probably unsustainable. Management ended up eating those words. The inventory proved to be a key factor to the company missing expectations in Q1 of 14. Bigger picture, management has yet to demonstrate that it can set achievable expectations for its business teams and investors in a consistent manner. This is what leads to poor allocation of resources and decision making. Canned soup declines appear structural Canned soup will always be an important category to consumers and retailers, but we think it is declining in a slow and structural manner. The business is getting picked away by organic/fresh soups at the high end and multi-serve meals at the low end. The company has launched several ideas to re-ignite consumer interest (Go Soups in a pouch, Slow Kettle Style soups in plastic tubs, and a new Skillets platform), but these are $50 million ideas that are too small to matter when put in the context of a $2 billion soup business. Growth areas in the portfolio are dilutive to margins and capital returns The company's relative market share, scale and capital investments in canned soup give it a competitive advantaged versus its peers in terms of gross margin flexibility. But this presents a structural problem with the company's portfolio. As the company innovates into new packaging ideas, it pushes its margin structure lower by utilizing lower margin co- packers outside of its existing platform. Plum Organics is a good example of this as it utilizes more co-packers than the entire Campbell organization despite having only a tiny base of sales.
Exhibit 26: Campbell's Gross Margin Is Down 370 bps Exhibit 27: Campbell's ROIC Is Down Over 800 bps Since Since FY 10 FY 10 42.0% 30.0% 41.0% 26.7% 41.0% 40.2% 24.8% 25.3% 25.0% 40.0% 38.8% 39.0% 38.3% 20.0% 18.6% 18.3% 18.2% 38.0% 37.3% 16.2%16.5% 36.8% 37.0% 15.0% 35.7% 36.0% 35.7% 10.0% 35.0% 34.0% 5.0% 33.0% 32.0% 0.0% 2010 2011 2012 2013 2010 2011 2012 2013
Campbell Food Average Campbell Food Average
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates No obvious solution to turn around declines in V8 beverages V8 beverage was considered a major growth driver of the portfolio a few years ago, and management directed significant investment into it Management blames the weak trends in the category, but V8's unique positioning in vegetable-based ingredients should have insulated it from the category trends. We think are several problems with beverages division: first of all, the management team diluted the equity of the brand by extending into too many sub-brands (Splash, Energy, and Fusion). These efforts starved the core V8 red brand of consistent advertising support and left it unable to regain the consumers it lost when it tried to reduce sodium content.
2014 Packaged Food Preview 22 09 January 2014
We also think Campbell lacks the distribution infrastructure to compete effectively in single-serve beverages. They rely on a partnership with Coca Cola to get their products into refrigerated cases in convenience stores, but the brand's weak presence in this channel indicates that Coke has other priorities within its portfolio. Low growth rate due to low exposure to growth segments Despite the acquisitions, Campbell's low exposure to emerging markets, high exposure to off-trend categories, and inconsistent marketing efforts to the demographics with strong growth (especially Hispanics and Millenials) explain why Campbell's growth algorithm of 5- 7% EPS is so far below its peer group. Entrenched family ownership stake Campbell is the perennial take-out candidate due to its unleveraged balance sheet, strong cash flow, and the obvious administrative and supply chain synergies it would have with Heinz in tomato processing. But by all accounts, the Dorrance family (with almost 50% ownership of the stock) remains firmly commitment to maintaining control. The Dorrances weren't fans of Heinz when the outspoken Bill Johnson was CEO. We think they would be even less willing to sell to a private equity firm such as 3G.
2014 Packaged Food Preview 23 09 January 2014 ConAgra Investment Highlights Ralcorp acquisition creates synergies and potentially enhances growth The acquisition of Ralcorp represents a big bet by ConAgra on the long-term prospects for private label in the U.S. both in terms of consumer demand and retailer merchandising. Combining Ralcorp with ConAgra's legacy private brands operations creates a $4.5 billion division with six business units based on specific grocery categories. This makes them by far the biggest private label processed food manufacturer in the U.S. and the only food company positioning itself as a hybrid brand/private label company. The argument that private label has plenty of headroom for growth has always been a compelling one. Consumers are increasingly using private label because the quality is getting better and many retailers have come to recognize that they need to use their store brands to differentiate themselves for competitors, especially in a market where consumers have become highly value conscious. Retailers have extended their offerings to include premium products, which often meet or beat the branded counterparts in terms of quality. These efforts have helped increase the penetration of private label into higher income households. The strategic rationale for buying Ralcorp is that it leverages ConAgra's core competency in manufacturing and selling value products to lower-income consumers. The hybrid branded/private label model would theoretically strengthen ConAgra's strategic relationships with retailers who are looking for category management solutions that optimize the balance of their branded and private label offerings. But the company is still trying to figure out how to best combine (and not combine) their branded and private label assets given the inherently contradictory philosophies they tout and the risk that retailers will demand better terms on branded products in exchange for agreeing to private label contracts. The acquisition also presents significant opportunities for synergies ($300M by 2017) and earnings accretion. ($0.25 in FY 14). The "Initial Plan" consolidates and optimizes the multitude of private label manufacturing facilities, and stretches into the broader organization by combining the branded and private label mixing centers and reducing administrative headcount. Charges for the initial phase will total $200 million, followed by another phase at a time to be determined. Focus on free cash flow and productivity Management has transitioned the company into an operating company that is being run with a focus on free cash flow and productivity (as opposed to volume). ConAgra has one of the highest FCF yields in our group and is delivering free cash in the range of 1x adjusted net income. Coming off the back of the massive Ralcorp acquisition, the cash flow priority is debt reduction. Management is targeting $1.5B in debt repurchases by 2015 with repayments of around $600 in 2014. And this likely represents the low end because it does not include the use of roughly $400M - $500M of proceeds from the Ardent Mills JV. Experienced and talented executive team We believe that if any management team can pull of a difficult integration, it's probably this one. CEO Gary Rodkin, CFO John Gehring, President of Consumer Foods Tom McGough, President of Commercial Foods and Private Brands Paul Maass, Chief of Strategy Andrew Ross, and EVP of Research, Quality, and Innovation Al Bolles have shown that it is possible to turn a holding company into a dependable operating company (even if the brands aren’t all top tier).
2014 Packaged Food Preview 24 09 January 2014
That said, we have doubts about the depth of the management bench. The company does not have a strong reputation for brand management. They do not have a strong training program and they do not recruit from major MBA programs. Lamb Weston is an unsung contributor to growth We believe Lamb Weston has a better growth profile than investors realize. While profits have been down recently, the weakness was expected due to the loss of a major customer. The Lamb Weston foodservice business has a leading market position in Japan, China, Korea, and the Middle East. It makes a high quality product and is known as a quality innovator and product developer, well-equipped to suit customers' needs. The global expansion of restaurant chains has helped the business expand further into emerging markets. Additionally, the recent investment in sweet potatoes has expanded the range of the portfolio, In addition, we believe the Ardent Mills divestiture is a positive because it continues to de- commoditize the business and reduce the volatility of the earnings profile. The stock is cheap relative to peers Trading around 13x earnings, CAG is relatively inexpensive when compared to its peers, which currently trade at an average forward PE of 16x. However, for reasons we discuss in our investment risks section, we believe the discount is merited and do not see a clear catalyst for multiple expansion. Investment Risks Weak brand portfolio that is disproportionately skewed to low-income consumers ConAgra has a strong management team that has proven it can generate value for shareholders by instituting operating and financial discipline to underperforming assets. However, it is clear the lower-end consumer is struggling the most and ConAgra has significant exposure to this particular demographic. Individuals are stretching their dollars by wasting less and shopping on an "as-needed" basis instead of stockpiling inventory. This has led to significant volume "misses" where even management was surprised by how poorly the consumer was fairing. At this point, there is little to lead us to believe that this trend will reverse in the near term. As an example, the frozen business has not been performing well. The frozen category was traditionally dominated by the carried lunch occasion, which has suffered in the weaker labor environment. And shifting consumer preferences toward fresher foods (frozen is understandably not perceived as "fresh") has also weighed on sales. As with many other categories in the industry (i.e. cereal and soup), it is up to the branded leaders to change how the consumer thinks about these products. In order to fix this problem, management will change course by redirecting much of the marketing and advertising spend towards promotion and merchandising in an effort to boost volume and regain share. In our view, this is not a sustainable brand-building strategy; however it is likely the best solution in the short-term. Marriage of a branded and private label business The complexity of the Ralcorp integration and the quality of Ralcorp assets remains our biggest concern. It remains to be seen whether the hybrid model will enhance ConAgra’s strategic relationships with retailers or even the degree to which the company will try to leverage the model in its selling and marketing efforts. Coordination between the branded and private label businesses will be very difficult to manage. In addition, Ralcorp itself was always run as a loose affiliation of different operating units without any regard to a unified approach to selling or supply. ConAgra appears to have effectively addressed this problem by consolidating the sales forces into a “one-face to the customer approach” while still giving P&L responsibility to the six business units.
2014 Packaged Food Preview 25 09 January 2014
Volatile earnings track record This is a company that has been forced to cut its EPS guidance in three out of the last six years (FY 09, FY 11, and now FY 14). This is a function of the company’s relatively disadvantaged brands, low gross margins, and arguably a lack of manufacturing scale. For example ConAgra’s Consumer business has 38 manufacturing facilities with $9B in sales compared to Kraft with 40 facilities and $18B in sales. Ralcorp increases the volatility of the model, in our view, because private label manufacturers don’t have long-term contracts with their customers and because prior management didn’t adequately invest in the business. The break-down in Ralcorp’s customer service and pricing architecture during the initial integration shows just how out of control the business can get.
2014 Packaged Food Preview 26 09 January 2014 General Mills Investment Highlights Well-positioned in attractive categories General Mills has dominant positions in two of the fastest growing categories in the U.S. – snack bars and yogurt. The U.S. is like an emerging market for the yogurt company with per capita consumption rates growing rapidly as consumers look for healthier meal and snack products. In snack bars, the company has developed an outstanding franchise for its Nature Valley granola brand and Fiber One. Exhibit 28 calculates implied growth rates for General Mills using the Euromonitor growth estimates that management provides for its largest retail categories. Weighting these growth rates by the company's portfolio mix yields a 5% annual growth rate. Accounting for the geographic split of General Mills' exposure to these categories, the weighted average growth rate of the company's categories is above 4%. To their credit, management maintains guidance at "low single-digit" and does not run the business with excessively high targets in mind.
Exhibit 28: Global and U.S. Growth Estimates for Top 5 Categories Cateogry Projected 5-yr CAGR Weighted % GIS 1 2 1 (US$ in billions) Sales Global U.S. Growth Portfolio
Ready Meals $92 4% 4% 4% 15% Yogurt 76 8% 4% 6% 15% Ice Cream 72 6% 3% 6% 5% RTE Cereal 26 5% 3% 4% 21% Snacks Bars 12 6% 5% 6% 16% Other NA 4% 3% 3% 29% Implied Weighted Average 5.2% 3.8% 4.4% 100% Source: Company data and Euromonitor 1. Provided by management in 2013 CAGNY presentation. 2. Using CS assumption for domestic / international sales split by category. Expanding internationally General Mills has historically been a landlocked company with large domestic exposure. Over the past few years, it has taken important steps to expand the portfolio into faster growing emerging markets and into faster growing categories. The acquisitions of Yoki and the Yoplait license along with the heavy investment into China have significantly changed the mix and potentially improved the growth profile. In mid-2012 CFO Don Mulligan suggested that Mills could conceivably shift its mix to 40-50% international sales over time.
■ Latin America is now $800M with more than $500M from Yoki in Brazil. Yoki is growing at 2x the rate of its categories, which are up double-digits percent.
■ China is expected to grow to $900M by FY 15 from $600M currently as the company opens new Haagen-Dazs stores and expands the Wanchai Ferry frozen business.
■ In Europe, sales are flat but Yoplait is taking share from Danone.
2014 Packaged Food Preview 27 09 January 2014
Exhibit 29: 2009 Sales by Geography Exhibit 30: 2014E Sales by Geography
Int'l 18% Int'l 31%
U.S. 69% U.S. 82%
Source: Nielsen xAOC, Credit Suisse research Source: Nielsen xAOC, Credit Suisse research Strong free cash flow generation General Mills has generated strong free cash flow over the last five years and we are projecting approximately $2.1B in 2014. Management expects free cash to exceed 1x net income. This reflects the strong cash generation while maintaining a healthy level of capital expenditures around 4% of sales.
Exhibit 31: FCF Growth Since 2009 of 11% $2,500
$2,000
$1,500
$1,000
$500
$0 2009 2010 2011 2012 2013 2014E
Source: Company data, Credit Suisse research
2014 Packaged Food Preview 28 09 January 2014
Exhibit 32: General Mills FCF to Sales Conversion Outpaces the Peer Average 14% 13.0%
12% 10.5% 10.4% 10% 8.6% 8.5% 7.8% 8% 7.3% 5.9% 6%
4%
2%
0% 2010 2011 2012 2013
General Mills Food Average
Source: Company data, Credit Suisse estimates The strong free cash flow has given management significant flexibility with regards to capital allocation, and they have done a good job of keeping their shareholders happy with it. The company has spent $2 billion on acquisitions over the past few years, but it operates at a very manageable debt-to-EBITDA ratio of just over 2.0x. As a result, we expect the company to place an even bigger priority on returning cash to shareholders. For example, the company has repurchased over $4.5B worth of stock since 2009 and they are guiding to an annual share count reduction of 2% from share repurchase. The company has increased its dividend 75% since 2009 including a big increase of 15% in FY 14. We expect high single digit increases going forward. For FY 14, we expect the company to allocate 100% of its free cash flow (we estimate $1.9 billion) to shareholders through share repurchase and dividends. This compares to 83% in FY 13. Significant cost savings through HMM Holistic Margin Management is the company's response to rising input costs that includes productivity savings, mix management, and pricing. Cumulative savings since 2010 have been $1.4B with a cumulative goal of $4B by 2020 through international expansion. Through a combination of HMM and pricing, the company has done a fairly good job of managing through volatile inflation and has kept gross margins flat since FY09 even despite dilutive acquisitions. As shown in Exhibit 33, input inflation has averaged 4% since 2009 and the average y/y change in gross margin has been 0 bps. Over the same period, SG&A as a percent of sales (ex advertising and R&D) has trended down approximately 60 bps.
2014 Packaged Food Preview 29 09 January 2014
Exhibit 33: Adjusted Gross Margin vs Y/Y Input Cost Inflation 41% 12% 10% 39% 8%
37% 6% 4% 35% 2% 0% 33% -2% 31% -4% 2009 2010 2011 2012 2013 2014E
Adj Gross Margin Input Inflation
Source: Company data, Credit Suisse research, management inflation estimates
Investment Risks Large exposure to struggling cereal category Approximately 21% of sales are in ready-to-eat cereal. This is a category that has struggled for some time. Cereal has consistently underperformed overall food sales since 2009. In that time period, cereal volume was down 3% annually compared to overall food that was flat.
Exhibit 34: Food Sales vs Cereal Sales Exhibit 35: Cereal Sales Growth vs Price Growth 6% 5% 4.5% 4.8% 5% 4% 3.2% 4% 3% 3% 2.1% 2% 1.5% 1.8% 2% 1.5% 1.5% 1% 1% 0% 0% -0.3% -1% -0.3% -1% -0.6%
-2% -2% -2.0% -3% -3% -2.9% -2.9% -3.4% -4% -4% -3.4% 2010 2011 2012 YTD 2013 2010 2011 2012 YTD 2013
Food Sales (CAGR 3%) Cereal Sales (CAGR -1%) Cereal Sales Growth Cereal Price Growth
Source: Nielsen xAOC, Credit Suisse research Source: Nielsen xAOC, Credit Suisse research International expansion has diluted operating margins While we agree with the strategic rationale for international expansion, investors need to be cognizant of the degree to which these deals have diluted the company's operating margin. International margins average 10% versus a whopping 23% for U.S. Retail. Greater scale and HMM implementation will help narrow the gap over time. But despite spending $2 billion on deals in a low-cost borrowing rate environment, EPS is still growing below the company's high single-digit algorithm. The company's target to achieve $3.35 of EPS by 2015 clearly isn't going to happen.
2014 Packaged Food Preview 30 09 January 2014
Exhibit 36: Operating Margin Dilution 20% 300
18% 200
16% 100
14% 0
12% (100)
10% (200) 2010 2011 2012 2013 2014E
Adj EBIT Margin y/y change (bps)
Source: Company data, Credit Suisse research Low growth profile does not stand out against peers Despite having strong market positions in good categories, General Mills has been delivering top-line growth at a below-peer rate. A big reason for this weakness is poor management in the U.S. yogurt category. What went wrong? Simply put, management was late to recognize the threat that Greek yogurt posed to its Yoplait brand, and it has been trying to catch up ever since. General Mills' U.S. yogurt sales declined and missed its operating plan in FY 12 and FY 13. The popularity of Greek has shifted the dynamic of the entire category and changed the landscape. General Mills is now putting significant resources behind its Yoplait Greek product with the expectation that it can fetch its fair share of the category. Indeed, after some initial stumbles, Yoplait Greek is performing well with sales up 75% YTD. But it is still a relatively small portion of the company's yogurt portfolio, and we question whether it has the authenticity to compete with brands like Chobani longer term. In addition, category pricing is coming down as capacity increases.
Exhibit 37: Calendar Organic Growth vs Peers 5%
4%
3%
2%
1% 2010 2011 2012 2013E 2014E
GIS Organic Growth Peer Organic Growth
Source: Nielsen xAOC, Credit Suisse research
2014 Packaged Food Preview 31 09 January 2014
Exhibit 38: 2013 Y/Y Change in Yogurt Sales 15%
10%
5%
0% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov (5%)
(10%) Y/Y Salesin Y/Y Change (15%)
(20%)
Yogurt Category GIS Total Yogurt Yoplait
Source: Nielsen xAOC, Credit Suisse research The biggest success story within our companies is snacks. They have grown the business to $1.7B from $1.2BM in 2009. This is a result of excellent marketing and strong growth in the bar category. Unfortunately, yogurt and snacks is only 22% of Nielsen measured US retail sales.
2014 Packaged Food Preview 32 09 January 2014 Hershey Investment Highlights Enjoys benefits of a duopoly in domestic chocolate One of the biggest reasons for Hershey's long-term success is that it competes in a duopoly category (chocolate) with a rational competitor, Mars, with no serious threat from private label. As a result, the market leaders can focus on investing in the long-term health of their brands through advertising, product innovation, and supply chain enhancements rather than get distracted by short-term promotions. This dynamic, along with the consumer's inherent passion for chocolate, gives Hershey significantly more pricing power than the typical processed food company. One of the concerns we hear regarding Hershey is that Mars may someday “wake up” in the U.S. and decide to grab back the market share they lost to Hershey in chocolate in the U.S. However, our industry sources indicate that Mars is quite happy with the growth they have achieved in the U.S. in chocolate, and has no intentions of departing from its rational approach to pricing, even though commodities are lower. Mars views the U.S. as a source of cash for reinvestment into its massive platform in emerging markets, so they are probably quite satisfied with their current pace of low single-digit growth in the U.S. It makes sense that the company would not want to rock the boat. Good visibility on further gross margin expansion Falling cocoa input prices and strong volume sales boosted the company's gross margin by 250 bps in 2013. In 2014, we expect cocoa prices to stabilize, but the benefits of volume growth and fixed cost leverage to continue, driving gross margin up another 100 bps. Plant closures and the opening of state-of-the-art facilities in Mexico and Pennsylvania have driven down the company’s fixed costs and improved its efficiency. In addition, the business in China should generate SG&A leverage as it grows into its infrastructure. Strong international growth and strong leverage to emerging markets Hershey is no longer the land-locked US company it used to be, and International sales are on track to become 25% of sales by 2017 at ~$2B (from $700M in 2012). M&A is additive to this number. The countries that Hershey is placing a focus on are China, Brazil, Mexico, and India, and growth in these markets is expected to be accretive to the gross margin. China presents a large and unique opportunity for Hershey given the changing dynamics in the confectionary category from a consumer demand and retail channel perspective. The chocolate category in China is shifting from a product consumed solely on special occasions and gifts to an everyday treat. On the retail side, the c-store channel is becoming modernized (thanks to 7-11) and offering more single-serve offerings of items, including chocolate. Broadline stores (Wal-Mart, Carrefour, and Century Mart) should begin to merchandise single-serve chocolate bars near the cash register to encourage impulse purchases. Hershey is advertising the Hershey brand for the first time (as opposed to just Kisses) and marketing it as a snack rather than a gift. The company is also expanding its distribution (which is currently in 14 major hubs), using third party distributors, and testing new methods such as smaller vans that distribute to smaller cities. We think Hershey China can grow to approximately $600M by 2017 from about $90M in 2012. Hershey is growing at 4-5x the category rate in China, which implies 50-60% growth in China in 2013. The company’s market share is about 4%. We believe the investments in market research, distribution infrastructure, advertising, and new manufacturing can increase the company’s market share to the double digits. With the chocolate category at $2B in China today, we believe Hershey can grow its chocolate sales to $400M by 2017 if
2014 Packaged Food Preview 33 09 January 2014 we assume a 12% market share on continued category growth of low double digits. Non- chocolate brands (Jolly Rancher and Ice Breakers) will likely get us to our $600M estimate. We believe Hershey’s commitment to this goal is strong, as further evidenced by the recent acquisition of Shanghai Golden Monkey Food Company (growing in the double- digits). The private confectionary company produces hard candy, chocolates, and protein based bean products. In our view, the acquisition strengthens Hershey's distribution capabilities in the traditional trade in China, expands its manufacturing platform, and creates opportunities for leveraging scale in procurement and advertising.
Exhibit 39: Hershey International Growth Estimates 2009 through 2017 CAGR 13- Revenues 2009 2010 2011 2012 2013 2014 2015 2016 2017 17 Total Hershey 5,299 5,671 6,081 6,644 7,098 7,560 8,051 8,575 9,132 6.6% % growth 7.0% 7.2% 9.3% 6.8% 6.5% 6.5% 6.5% 6.5% Hershey USA 4,542 4,843 5,135 5,574 5,897 6,161 6,403 6,623 6,822 4.1% % growth in USA 6.6% 6.0% 8.6% 5.8% 4.5% 3.9% 3.4% 3.0% USA % of total 86% 85% 84% 84% 83% 82% 80% 77% 75%
CAGR 13- Revenues by Country 2009 2010 2011 2012 2013 2014 2015 2016 2017 17 Canada 315 325 335 350 371 393 417 442 468 6.0% China 32 48 65 90 144 209 303 439 615 46.8% India 76 70 65 60 63 69 80 92 105 11.9% Mexico 109 125 156 180 207 248 298 349 401 17.4% Brazil 60 75 80 85 96 110 127 144 161 13.6% Export and other 165 185 245 305 320 368 424 487 560 12.9% Total International 757 828 946 1,070 1,201 1,399 1,648 1,952 2,310 16.6% Int'l % of total 14.3% 14.6% 15.6% 16.1% 16.9% 18.5% 20.5% 22.8% 25.3% Total Emerging Markets 277 318 366 415 510 637 808 1,023 1,282 as % of total 5.6% 6.0% 6.2% 7.2% 8.4% 10.0% 11.9% 14.0% contribution to Hershey growth 0.8% 0.8% 0.8% 1.4% 1.8% 2.3% 2.7% 3.0% Total Int'l ex Canada 442 503 611 720 830 1,005 1,231 1,510 1,842 % growth 14% 21% 18% 15% 21% 22% 23% 22% 20.7% as % of total 8.3% 8.9% 10.0% 10.8% 11.7% 13.3% 15.3% 17.6% 20%
CAGR 12- Growth estimates by Country 2009 2010 2011 2012 2013 2014 2015 2016 2017 17 China 50% 35% 38% 60% 45% 45% 45% 40% 46.8% India -8% -7% -8% 5% 10% 15% 15% 15% 11.9% Mexico 15% 25% 15% 15% 20% 20% 17% 15% 17.4% Brazil 25% 7% 6% 13% 15% 15% 13% 12% 13.6% BMIC 15% 15% 13% 23% 25% 27% 27% 25% 25.3% BMIC as % of total 5.6% 6.0% 6.2% 7.2% 8.4% 10.0% 11.9% 14.0% Export and other 12% 32% 24% 5% 15% 15% 15% 15% 12.9% Canada 3% 3% 4% 6% 6% 6% 6% 6% 16.6% Total international % growth 9.4% 14.3% 13.1% 12.3% 16.4% 17.8% 18.4% 18.4% 17.6% Intl ex-Canada % growth 21% 18% 15% 21% 22% 23% 22% 20.7% Source: Company data, Credit Suisse estimates The re-investment is working While other food companies are forced to cut their advertising budgets in response to weak volume trends and the need for short-term promotional spending, Hershey keeps investing at a rapid rate and keeps getting positive returns. Advertising was up 16% in 2012 and guidance for 2013 is +22-23%. Volume has responded positively by growing in the mid to high single digits and Hershey is consistently growing share in the traditional
2014 Packaged Food Preview 34 09 January 2014 and c-store channels. In addition, the implementation of the IDP program with retailers has grown the category and strengthened Hershey’s competitive advantage.
Exhibit 40: Advertising up 450% since 2007 $700
$600
$500
$400
$300
$200
$100
$0 2007 2008 2009 2010 2011 2012 2013
Source: Company data, Credit Suisse estimates Bolt on M&As drive growth The Brookside acquisition (transaction from December 2011) is adding a point of growth this year as Hershey advertises it nationally and extends its distribution into new channels. We are becoming increasingly convinced that the appeal of this product is broad-based. Trial and repeat are tracking ahead of the company’s initial estimates, but manufacturing capacity constraints have limited the company’s ability to merchandise the brand as aggressively as they wished. In 2014, Hershey will launch new varieties and probably launch the brand into new geographies. The recently announced acquisition of Shanghai Golden Monkey fits the company's M&A strategy perfectly. Hershey looks for companies that have strong regional/local brands with accelerating revenue growth and go-to-market capability. The company will focus on confection and snacking categories. Bolt-on acquisitions that are accretive in year two are preferred. Management consistently executes The experienced management team at Hershey continues to deliver on a consistent basis. In addition to increased gross margin targets mentioned above, the long-term EPS growth algorithm was recently increased to 9-11% (from 8-10%), and FCF and ROIC continue to increase.
2014 Packaged Food Preview 35 09 January 2014
Exhibit 41: Continued ROIC improvement 35%
30%
25%
20%
15%
10%
Source: Company data, Credit Suisse estimates
Exhibit 42: Increasing FCF $1,000 $900 $800 $700 $600 $500 $400 $300 $200 $100 $0
Source: Company data, Credit Suisse estimates
Investment Risks Valuation The pushback we hear on the stock is that there has been a significant increase in the stock and at current levels it is priced for perfection.
2014 Packaged Food Preview 36 09 January 2014
Exhibit 43: HSY Share Price 2000-2013 $100
$90
$80
$70
$60
$50
$40
$30
$20 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Source: Factset With the P/E multiple at 23x, the premium versus the group is 42%, which is above the 5- year average premium of 35%. However, we would argue that the premium is warranted given EPS growth in the low double digit range over the coming years, high quality volume growth, and leverage to fast growing emerging markets.
2014 Packaged Food Preview 37 09 January 2014 Hormel Investment Highlights Consist growth; strong ROIC and shareholder return One of the pushbacks we get on Hormel is that it participates in highly commoditized meat categories with lower margins. But the company's track record and targets for growth are higher than its packaged foods peers. Hormel’s sales growth goal is to hit roughly $10.6B by 2017. That represents a CAGR of 5% between 2012-2017. For EPS, the company plans to grow earnings at a CAGR of 10% (~$2.90 by 2017) compared to a rather consistent rate of 11% historically. Hormel targets an ROIC in the top 25% of the companies it considers its peer group, which includes a combination of packaged foods companies (Smucker, McCormick, Hershey) and protein companies (Tyson, Smithfield, Hillshire).
Exhibit 44: Sales History Exhibit 45: EPS History
$10 $2.00
$8 $1.50
$6
$1.00
$4
$0.50 $2
$0 $0.00 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Est. 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Est. Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
Exhibit 46: Hormel ROIC Exhibit 47: HRL Total Shareholder Return by far exceeded packaged foods group and S&P 500 25% 21.3% Comparison of 5-Year Cumulative Total Return 20.2% 20% 18.7% 330 16.7% 16.9% 300 15% 13.9% 270 240
10% 210 180 150 5% 120 90 0% 60 HRL 2008 HRL 2009 HRL 2010 HRL 2011 HRL 2012 Packaged Food 1/8/2009 7/8/2009 1/8/2010 7/8/2010 1/8/2011 7/8/2011 1/8/2012 7/8/2012 1/8/2013 7/8/2013 Peers 2012 Hormel Foods Corporation S&P 500 S&P Packaged Food & Meats Source: Company data, Credit Suisse estimates Source: Factset Substantial step up in FY14 earnings We believe two main factors are setting up FY14 to be an above algorithm year for earnings growth: 1) We expect a significant rebound in the commodity elements of the portfolio to boost margins to the high end of the company’s normalized range, especially in turkey, 2) We believe the Skippy acquisition is likely to exceed accretion targets. In 2014 the U.S. turkey market is poised for a record year in profit margins, similar to the type of year that chicken producers enjoyed in 2013. This will come from a combination of falling grain prices and a big cutback in turkey supplies (thus raising commodity turkey prices). Below we provide our estimate for the major drivers of EPS growth in our model.
2014 Packaged Food Preview 38 09 January 2014
For purposes of conservatism, we are excluding a $0.10 benefit that we think is possible from rising commodity turkey prices. We arrive at this math by assuming a 10% increase in turkey whole bird and dark meat prices (~25% of JOTS sales) increases operating income by $40M. Hormel is a net seller of whole birds and dark meat.
Exhibit 48: FY14 EPS Bridge for Hormel $2.50
($0.02) $2.25 $0.06 $0.14
$2.00 $0.14
$2.25
$1.75 $1.92
$1.50 CS CY13 EPS Grain Deflation Skippy Refrigerated Foods Loss of Splenda CS FY14 EPS
Source: Credit Suisse estimates. Corn benefit assumes a $1.60/bushel cost reduction on 35M bushels of corn per year We believe that Skippy will accelerate the company’s organic growth rate in the near-term as Hormel invests in a new advertising campaign and new products and regains the market share that Skippy lost while it was under-managed by Unilever. Skippy also represents an interesting opportunity for Hormel to build scale in China and other international markets. Value-added expansion Hormel continues to move away from a commodity-based protein company and toward a predictable and stable branded packaged food company. We believe that at this point, only ~20% of the company is truly commoditized products and ~80% is value-added. In our view, this merits a trading multiple in-line with the packaged food stocks (P/E multiple in the high teens) rather than ag companies (in the low double digits). The market must agree since HRL’s 1-year forward P/E is in the high teens (please see risk section below).
Exhibit 49: We estimate that about 22% of the business is commodity or supply chain (as Hormel calls it) and 78% value add
% of Weighted Segment 2012 Sales Company % Value Add Value Add Grocery Products $1,171 14% 100% 14% Refrigerated Foods $4,223 51% 70% 36% Specialty Foods $924 11% 100% 11% Jennie-O Turkey Store $1,549 19% 70% 13% All Others $363 4% 70% 3% Total Company $8,231 100% 78% Source: Company data, Credit Suisse estimates Savvy acquisition strategy bolstered by pristine balance sheet An important part of the Hormel investment proposition is its success as a roll-up play. Hormel's pristine balance sheet (more cash than debt) gives it substantial flexibility. Management has proven to be highly strategic and careful about how much it spends. In the 2000's, the company focused on protein-based products (like Lloyds and Farmer John)
2014 Packaged Food Preview 39 09 January 2014 with low-hanging opportunities to improve their supply chain. More recently, management has been investing in higher margin, highly stable grocery products (like Skippy and the Mega Mex JV).
Exhibit 50: Key acquisitions by business unit JOTS
Refrigerated Foods Value-added protein
Convenient Meals
Grocery Products Traditional
Mexican
Specialty Foods
Source: Company data, Credit Suisse estimates Investment Risks Roughly 20% of sales are still pure commodity businesses, which are difficult to predict. As demonstrated by the drought in 2012 and the rapid surge in corn prices (amongst many other examples), things can change rather quickly and hurt commodity business margins. Skippy is a different type of protein. Given Hormel specializes in meat, peanut butter will be a new endeavor. However, as demonstrated by the success in the branded/value- added products that span outside of meat, Hormel has excellent consumer marketing capabilities. In addition, we think the company will be able to manage peanut price inflation well given its expertise in managing other commodities. Turkey consumption in the U.S. has slowed. From 2005-2008, per capita consumption of turkey grew dramatically (up 5%) as U.S. consumers increasingly turned to it as a healthier substitute for red meat. Jennie-O's turkey sausages, patties, and lunchmeats benefited from this trend. The growth rate slowed during the recession, however, exacerbated by a slow-down in exports in 2012 and 2013. Consumption appears to be improving recently.
2014 Packaged Food Preview 40 09 January 2014
Exhibit 51: U.S. turkey consumption stagnated after the 2008 recession (2005 =100 index) 115
110
105
100
95
90
85
80
75 2005 2006 2007 2008 2009 2010 2011 2012 2013P
Beef Pork Broiler Turkey
Source: USDA. Figures represent pounds of turkey consumed in the U.S. Valuation is already well above the packaged food group. Hormel’s 1-year forward P/E is at 19.5x, above the packaged food group at 16x and the 10-year average of 16.2x.
2014 Packaged Food Preview 41 09 January 2014 Kellogg Investment Highlights Portfolio shift to higher-growth categories The acquisition of Pringles from P&G changed the ballgame for Kellogg by shifting the portfolio away from cereal and more into snacks and international markets. This reduced Kellogg's percent of sales from breakfast cereal to 45% from 50% and increased the international sales to 34% from 30%. Kellogg folded its under-scaled European snacks business into Pringles' management infrastructure in Geneva. They also made good headway integrating Pringles in the U.S. without having to take on the complicated challenge of folding into the U.S. Snacks' division's DSD network. While expanding snacks was the right thing to do, the saturation of the Pringles business domestically and globally makes us skeptical that it will improve Kellogg's growth profile. Project K and global reorganization should improve efficiency Partly in response to declining demand, Kellogg announced a massive $1.2 to $1.4 billion Project K restructuring program to reduce administrative costs, cut capacity, and reduce headcount 7%. The bright spot in this program is that it has realigned the organization around global brand management teams. The risk of global brand management is that companies can lose track of the distinctiveness of local tastes as it introduces new product platforms and advertising campaigns around the world. But Kellogg had a pattern of giving too much leeway to its local business managers to tweak or delay the dissemination of legitimate global ideas. As a result, it left a lot on the table in terms of revenue growth and synergies. Europe was notorious for this in the breakfast cereal category. We think the appointment of Paul Norman to the role of Chief Growth Officer will increase the speed to market of global ideas. But this will depend on the flexibility of the company's culture, which is difficult for outsiders to gauge. Strong free cash flow generation Kellogg has strong free cash flow in relation to its peers, but it has had to direct more of its cash toward debt reduction following the acquisition of Pringles. This could change for the better for equity investors in 2014 if Kellogg increases share repurchases as a priority for cash flow and if pension contributions represent a smaller call on cash. Breakfast cereal should benefit from aging U.S. consumer and rising adoption rates in developing markets. Consumers in the U.S. eat more cereal per capita as they get older, but Kellogg has yet to figure out a way to capitalize on this demographic benefit. In addition, the promise of driving higher consumption in developing markets like Mexico, Russia, and China also has yet to materialize due to stubbornly persistent local preferences. For example, in China, consumers simply prefer a hot breakfast in the morning over a cold one. In Mexico, breakfast cereal has trouble attracting a following with lower income consumers because traditional tortillas offer higher nutrition at a lower price. Investment Risks Gross margin impaired by company-specific supply chain issues Kellogg now admits that the K-Lean productivity program of 2008-2010 severely denuded the operations of the company as it led to the removal of hundreds of personnel from key positions and stripped the quality control from its procurement process. To give you a sense of just how far the company went to cut costs, the board made K-Lean cost savings the only objective of management's three-year long-term executive compensation plan. The lesson here is that the executives who are incentivized the wrong way will inevitably make the wrong decisions for its business. Management estimates that it now spends an
2014 Packaged Food Preview 42 09 January 2014 incremental $100 million per year on head count and training at its facilities to rebuild quality control. Departures of top managers Three of Kellogg's top managers- David Denholm, Todd Pendegrass, and Brad Davidson- recently exited the company either by choice or, in the case of Davidson, through the restructuring. This strikes us a negative sign regarding the health of the business. To make matters more challenging, Kellogg has traditionally found it difficult to recruit top talent due to its headquarters location in far off Battle Creek Michigan. Breakfast cereal category in a deep, long-lasting cyclical decline Consumer tastes have shifted to more protein-rich breakfast solutions like Greek yogurt and protein sandwiches (such as Jimmy Dean) in the morning. The fast food restaurants have done a good job of providing more convenience for consumers who don't want to take the time to pour a bowl of cereal. We view this a cyclical problem rather than a structural one, but this particular cycle has proven to be very long and painful with no end in sight. Kellogg and General Mills could have blunted the inroads of these breakfast substitutes if they had proactively come up with compelling news around the health benefits of whole grain and fiber. Instead, Kellogg's strategy was to launch indulgent UK products (like Krave and Crunchy Nut) into the U.S. These products taste good, but they don't do anything to improve the health and well ness perception of the category. To make matters worse, Kellogg and Mills hurt the price-value equation of the category by aggressively raising prices to offset rising commodity costs. They also shifted more of their R&D and marketing resources to develop their own versions of substitutes, including nutritional beverages (Special K Protein Shakes), frozen sandwiches (Special K Flatbread sandwiches), and, Yoplait Greek yogurt. Kashi brand over-extended and is now declining Kashi was a huge success story for the company, growing to $750 million in sales at its peak and extending into multiple directions outside of cereal. Sales slipped into negative territory, however, when its pipeline of resonant new cereal products dried up and high income, organic foods consumers shifted their attention to Greek yogurt and other breakfast solutions. It is quite possible that Kashi lost some of its credentials among these consumers when it became a target of Proposition 37's efforts to enforce GMO labeling. The risk of further declines to Kashi's reputation only goes higher now that Kellogg has closed the La Jolla headquarters where Kashi got its start. Whole Foods' recent decision to remove Kashi from its shelves isn't material from a volume perspective, but it could be material in terms of Kashi's brand equity.
2014 Packaged Food Preview 43 09 January 2014 Kraft Foods Investment Highlights Renaissance in general management Kraft was once known as a best-in-class marketing and financial organization that attracted the best management talent and trained young business managers to be strong general managers. Many CEOs and CFOs had years of Kraft in their resume in the 1980's such as Jim Kilts (Gillette), Bob Morrison (Quaker), Bob Eckert (Mattel), Alan Lacy (Sears), Doug Conant (Campbell) and Gary Coughlin (Abbott). Somewhere along the way, the company lost track of the training regimen and operating advantages that made it so effective. CEO Tony Vernon's big idea is to re-establish Kraft as a training ground for excellence in general management. The company restarted the "Kraft University" training program that was popular in the 1990's. They have re-instituted brand management positions on brands that had been left vacant for over ten years. The brand teams now operate with a highly rational 4M's approach, meaning that they have to demonstrate that they have momentum, materiality, strong margins, and a strong marketing message before they get a marketing budget. They also run portfolios with a "Good-Better-Best" segmentation strategy, with a large portion of their product innovation geared toward smaller-sized, lower-priced products that low-income consumers can afford and increases Kraft's presence in value channels like Dollar Stores and Club. Splitting from Mondelez allowed Kraft to shift toward this more active investment approach. While under Mondelez, management treated the Kraft U.S. business as the cash cow in the portfolio to fund growth in developing markets and spent years trying to unsuccessfully combine a DSD Nabisco sales force with Kraft's 50 warehouse-delivered product lines. As a result, the brand equities deteriorated with consumers and the supply chain didn't get the investment it needed to operate at best-in-class margins. Significant margin expansion opportunity CEO Tony Vernon sounds almost gleeful when he confesses that the company lacks cost leadership in just about every one of its categories. How this is possible for a company that averages twice the market share of its nearest competitor. To fix this, the company has instituted Lean Six Sigma training and made capital investments to improve the productivity of its manufacturing lines. The brand teams now have better visibility into supply chain productivity than they ever had before. We think gross margins can expand from 32% currently to the packaged foods average of 35% by 2016. Kraft has significantly improved its overhead as a percent of sales to 8.7% with another 70 bps to go to arrive at Best-In-Class status. This included significant overhead reductions from closing its Glenview Illinois headquarters, implementing a voluntary retirement program, and switching a big portion of its sales force to a third party broker network (Acosta). The CEO leads by example, enforcing tight controls on his travel and expenses and his direct reports. Focus on cash flow Kraft's "Cash is King'' approach is the best way to create value for shareholders. They have made cash flow a bigger part of management's executive compensation evaluation, instituted "manage for cash" training throughout the organization, and provided investors with a dividend payout of 76% (of 2013E earnings). As an example of their progress, Kraft has reduced cash tied up in inventory by putting more controls on how much work-in- process inventory it holds and reducing net SKUs by more than 20%. This includes better planning within the cheese division, which tends to hold inventory for six months on average.
2014 Packaged Food Preview 44 09 January 2014
Investment Risks Advertising investment needs to increase Kraft freely admits that they need to reinvest a good portion of their savings back into advertising sales growth. Kraft's advertising as a percent of sales needs to get closer to 5.0% to meet the peer group average (although the peer average is falling). While increasing its willingness to spend, management has also raised the bar on testing whether the brand's strategy and execution is good enough to merit the spending. The majority of these "Big Bets" delivered strong sales growth in 2013 including Velveeta, Mac & Cheese, Lunchables, MiO, Gevalia coffee, and Planters. Jell-O and Capri Sun advertising, however, failed to move the needle. Perhaps the bigger risk to this approach is that declining brands tend to get worse when management chooses to delay the onset of advertising support for one reason or another. Salad dressing and mayonnaise declines, for example, accelerated to the downside this year because management felt that price discounting by competitors was too intense to justify an advertising response. It is unclear what percent of the portfolio can operate with a sustainable competitive advantage One of the things we worry about with Kraft is that for every success story within the portfolio there seems to be an opposing story of a brand that is struggling to compete with its branded competitor or justify a premium to private label. This includes antiquated brands that face major competitive threats (like Maxwell House and Jell-0) and brands that simply operate in unattractive categories (like Kraft salad dressing, Mayonnaise/Miracle Whip, and Capri Sun). Management sounds unwilling to entertain the idea of divesting disadvantaged brands. The best example we can think of to counter this concern is Kraft's success in the cheese category. Under the leadership of George Zoghbi, who Kraft hired from the New Zealand- based dairy company Fonterra, this division became the first implement integrated business planning, hired or reassigned 60 leaders to new roles, improved the supply chain to a minimum level of 3.5 sigma, and innovation to 9% of sales from 3% on a three-year rolling basis. As a result, the division has shown positive and steady improvement in operating margins and profits despite a highly volatile commodity input environment with costs up $500 million (30%) 2010.
Exhibit 52: Cheese Division Performance Cheese Division 2011 2012 2013E Sales 3,788 3,829 3,975 % growth 7.4% 1.1% 3.8% Operating Income 629 618 667 % growth 5.2% -1.7% 7.9% % margin 16.6% 16.1% 16.8% Source: Company data, Credit Suisse estimates
2014 Packaged Food Preview 45 09 January 2014 Mondelez Investment Highlights It's in the right geographies and categories This is the most compelling element of the bull case on the company. Mondelez has 40% of sales coming from developing countries and 90% of sales coming from attractive snack categories with multiple opportunities for consumption during the day. As consumers enter the middle class in developing markets, they increasingly adopt western eating habits, which means more on-the-go snacking due to time compression and less structured meal times. Category growth rates have slowed considerably, but we can take it for granted that more and more consumers in these markets will enjoy rising income over the next ten years, and that they will increase their consumption of great tasting snacks (Oreos, Cadbury, and Trident) as they do. Chocolate and biscuits have enormous opportunities for distribution gains. As the modern trade in developing markets grows, they open up more distribution opportunities at the point-of-sale for impulse purchase. While in China, we saw strong distribution of Mondelez, Mars, and Nestle products at the check-out counters at modern retailers. This included a huge push for the 2012 launch of Stride gum and multiple sizes of Oreos designed for impulse purchase. We also saw how the 7-11 chain has expanded by converting mom- and-pop stores into temperature-controlled formats more suitable for chocolate. We expect Mondelez to follow the "white space" launch of Stride with a Cadbury chocolate launch in China at some point in the near future. In a 2013 presentation, Mondelez management announced that it is investing in sales force expansion and merchandising capabilities to reach 1 million points of distribution in emerging markets.
Exhibit 53: More room to run in Emerging Markets Distribution
MDLZ Coverage of Traditional Trade Outlets Hot Zone Presence in MDLZ Covered Outlets 2013 Increase in % Outlets 2013 Increase in % Outlets Estimated 2013 v. 2011 Covered 2013 Estimated 2013 v. 2011 Covered 2013
Brazil 274,000 +18,000 32% 1,800 +300 59%
India 1,000,000 +298,000 14% 6,200 +3,100 62%
China 450,000 +348,000 20% 56,700 +34,400 52% Source: Company data Unique visibility into gross margin expansion Perhaps no company in US staples has been through more radical changes than Mondelez over the past six years as it has integrated LU and Cadbury, and then split away from Kraft Foods. Management readily admits that they didn't do enough to optimize their supply chain cost structure during these transitions. Mondelez needs to address a significant labor cost disadvantage, which has crept up on them over the years due to unfavorable union agreements and legacy agreements with works councils following acquisitions in Europe.
2014 Packaged Food Preview 46 09 January 2014
The head of Mondelez's supply chain, Daniel Myers formerly of P&G, gave a highly compelling presentation about his strategic plans. The gist is to build eight new flagship plants and double capacity at 16 existing sites while consolidating subscale plants and distribution centers. Mondelez expects volume produced at low-cost sites to jump from 15% today to 50% by 2016 to 80% by 2020. For example, a new biscuit plant in Mexico scheduled to open in the second half of 2014 is being described as the "design of the future," at 5x the size of typical plants. It has 250 acres reserved for strategic suppliers, an on-site distribution center, and only 1/3 the staff required to produce the capacity of older facilities. Overall, the company expects to open eight new sites in 2013-2016 and another five in 2017-2020. In addition, Mondelez is implementing productivity initiatives that don't require significant capital. Over the past four years Mondelez has delivered $400M of productivity savings through Lean Six Sigma. They have introduced the Lean Sigma process at 14 plants and they expect to expand to 100 facilities by 2015. Capacity has increased 15% at lead plants. In terms of procurement, the company is developing stronger relationships with fewer suppliers as it streamlines its product line and product components. They plan to reduce SKUs from 4,000 today to 2,500 by 2016. Streamlining food formats, technologies, and production lines should reduce complexity by 60% and reduce costs by $100 million per year. Management's targets imply 300 bps of margin expansion by 2016
■ 500 margin expansion in North America
■ 250 bps of margin expansion in Europe implies as much as 15.5% of by 2016, which equivalizes to 6.8% of Europe segment operating income growth per year.
■ 300 bps of total EBIT margin expansion with 250 bp from gross margin While we arrive at a more conservative estimate that what management promises {13.7% margin as opposed to 14-16%), this is still enough upside for Mondelez to deliver 12% EPS growth over the next three years. Our conservative estimates are based on a proprietary "reality check" we developed by reconstructing what the margin structure of the individual businesses looked like when they were operating at the height of their powers in the 1990's and 2000's. Management's aggressive forecast for margin expansion implies a 17% average rate of EPS growth.
2014 Packaged Food Preview 47 09 January 2014
Exhibit 54: Best-Case Scenario For MDLZ EPS Growth Exhibit 55: Conservative Scenario For MDLZ EPS Growth (operating margin 15% by 2016) (operating margin 13.7% by 2016) Best Case Conservative 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 Revenue 35,015 35,671 37,756 40,008 42,443 Revenue 35,015 35,671 37,373 39,201 41,163 Growth 1.9% 5.8% 6.0% 6.1% Growth 1.9% 4.8% 4.9% 5.0% North America 6,903 6,979 7,223 7,476 7,738 North America 6,903 6,979 7,163 7,352 7,546 Growth 1.1% 3.5% 3.5% 3.5% Growth 1.1% 2.6% 2.6% 2.6% Europe 13,817 13,709 14,052 14,403 14,763 Europe 13,817 13,709 13,914 14,123 14,335 Growth -0.8% 2.5% 2.5% 2.5% Growth -0.8% 1.5% 1.5% 1.5% EEMEA 3,735 3,948 4,343 4,777 5,255 EEMEA 3,735 3,948 4,264 4,605 4,973 Growth 5.7% 10.0% 10.0% 10.0% Growth 5.7% 8.0% 8.0% 8.0% Asia Pac 5,164 5,317 5,849 6,433 7,077 Asia Pac 5,164 5,317 5,742 6,202 6,698 Growth 3.0% 10.0% 10.0% 10.0% Growth 3.0% 8.0% 8.0% 8.0% LatAm 5,396 5,718 6,290 6,919 7,610 LatAm 5,396 5,718 6,290 6,919 7,610 Growth 6.0% 10.0% 10.0% 10.0% Growth 6.0% 10.0% 10.0% 10.0%
Operating Profit 2012 2013 2014 2015 2016 Operating Profit 2012 2013 2014 2015 2016 North America 955 984 1,084 1,308 1,470 North America 955 984 1,074 1,176 1,241 % margin 13.8% 14.1% 15.0% 17.5% 19.0% % margin 13.8% 14.1% 15.0% 16.0% 16.4% Europe 1,765 1,801 1,897 2,088 2,303 Europe 1,765 1,801 1,878 1,949 2,007 % margin 12.8% 13.1% 13.5% 14.5% 15.6% % margin 12.8% 13.1% 13.5% 13.8% 14.0% EEMEA 523 535 604 664 736 EEMEA 523 535 593 640 696 % margin 14.0% 13.6% 13.9% 13.9% 14.0% % margin 14.0% 13.6% 13.9% 13.9% 14.0% Asia Pac 716 715 795 875 991 Asia Pac 716 715 781 843 938 % margin 13.9% 13.4% 13.6% 13.6% 14.0% % margin 13.9% 13.4% 13.6% 13.6% 14.0% LatAm 814 677 786 934 1,142 LatAm 814 677 786 934 1,142 % margin 15.1% 11.8% 12.5% 13.5% 15.0% % margin 15.1% 11.8% 12.5% 13.5% 15.0% Total Segment Op Profit 4,773 4,712 5,166 5,870 6,641 Total Segment Op Profit 4,773 4,712 5,113 5,543 6,024 % margin 13.6% 13.2% 13.7% 14.7% 15.6% % margin 13.6% 13.2% 13.7% 14.1% 14.6%
Total Corporate (534) (405) (395) (380) (370) Total Corporate (534) (405) (395) (380) (370) Operating Income 4,239 4,307 4,771 5,490 6,271 Operating Income 4,239 4,307 4,718 5,163 5,654 % growth 1.6% 10.8% 15.1% 14.2% % growth 1.6% 9.5% 9.4% 9.5% Operating Margin 12.1% 12.1% 12.6% 13.7% 14.8% Operating Margin 12.1% 12.1% 12.6% 13.2% 13.7% Interest Expense 1,034 921 937 930 Interest Expense 1,034 921 937 930 Pretax income 3,273 3,796 4,226 4,724 Pretax income 3,273 3,849 4,553 5,341 Income tax 427 664 836 1,016 Income tax 427 674 901 1,148 Adjusted tax rate 13% 18% 20% 22% Adjusted tax rate 13% 18% 20% 22% Minority Interest 18 24 24 24 Minority Interest 18 24 24 24 Net income 2,828 3,108 3,366 3,684 Net income 2,828 3,152 3,629 4,169 Share Count 1,788 1,746 1,701 1,667 Share Count 1,788 1,746 1,701 1,667 EPS $ 1.58 $ 1.78 $ 1.98 $ 2.21 EPS $ 1.58 $ 1.81 $ 2.13 $ 2.50 EPS Growth 13% 11% 12% EPS Growth 14% 18% 17% Average EPS growth 12% Average EPS growth 17% Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Chewing gum category is still viable and valuable Despite the consensus view that gum will continue to be a drag on the company’s sales growth, we believe Mondelez’s chewing gum business (9% of sales) could be a significant contributor to growth if the company takes steps to turnaround the business. We think the category is attractive because consumption is expandable, the products have good profit margins, and consumers use it for fresh breath, oral hygiene, and social confidence. What teenager doesn’t want fresh breath and social confidence? In addition, unlike food, consumers can continue to chew as much as they want without worrying about calories. The opportunity for expansion in emerging markets is still very large, as evidenced by the successful launch of Stride in China. We believe the recent declines are due to cyclical not structural reasons. Our analysis indicates that the largest reasons for the reduction in frequency of gum chewing is due to 1) consumers just don’t think about it and 2) they think it is too expensive. Gum companies over-developed the category with too many confusing items and then cut advertising when consumption started to decline. Mondelez and Mars have started taking the right steps by rationalizing SKUs and simplifying merchandising. However, there is a long way to go. In our view, growth would re-accelerate if the manufacturers marketed the oral care benefits of the products more aggressively and provided more affordable options.
2014 Packaged Food Preview 48 09 January 2014
The risk to our thesis on gum is that it is only a small percent of sales for Mondelez and Mars. Gum was much more important to Cadbury and Wrigley when they were stand- alone companies. The priority for investment isn’t as big now as it was then, which could mean lower expectations for growth. Pressure from Trian We expect Trian to put a slate of directors up for nomination when Mondelez releases its proxy in early 2014. Trian now owns a 2.3% stake in Mondelez and has publicly expressed discontent with the company's elevated operating expenses, the governance of the board of directors (especially with regards to executive compensation}, and the weak execution. We put a high probability on Trian agitating and obtaining seats on the Mondelez board but a low probability on Trian achieving its ultimate end game for a merger between Mondelez and Pepsico's snack division. As with Heinz in 2006, the pressure from Trian has benefited equity shareholders by forcing Mondelez management to take a more proactive approach toward creating value for shareholders (e.g. the $7.5 billion approved for share repurchase) and instituting an aggressive plan for expanding margins. We may quibble with the details of Trian's vision for Mondelez (radically reduce operating expenses, divest the coffee business, and boost margins to 20%+), but our experience with Heinz indicates that when Trian gets involved with an under-performing CPG company, good things happen for equity investors. Investment Risks "Accident-prone" business model With so many execution mishaps in emerging markets, why should investors believe that this global snack roll-up play (Nabisco + Cadbury + LU) has the right management, infrastructure, and brands to grow faster than its food peers a profitable way? In 2012, sales in developing markets slipped to 1% because of inventory build-up in Brazil (resulting from a transition to a new information system and poor allocation of marketing resources) and management in Russia failed to respond to widening price gaps in coffee and chocolate. In 2013, China sales fell double-digit in 3Q because management unwisely thought they could "bend the trend" in the biscuits category by ramping up marketing and distribution, which led to a build-up of inventory at distributors. Overly aggressive growth targets Management announced a 5-7% target for top-line growth when they split-up from Kraft at a of high macro uncertainties. The problem with this target is that it didn't provide for any contingencies in case category growth slowed or execution faltered. This led to some bad decision making, in our view, as management put pressure on certain business units to compensate for the poor performance in others. China in 2013 is a good example- why did they pour so much money into China at a time when every CPG company knew that growth was slowing? Management now admits that they should have run the business with a more flexible approach. We are pleased to see management recognize the error of its ways by signaling a more rational outlook for growth in 2014. But with so much of management's plans for gross margin expansion based on opening greenfield facilities, what happens to those plans if the demand growth isn't strong enough to justify the new facilities? For example, Mondelez plans to increase capacity by 25% over the next three years by building new facilities and introducing new production lines at the old ones. Presumably they can delay the opening of these facilities if the demand isn't there to support it.
2014 Packaged Food Preview 49 09 January 2014 McCormick Investment Highlights Market leader in an attractive category Consumer demand for spices and seasoning continues to grow, and McCormick holds the highest share at 22% (4x that of the next largest competitor) in the category. Herbs and spices is one of the fastest growing flavor categories, and the growth is levered toward emerging markets and a rebound in cooking at-home in developed markets. Emerging markets to expand to 20% of sales by 2015 In 2012, emerging markets represented 14% of sales (up from 10% in 2011) with acquisitions focused on emerging markets. The purchase of WAPC (Wuhan Asia Pacific Condiments) in May is expected to increase the company’s sales in China by more than 60%. It is also exceeding internal expectations in both sales and profit. The 2011 Kamis acquisition in Poland also exceeded management expectations in its first year on a sales growth basis, but Kohinoor in India was more challenging. In 2013 McCormick launched 14 new recipe mixes under the Kamis brand and put strong advertising around it (digital and TV).
Exhibit 56: Acquisition strategy focused on emerging markets JV/Acquisitions to enter/increase scale in emerging markets:
Acquisitions to expand regional leaders:
Source: Company data, Credit Suisse estimates Free cash flow generation outpaced peers; FCF priority now is returning to shareholders McCormick’s free cash flow has grown at a CAGR of 11% since FY02. As a percent of sales, the company’s FCF has generally outperformed its peer group over the past four years.
Exhibit 57: MKC FCF FY02-FY13 Exhibit 58: MKC FCF vs. Peers $400 12% 9.8% $350 10% 8.9% 8.6% 8.6%8.5% 7.8% $300 8% 7.3% 6.6% $250 6% $200 4% $150 CAGR: 11% 2% $100 0% $50 2010 2011 2012 2013 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 McCormick Food Average
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
2014 Packaged Food Preview 50 09 January 2014
Excellent track record for returning cash to shareholders. For example, the company has repurchased over $4.5B worth of stock since 2009 and the board recently authorized a new $400M share buyback program. The company increased its dividend each year for the past 27 years. With the company recently returning to a comfortable debt/EBITDA range of 1.5x to 1.7x, we expect management to make returning cash to shareholders a bigger priority. For FY 14, we expect the company to allocate 100% of its free cash flow (we estimate $350-$400 million) to shareholders through share repurchase and dividends. For FY13 we are expecting at least 86% of FCF will go to dividends and share repurchases. Strong reinvestment into marketing In category where practically none of McCormick's competitors are investing in advertising, McCormick stands out for its commitment to investment and category growth. This gives the company a competitive advantage in its relationship with retailers and consumers. McCormick has doubled its advertising spending since 2005 to $30M in FY13. They are spending a larger proportion of dollars on digital in response to rising social media participation and searches for online recipes. 2014 should be a more normalized year for earnings growth While FY13 has been impacted by a number of one-off issues (we are expecting +3% adjusted EPS growth), we think 2014 should return to normal. MKC has not yet issued official guidance for 2014 but the commentary around it is that EPS growth will likely be in the long-term rate of 9-11%. In addition, sales will likely be in the long-term algorithm of 4- 6%, with one-third of that coming from acquisitions, one-third from base business improvement, and one-third from innovation. We believe this is fair given that input cost inflation will probably be in the low single digits, the increase in the discount rate vs. FY13 will likely lead to a lower retirement benefit expense, industrial division issues are clearing up, and the tax rate should be lower relative to FY13. Investment Risks Risk reward is unfavorable Valuation is stretched at 19.7x 1-year forward EPS. This is well above MKC’s 5-year average of 16.7x and the current packaged food group multiple at 16.4x. Industrial division continues to struggle Management used to tout the huge potential for margin expansion in the Industrial division from moving up the value-added curve, but the business has largely failed to achieve its profit margin target of 12%. Part of the problem is that it McCormick has had trouble fetching a premium price for all of the R&D and consumer research it does on what are essentially unbranded ingredient solutions for big customers like Pepsico and Yum. In 2013, the Industrial business was negatively impacted by weaker QSR (quick serve restaurant) demand in the US as well as in China due to product safety scares. While China has begun to recover, QSR customers in the Americas have been de-emphasizing menu items that use MKC’s flavors in coffee and breakfast. The challenges in Industrial put more pressure on the Consumer Division to pick up the slack.
2014 Packaged Food Preview 51 09 January 2014 Mead Johnson Investment Highlights Best emerging market play in consumer staples Mead Johnson is the global leader in the fast-growing pediatric nutrition category with positions 50 markets and 65% of sales coming from Asian and Latin American markets. One of the most compelling aspects of the pediatric nutrition category is that it is the first thing young families in emerging markets seek when they enter the middle class. Better nutrition for their young children is a huge priority because they don't have the same access to vitamin-enriched foods or supplements that we in the U.S. take for granted. Because income levels are still low, the per capita use of pediatric nutrition products still has plenty of room for growth in Asia and Latin America when compared to the U.S. and Europe. Premium-ization continues to an important degree in developing markets, and the company's strong R&D and marketing capabilities provide it with a competitive advantage in this segment. For example, Mead is the pioneer in research and product development emphasizing DHA for brain development in young children. The Enfa brand's positive reputation supports the brand's premium positioning and price. Operating and financial leverage supports double-digit EPS growth The company's ability to leverage "non-demand generating expenses" (such as IT) suggests 20-30 bps of margin expansion per year through 2016. The ability to drop this benefit to the bottom line depends on the necessity to fund incremental demand generation or (in recent years) compensate for unexpected challenges in emerging markets. The board recently approved a $500 million share repurchase program, which we believe will lead to share count reductions that do more than just offset dilution from options. In addition, the company's tax rate is likely to keep falling further as it expands manufacturing capacity in Singapore's low tax regime. Strong consumer demand in China China has been a volatile market, but there are several long-term factors that make it uniquely attractive
■ The memories of the 2008 melamine scandal in the local dairy industry remains very strong in the minds of consumers and engenders loyalty to foreign brands produced of China.
■ The easing of the One-Child policy is expected to result in a 1. 5 million increase in births over time.
■ Ninety percent of the women in China have full time jobs, which accentuates the importance of the category as a supplement for breast feeding.
■ The premium segment of the category is frighteningly expensive with higher retail prices than just about anywhere in the world. But many Chinese families still have the financial wherewithal to afford the product because they often have as many as 3 or 4 income generators (including grandparents) contributing to the financial needs of the child. Mead also stands to benefit over the next twelve months from market share gains China the expense of its biggest competitor Danone, which suffered from a product recall and a bribery scandal. Our experience in the U.S. is that the market share gains from competitor product recalls tend to last at least 12 months because new mothers who start their children on a given brand tend to stay loyal to that brand during their first year. Danone
2014 Packaged Food Preview 52 09 January 2014 management in fact, has warned investors that the combination of the recall and the negative press from their bribery scandal has severely hurt the image of their brand with consumers and is not likely to reverse quickly. Early stages of penetration in Latin America The company is the #2 player in Latin America (Nestle is #1) with strong positions in Mexico, Ecuador, Peru, Argentina and Brazil. They continue to expect 15% growth in these markets due to increased investment and the growth of the premium segment, in which they are the market leader. Brazil represents the highest potential because it has such a big middle class with very low per capita usage of the category. Mothers in these markets tend to shift their children to regular milk when they are still infants, which is highly detrimental to nutritional development. Much of Mead's investment in the market is therefore focused on educating pediatricians and mothers on the benefits of using nutritional products instead. We expect Mead to continue to make tack-on acquisitions in Latin America. Their strategy is to acquire a strong local brand with good distribution, then introduce their Enfa brand as a premium entrant. The acquisition of Sancor, the #2 competitor in Argentina, was the perfect example of this type of deal. North American demand recovering The U.S has strong potential for a rebound both in terms of sales and margins.
■ The decline in funding for the WIC program has paradoxically increased the percentage of volume sold at full price at retail. Mead's incremental gross margin on full-priced product in the U.S. is probably as high as 80%.
■ The economic recovery in the U.S. (such as it is) as helped stabilize the multi-year decline in the birth rate since the recession.
■ Demographically, there is a big increase in the number of woman 16-26 due to the "boom-let" in in the 1980's.
■ These factors help offset the structural challenge of declining per capita usage of the category as nurses and push new mothers to breast feed exclusively and even ban the free product samples of infant formula that Mead's DTP sales forces provides. Investment Risks China government is intent on building a local brand champion The most frequent concern we hear from investors is that the company's results and stock price have become more volatile now that the Chinese government has placed the foreign brands in firmly its crosshairs. Investors who own this stock unfortunately must live with the inevitability of negative headlines, even if they prove to be immaterial. We list a few big ones below:
■ The Chinese government recently launched an anti-trust investigation, which led to price rollbacks and fines for the leading manufacturers.
■ The Hong Kong government put a limit on how many cans of infant formula people could bring over the border into the mainland of China.
■ The Chinese government announced that it would provide significant financing to local competitors in the category to foster consolidation
■ The Chinese media aired a highly negative news program, which cited instances where pediatric nutrition manufacturers had been bribing pediatricians to recommend their products to consumers. Although the program only provided evidence for one manufacturer, Danone, the program implicated all of the major foreign brands. This,
2014 Packaged Food Preview 53 09 January 2014
plus a letter from the SEC, led Mead to announce an internal investigation into its direct-to-professional sales force in China which is still pending. But while the government's consolidation of the category may indeed build a bigger local brand merely through consolidation, it will take a much longer time to persuade the Chinese consumer to buy the brand instead of foreign-made products. Consumers make the final decision on what to buy for their children, not the government, and the consumer's loyalty to foreign-made brands in this sensitive category runs very deep due to the memories of the melamine scandal. Volatility and management miscues We often get the question as to whether Mead's management team and asset platform is really better than its competitors or whether this company is just "lucky" to operate in such an attractive category. Management's habit of accentuating the negative in its conference calls and providing cautious guidance raises concerns as well. Indeed, we can point to several instances where management was slow to adjust to consumer changes in the markets such as in the development of a marketing strategy for social media, Hispanic marketing efforts, the development of ready-to-drink liquid products in the U.S., and the delayed launch of later-stage nutritionals for toddlers in the U.S. For example, Mead's contention in the past regarding China was that the support the company provided to the Chinese government (conducting/financing research studies for the pediatric community, sharing best practices in quality assurance, partnering with the local government in Guangzhou) provided Mead with something of a competitive advantage. Despite this relationship, Mead seems to have endured more than its fair share bad news from the government's intervention. The fine Mead paid for the anti-trust investigation was bigger than its peers as a percentage of Mead's sales. Mead also misread the market in 2012 when it took a major price increase at a time when the category was slowing and all of its major competitors were promoting aggressively. Not only did Mead lose substantial market share, it also put a bit of a target on its back for the Chinese government's sensitivity to price gouging. These issues raise some concerns about the quality of management in China. Since 2012, Mead replaced the head of its Asian division and the head of its Chinese operating unit. They also have backed away from their objective of launching Enfa in 50 new cities per year. Despite these issues, we believe the management team generally operates at a higher level of effectiveness than its peers (as evidenced by the higher margins) and that the company's conservative sensibilities foster a higher quality, more sustainable position in emerging markets. In China, we look forward to the day when Mead can give investors better visibility into the category growth rate in China, provide more market share data to confirm their outperformance, and speak more confidently about their competitive advantages.
2014 Packaged Food Preview 54 09 January 2014 Smucker Investment Highlights Diversified portfolio of market leading brands The top five categories in Smucker's portfolio are coffee, peanut butter, fruit spreads, oils and shortenings, and baking mixes/frostings. The company is either #1 or #2 in each of these categories in terms of market share as well as several niche categories like canned milk (4% of 2013 sales), frozen peanut butter and jelly sandwiches (3% of sales), and ice cream toppings (2% of sales). This puts at least 80% of the company's portfolio in an advantaged position.
Exhibit 59: Top Five Categories with Market Share and Percent of Sales Closest Other % of 2013 Smucker Brand Sales
Coffee 34% 15% 48%
Peanut Butter 46% 16% 13%
Fruit Spreads 44% 15% 6%
Oil and Shortening 11% 14% 6%
Baking Mixes & Frostings 19% 36% 6%
Source: Nielsen xAOC (YTD as of 28 September), Company data, Credit Suisse research. Closest competitors: Green Mountain (coffee); Hormel (peanut butter); Welch's (fruit spreads); ConAgra (oil and shortening); Duncan Hines (baking mixes and frostings). Smucker's market-leading positions benefit the company in many different ways:
■ It give Smucker scale with retailers to get better merchandising
■ Smucker is the category leader in pricing, thus giving it more control over its destiny
■ Smucker has greater scale than its competitors in manufacturing and distribution, thus making them the low-cost provider to its customers Proven acquisition strategy The company has executed a disciplined approach to acquisitions over the years that has created enormous value for shareholders. Consistent with their portfolio strategy, they focus almost entirely on brands with leading market positions, thus reinforcing their market power. Since 2002, acquisitions have contributed approximately $3.5B in incremental sales with the highly successful Reverse Morris Trust mergers with Folgers in 2008 and Jif/Crisco in 2002 (both from Procter & Gamble) playing the biggest roles. As the chart below depicts, these deals have driven shareholder returns far in excess of the overall market. On the flip side, it highlights the risk that, in the absence of future transformational transactions, the company may not be able to generate outsized returns.
2014 Packaged Food Preview 55 09 January 2014
Exhibit 60: Stock Performance vs. Food Peers During Transformational M&A Periods
October SJM Outperformance: 2001 + 25 pts + 42%
+ 17%
June 2006
May SJM Outperformance: 2008 + 35 pts + 94%
+ 60%
May 2013
Compound Annual Growth Rate (Oct 2001 - May 2013) SJM 12% S&P Packaged Foods 7%
Source: Company data, FactSet, Credit Suisse research. Falling coffee and peanut butter costs provide flexibility It is well recognized that Smucker is certain to enjoy a fair degree of gross margin expansion from commodity deflation over the coming quarters. Since the last list price cut in February 2013, coffee futures have come down approximately another 10%. By our math, the 10% decline in costs provides the company with approximately $100 million of flexibility to simultaneously discount prices for consumers and expand the bottom line EPS for investors. In addition, we believe the company will have around $10M of cost favorability in the back half of FY14 when the company's contracts with peanut farmers roll over. As the largest purchaser of peanuts in the country, Smucker took longer positions than usual with peanut farmers to discourage them from rotating out of the crop when peanut prices started falling off of their record highs. This resulted in the company locking in higher prices further out the curve than usual and incurring a fair degree of margin erosion in the first half of FY14 following a 10% list price cut in January 2013. We estimate a net benefit of $72 million in FY14 by taking the difference between Smucker's price cuts in these two key categories and our estimate for commodity deflation in FY14. The benefits in peanut butter could theoretically extend into FY15 as the company laps the price cut.
2014 Packaged Food Preview 56 09 January 2014
Exhibit 61: We Estimate a $72 Million Net Benefit to Smucker FY14 Profits From Commodity Deflation Net Of Price Cuts ($USD in millions) FY13 (est) Δ FY14 (est) $ Impact
Original Commodity / Pricing Expectations: Coffee sales 2,831 Coffee price (6.0%) (170) Coffee bean cost 965 Coffee beans (20.0%) 193
Subsequent Commodity Changes Since March 2013: Coffee Input Costs (10.0%) 77
Estimated FY14 Promotional Budget 100
FY13 (est) Δ 1H14 Δ 2H14 Δ 1H15
Estimated Timing of Price / Cost Flows: Peanut butter sales 767 PB price (10.0%) (5.0%) 0% Peanut cost 193 Peanut costs 0% (30.0%) (30.0%) (38) 10 20
Peanut Butter Peanut Estimated FY14 Net Impact (ex 1H15) (29)
Estimated FY14 dollar impact to profits 72 Estimated FY14 impact to margin 123 bps
Source: Company data, Credit Suisse estimates. Note: Some values may not add up due to rounding. Superior cash flow generation and high margins Smucker's FCF yield is among the highest in its peer group. It is one of the most efficient cash generators in the sector owing to strong capital discipline, low capital spending requirements on its base business, and the strong margin structure. The advantage to having large profit margins in the consumer staples space is that it gives a company more flexibility to respond to volatility in the market. This is especially important in a portfolio like Smucker's that has a high exposure to commodity price movements as well as intense competition from other brands.
Exhibit 62: EBITDA Margins vs. Peers
30%
25%
20%
15%
10%
5%
0% BGS SJM HSY GIS CPB K KRFT MKC PF MDLZ HSH CAG 2010A 2011A 2012A 2013A Peer Avg
Source: Company data, Credit Suisse research. Smucker's FCF yield of 7.2% is among the highest in its peer group. It is one of the most efficient cash generators in the sector owing to strong capital discipline, low capital spending requirements on its base business, and the strong margin structure.
2014 Packaged Food Preview 57 09 January 2014
Exhibit 63: Current FCF Yield vs. Peers 9%
6%
3%
0% PF CPB SJM CAG GIS K KRFT THS MKC HRL BGS MDLZ HSY MJN
Source: Company data, Credit Suisse research.
Low cost manufacturer with an advantaged supply chain Smucker is the low-cost manufacturer of ground coffee owing to a supply chain that enjoys a number of competitive advantages.
■ A superior technology that includes a flavor management system that provides consistent flavor profiles for coffee using different beans and blends. This gives Smucker flexibility in sourcing different types of beans from various suppliers as it suits the company while still maintaining its taste standards.
■ The coffee operations are located exclusively in New Orleans, where there is a large port closely located to SJM's roasting and finishing facilities. This reduces transportation costs and improves the speed to market.
■ SJM has an advanced team structure that is cross functional. It has an expert procurement team with the most years of experience and the best industry relationships around the world. These procurement teams sit down the hall from the marketing team in Ohio, which provides for a collaborative culture. The company also has a team on the ground in Brazil, giving it access to the best beans the fastest.
■ Acquisitions of Jif, Crisco, and Folgers from Proctor and Gamble gave SJM the best talent and a vastly enhanced quality management foundation. Many of the people who were acquired in the Jif/Crisco transaction are also managing coffee plants and brought many of the P&G best practices with them. Strong management and quality culture Five generations of Smucker family management have developed a corporate culture based on sustainable growth by investing in quality and legitimately caring for employees and consumers. The staples industry today is littered with management teams that are trying to turn around businesses that suffered from years of under investment in their supply chains, distribution, and brand equity. Smucker has never had this problem. Smucker's innovative product solutions, thoughtful acquisitions, and infrastructure investments demonstrate the high quality of the organization. This is a necessity for a sustainable investment that is often overlooked.
2014 Packaged Food Preview 58 09 January 2014
Investment Risks Smucker's positioning in single-serve coffee isn't strong We expect the at-home coffee category to grow at a healthy 5% pace over the next few years as the consumer palate for coffee varieties gets more sophisticated and as consumers buy more machines for single-serve consumption. However, we think the Smucker brands will grow at a slower pace than the category because they aren't positioned as well in this fast-growing segment. Most of the growth in the category has come from younger consumers who are buying Starbucks and Green Mountain brands and machines to mimic the coffee house experience at home. Folgers, on the other hand, is skewed to older consumers who are less willing to buy single serve machines and more price-sensitive on a per cup basis. The introduction of Folgers in single-serve K-Cups brought younger consumers to the category, but it is now being drowned out in the market by an influx of non-licensed single-serve cups following the expiration of the Keurig patent. Smucker's license of the Dunkin' Donuts brand isn't helpful in this regard because it doesn't include permission to market Dunkin in single-serve cups. Competition in key categories has re-awakened Kraft had been an easy target for Smucker in the coffee category until recently. When Kraft separated from its parent company, Kraft management made coffee a bigger priority by increasing its marketing investment, introducing single-serve versions of Gevalia and Maxwell House, and closing the gap with Smucker in supply chain efficiency. As a result, Kraft is now gaining market share again. We expect Kraft to continue to strengthen its position in the mainstream while Green Mountain and Starbucks dominate the premium segment. The bear case scenario for Smucker would be for its coffee sales to stagnate through 2016 and market share to decline. Given these assumptions, Smucker's coffee share would decline to 29% from 34% today, while Green Mountain, Kraft, and Starbucks would all see significant share gains.
Exhibit 64: Bear-Case Projection for Smucker's Market Share in Coffee
YTD 2013 2016 2010 Market Current Projected Assumed Share Share Share Change Growth
Smucker 41% 34% 29% (459) bps 0% Green Mountain 6% 15% 20% 477 bps 15% Kraft 19% 14% 15% 41 bps 6% Starbucks 9% 11% 14% 345 bps 15%
Category CAGR 20% 5% Source: Nielsen, Credit Suisse estimates. Similar to coffee, we expect Smucker's key competitor in peanut butter to pose a bigger threat in the years to come. The Skippy brand was a noncore asset in the Unilever portfolio that was receiving little-to-no marketing support. Under the auspices of Hormel, we expect Skippy's market share to improve as Hormel invests in marketing and new product innovation. The Skippy brand still resonates with consumers and is likely to regain much of the share it lost over the past few years.
2014 Packaged Food Preview 59 09 January 2014
Exhibit 65: Bear-Case Projection for Smucker's Market Share in Peanut Butter
YTD 2013 2016 2010 Market Current Projected Assumed Share Share Share Change Growth
Smucker 47% 46% 43% (264) bps 0% Hormel (Skippy) 18% 16% 19% 248 bps 7% ConAgra (Peter Pan) 10% 11% 10% (31) bps 1%
Category CAGR 12% 2% Source: Nielsen, Credit Suisse estimates. As a result of these market share trends, we believe Smucker will have to reinvest the vast majority of their $70M commodity benefit back into price discounts and merchandising to fend off competitors. This is the right thing to do for the consumer, but it will come at the expense of EPS growth, which we believe may get revised to something lower than the 6.5% to 8.5% algorithm management laid out. Multiple Contraction Valuation multiples in the packaged food sector tend to be positively correlated with organic growth rates. So in an environment where top-line growth is slowing, one might expect to see multiple contraction as a result. In fact, this has been the trend in the back half of calendar 2013 for Smucker where the P/E multiple has contracted by about two turns. With EPS growth stuck in a single-digit range and the top line going lower due to bigger price discounts in coffee, there is a high risk that Smucker's multiple will continue to contract. Market sentiment is already high Smucker is a darling of the market because of its strong track record, its strong corporate culture, and its leading market positions. We expect more downgrades of the stock than upgrades over the next 12 months as analysts come to grips with the reality that the company will have trouble dropping commodity benefits to the bottom line. Two sell-side shops already downgraded the stock in the back half of 2013.
2014 Packaged Food Preview 60 09 January 2014 Our Thesis: More Headwinds Than Tailwinds Lack of emerging markets exposure One of the main comments of our bearish thesis on food is that beverage, household products, and European-based staples stocks (like Nestle and Unilever) offer better growth than U.S. food stocks at a more reasonable price. U.S. food companies don't have nearly the same exposure to developing markets as their staples peers.
Exhibit 66: Developing markets as a percentage of sales 60%
50%
40%
30%
20%
10%
0%
P&G
Heinz
Nestle
Clorox
Diageo
Kellogg
Colgate
Pepsico
Danone
Hershey
Unilever
Carlsberg
Campbell
Heineken
Coca Cola
Mondelez
McCormick Kimblerly C Kimblerly GeneralMills Source: Company data, Credit Suisse estimates As a result, the U.S. food companies have a slower growth profile.
Exhibit 67: U.S Foods volume growth has lagged the consumer staples average (ex food) over the past three and six years 3.5%
3.0%
2.5%
2.0% 3-Year Avg 1.5% 6-Year Avg
1.0%
0.5%
0.0% U.S. Food Rest of Consumer
Source: Company data, Credit Suisse estimates. “Rest of Consumer” includes Reckitt, Coke, Colgate, P&G, Pepsico, Danone, Nestle, Unilever, Inbev, Heineken, SABMiller, Carlsberg, Diageo
2014 Packaged Food Preview 61 09 January 2014
We tend to get more positive on the food space when the valuation gap between food and other sectors widens to an attractive level. As can be seen in the chart below, the group is trading at a relatively low discount to its staples peers right now, and is therefore unlikely to outperform other staples sectors in 2013.
Exhibit 68: U.S. Food stocks are trading at an 7% discount to HPC/Beverage average compared to 12% historically
19x
18x
17x
16x
15x
14x
13x
Oct-10 Oct-09 Apr-10 Apr-11 Oct-11 Apr-12 Oct-12
Jun-11 Jun-10 Jun-12
Feb-10 Feb-11 Feb-12
Aug-09 Dec-09 Aug-10 Dec-10 Aug-11 Dec-11 Aug-12 Dec-12
Pkg Food HH Beverage Source: Company data, Credit Suisse estimates Below we highlight the headwinds that make us cautious on the group as whole. Weak economy = weak volume, despite trading down Some investors fall into the trap of believing that packaged foods sales go higher during a recession because consumers eat more at home and less at restaurants. In fact, Kraft and Unilever proudly claimed that “sandwich preparation” was the hot new trend for American consumers trying to save money in 2009. But the management teams of Kraft and Unilever would agree that it is easier to operate their companies in a strong economy as opposed to a recessionary one. That's because the volume they get from consumers eating more at home or trading down to sandwiches can't offset the volume they lose from more cautious consumer spending. If trading down really drives more at-home food consumption, why is it that U.S. food volume looks so weak?
2014 Packaged Food Preview 62 09 January 2014
Exhibit 69: U.S. Food Volume Growth Trends Since 2006 (based on shipments)
3.0
2.0
1.0
0.0
-1.0
-2.0
-3.0
-4.0
4Q11 2Q11 1Q12 2Q12 3Q12
1Q 081Q 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10
1Q11 3Q11 4Q12E
Source: Company data, Credit Suisse estimates Where did the volume go? Food is the first expense that consumers cut when they are trying to stay on a budget. Consumers have little-to-no control over their mortgage payments and taxes, but they actually have a lot of control over how much they spend at the grocery store on a weekly basis. They can keep their pantries leaner, they can trade down to lower price points, they can clip more coupons, they can trade down to private label, and they can shop at discount channels. They can prepare a bowl of pasta to feed the whole family rather than serve a single-serve can of Chunky soup. Yes, consumers have to eat, but they can save a lot of money (or at least feel better about how much they are spending) when they put effort into it.
Exhibit 70: U.S consumers changed their behavior in 2010 and many of them said those changes would continue Did This Past Year Will Continue To Do
• 52% Save on gas & utilities • 68% Save on gas & utilities • 40% Reduce take-out • 66% Reduce out-of-home entertainment • 37% Reduce out-of-home entertainment • 63% Spend less on clothes • 34% Spend less on clothes • 60% Reduce take-out • 33% Reduce Grocery Spend • 55% Reduce Grocery Spend • 23% Use car less often Source: Nielsen Global Online Consumer Confidence and Opinion Survey, November 2010 Processed food consumption skews to lower income consumers who are forced to make the most drastic changes to their shopping behavior. Business can’t be good for Chef Boyardee brand, for example, when their core consumer is under-employed and dramatically changing their shopping behavior. Their core consumer is shopping less often and reducing her transaction size per trip.
2014 Packaged Food Preview 63 09 January 2014
Exhibit 71: Trips and transactions move in sync with income Shopping Trips $ Transaction Size Per Trip 5% 5% 4%
0%
-5%
-10%
-15% All HHs < $20K $20K - $30K - $40K - $50K - $70K - $100K + $29K $40K $49K $60K $99K Household Income
Source: Nielsen Homescan, 2010 versus 2008. Excludes gas only or Rx only trips Record participation in the “SNAP” program (formerly called “food stamps”) is evidence of just how stressed the core consumer really is. Food stamps issued as a percent of total food purchased in the U.S. has skyrocketed to above 12% from 6% over the past five years. Management teams are fairly certain that the recent cuts in SNAP benefits will cause another shock, albeit temporary, to purchase trends.
Exhibit 72: Food Stamps Issued as a % of Total Food Purchased for Food at Home
Source: USDA, BEA, Food and Nutrition Service Grocers become hyper competitive with each other. In an attempt to drive store traffic, grocers either dip into their own gross margins to offer deep discounts pressure their suppliers to help them out. This hurts more than it helps. Frequency of store visits rises, but no one eats more food. The cereal and milk category were hit particularly hard in 2010 when grocers used them as “loss-leaders.” Grocers cut inventory and emphasize private label. Starting in 2009, Wal-Mart set out to cut inventory by reducing its variety of branded offerings and removing pallet displays that were cluttering its aisles. They also increased the number of Great Value private label facings. New management has reversed those policies and returned Wal-
2014 Packaged Food Preview 64 09 January 2014
Mart to its roots as purveyor of brands. But the focus on tighter inventory control remains a major tenet. Emerging market opportunities are limited Consumers in international markets tend to clean their house the same way and drink similar beer and colas. But the cultural idiosyncrasies on food consumption have been in place for thousands of years and are hard to change. U.S. food companies are trying to make acquisitions to catch up to their European peers. But they are years behind in terms of management experience in these markets and brand development.
■ Campbell experienced this famously when they entered Russia and China and found it impossible to commercialize soup preparation despite the fact that consumers were eating over 200 servings of soup per capita per year. ■ Breakfast cereal has failed to gain stronghold in China because of the cultural preference for warm food in the morning (congee) and the digestive problems related to dairy. ■ Frozen food presents a challenge in most emerging markets because most consumers don’t own freezers at home. ■ Confectionery brands are very global, but chewing gum is experiencing a cyclical downturn and chocolate preferences in Europe are very different from that of the U.S. ■ Coffee brands like Douwe Egberts, Nescafe, and Starbucks and powdered beverages like Tang have become truly global. ■ Biscuits and snack chips have gone global. Oreos and Frito Lay have adapted their brands to fit the local preferences of consumers in multiple markets. In fact, Oreos are now sold as a luxury good in the Duty Free shops of airports next to Louis Vuitton and Chanel. However, these brands are the exception to the rule. Most of the biscuits, crackers, and snack chips sold in Russia and China are sold as commodities in bulk bins. ■ Condiments are often global. Heinz has done an excellent job of introducing its Heinz master brand as the premium offering in markets like Russia, Poland, and China while simultaneously marketing a popular local brand. ■ Yogurt is global. The future success of General Mills depends heavily on whether it can introduce the Yoplait brand into emerging markets like China, Brazil, and India. It won’t be easy. Yogurt is considered a commodity in China, and not a particularly good one given digestive problems related to dairy. But at least they have never heard of Chobani. Marketing effectiveness is declining Food companies are more marketing companies than manufacturers – the largest percentage of their asset value rests in the intangible value of their brands. Maintaining the equity of these brands has become increasingly complex. In the 1970’s, for example, a food company could launch a national advertising campaign that would air on only three television channels and quickly grab the attention of millions of viewers. Since then, the explosion of cable channels, digital video recording, and video games has made the marketer’s task much more complex. People consume media in a much different way than before and they have more choices. Ex-CEO of Sara Lee Brenda Barnes once admitted to us that a new generation of young consumers is growing up without ever having to watch a commercial on TV. Food companies have responded by reallocating their marketing dollars away from television and into Facebook and Twitter. The adjustment has been not been easy. Not many consumers care enough Jell-O to join an on-line community.
2014 Packaged Food Preview 65 09 January 2014
In fact, one could argue that the growing appeal of Facebook and other social media vehicles reduces the barriers to entry for branded products. Television advertising is prohibitively expensive for a start-up brand, but it is really cheap to set up a Facebook page or produce advertisements on You Tube (especially when your consumers produce the ads for you). As more companies find ways to grow their brands through inexpensive word-of-mouth vehicles, what happens to the benefit of scale? In response, food companies have become more risk averse, not less. Product launches that truly drive category growth are expensive and risky. So the industry falls back on a more risk-averse approach. In fact, the industry has significantly cut back on new product introductions for fear that consumers simply don’t have the money to try them. This has boosted profit margins, but hurt volume.
Exhibit 73: The quantity of new product introductions in food has fallen substantially since 2007
Source: Company data, Credit Suisse estimates Food companies have been cutting their advertising investment. General Mills, ConAgra, Kellogg, and Campbell all cut their advertising budgets in response to weak sales trends and shifted their spending to short-term marketing vehicles such as in-store merchandising. This trend only exacerbates our concerns about the long-term health of these companies' brand equities.
Exhibit 74: Most Food Companies Have Reduced Exhibit 75: Hershey now spends the most on advertising Advertising Spending As % of Sales Over Past 3 Years as a percentage of sales. 2.0% 9.0% 8.3% 1.4% 7.6% 1.5% 8.0% 1.0% 1.0% 7.0% 6.0% 0.5% 5.2% 5.2% 5.2% 5.0% 0.1% 5.0% 0.0% 4.0% 4.0% -0.5% 2.9% -0.3% 3.0% -1.0% 2.0% -1.1% -1.1% -1.5% 1.0% -1.5% -2.0% 0.0%
Source: Company data, Credit Suisse estimates. All companies Source: Company data, Credit Suisse estimates. Campbell and represented on a FY 13 vs FY 10 basis except for CPB (FY 11) ConAgra include consumer promotion expense
2014 Packaged Food Preview 66 09 January 2014
Entrepreneurs are now the trend setters, not the big brands. These days, the big, disruptive innovation in food and beverage (e.g. Greek yogurt, premium soup, single-serve coffee, and coconut water) is coming from small, entrepreneurial manufacturers rather than big ones. Industry leaders aren’t launching products that reinvent how a consumers approach a food category or an eating occasion. Sometimes the big brands get it right – like Nespresso coffee pods, General Mills’ Nature Valley snack bars, and DiGiorno pizza all generated true category growth. But the vast majority of product innovation fails by year two. Most processed food companies are poorly positioned on health and wellness Demand is rising for processed foods with non-GMO ingredients, gluten-free grain, and reduced sugar. The conundrum for the big food companies is that it takes a lot of effort to develop good tasting products with these characteristics and do it in a scalable fashion. Their business models and asset platforms are designed to satisfy mass audiences, not the "early adopters." That said, General Mills' successful launch of gluten-free Chex and the conversion of Cheerios to non-GMO indicates that the management team is staying in touch (but then how did they miss Greek yogurt?) In fact, packaged foods companies are generally considered the villain in the fight against obesity and purity. Nutritionists actively discourage processed foods because of the low nutritional values and the complex ingredient statements. As a result, consumers are more willing to try niche “homespun” brands when seeking “natural” and “organic” solutions as opposed to the big corporate brands. Big brands have tried to get healthier by removing sodium and sugar, but these efforts usually hurt sales because they come at the expense of taste (just ask Campbell’s and Heinz). In order to grow, we think the big companies will simply accelerate the pace of acquisitions. Larabar, Bear Naked, Kashi and Food Should Taste Good are all now in the hands of bigger companies. Perhaps Annie’s Homegrown is next. Private label is still expanding The U.S. grocers have accelerated their efforts to expand their private label offerings. They view private label as a positive for several reasons: it gives them a way to differentiate the branding of their stores, it provides a negotiating tool in their dealings with branded suppliers, and it often enhances profit margins. The quality of packaged foods offerings has improved as well, which has helped improve consumer loyalty. Most grocers now have a two-tiered pricing strategy with premium and discount versions on the shelf next to each other. Costco’s strategy is to make Kirkland branded products that exceed their branded peers in terms of quality. The result of all these headwinds is market share erosion Leading manufacturers in the top 30 packaged food categories lost a startling 2.4 points of market share between 2004 and 2011. This trend continued in 2012. The middle tier benefited the most from the share shift, up 0.9 points, and private label improved 190 bps. Rather than getting squeezed out by the #1 and #2 brands, the middle tier is actually flourishing.
2014 Packaged Food Preview 67 09 January 2014
Exhibit 76: The leading food manufacturer has lost 250 bps of market share between 2004 and 2012 while private label gained 190 bps
14.3% 16.2% 41.0% 38.5% 27.0% 27.9%
17.8% 17.4%
Leading Food Manufacturer Leading Food Manufacturer #2 Manufacturer #2 Manufacturer Middle Tier Middle Tier Private Label Private Label
Source: Company data, Credit Suisse estimates What does this mean for Kraft? Kraft management readily admits that they have squandered their lead. Brands like Planters, Maxwell House, Jell-O, and Kraft Singles are shadows of their former selves. Management vows to mend its ways by investing in advertising (now slightly above 3% of sales), but only for the brands that develop a well- thought out path to profitability. What does this mean for Campbell? Campbell is the company we are most concerned about structurally because the company has yet to prove it can stem the declines in its canned soup business (and now beverages too?). They also lack any platform in emerging markets to compensate for the slowing macro trends in developed markets. Commodity volatility continues to reduce visibility The rising demand for commodities in emerging markets and the growth of the alternative fuels industry has led to structurally lower levels of inventories across grain and livestock. Food companies generally have the pricing power to pass along higher prices to consumers, but it always comes with a shock to volume. Perhaps more importantly, it is hard to focus resources on category growth when one is spending 90% of one’s time arguing with customers for another price increase. Food companies are more vulnerable to this issue than household products and beverage companies because ingredients tend to account for a larger percentage of their COGs – usually 35% to 50%.
2014 Packaged Food Preview 68 09 January 2014
Exhibit 77: We are expecting ~2% deflation in FY14
145 11% Inflation 0.3% 0-1% Deflation Inflation 1-2% 140 Deflation 5% Deflation 135 6% Inflation 130 11% Inflation 125
120 6% Inflation 115 110 105
100
Q1 07 Q1 09 Q4 Q2 07 Q2 07 Q3 07 Q4 08 Q1 08 Q2 08 Q3 08 Q4 09 Q1 09 Q2 09 Q3 10 Q1 10 Q2 10 Q3 10 Q4 11 Q1 11 Q2 11 Q3 11 Q4 12 Q1 12 Q2 12 Q3
Q1 13E Q1 13E Q2 13E Q3 13E Q4 14E Q1 14E Q2 14E Q3 14E Q4 Q4 12E Q4 Source: Company data, Credit Suisse estimates
Exhibit 78: Inflation/Deflation by commodity group CY14 Inflation/ % of cost Kellogg (Deflation) bucket Grain (flour, wheat, durum wheat, corn) -20% 10% Milk 2% 0% Cheese -1% 0% Cocoa 3% 4% Sugar/HFCS -18% 7% Coffee -4% 0% Protein -1% 0% Other ingredients -2% 19% Packaging 1% 17% Freight -4% 10% Energy 2% 3% Labor 3% 30% Weighted Average Deflation -2.7% Source: Company data, Credit Suisse estimates
2014 Packaged Food Preview 69 09 January 2014
Exhibit 79: Basket of COGS by Company CAG CPB GIS HNZ HSY K KRFT SJM MDLZ FY 13 Sales 15,474 8,052 17,774 11,529 7,098 14,829 18,190 5,898 35,499 FY 13 COGS 12,011 5,049 11,355 7,333 3,815 9,040 12,310 3,859 22,155 COGS % 78% 63% 64% 64% 54% 61% 68% 65% 62%
Total Packaging 19.8% 20.0% 17.0% 22.0% 13.0% 17.0% 20.0% 9.0% 20.0% Food Costs 51.2% 38.0% 40.0% 43.0% 55.0% 40.0% 45.0% 65.0% 55.0% Overhead/Labor 29.0% 42.0% 43.0% 35.0% 32.0% 43.0% 35.0% 26.0% 25.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Food Flour 0.6% 3.2% 3.6% 1.5% 0.0% 4.5% 0.0% 0.0% 5.0% Wheat 4.0% 1.2% 1.5% 0.0% 0.0% 0.0% 0.0% 3.0% 0.0% Durum Wheat 1.9% Corn 2.2% 0.0% 1.6% 0.5% 0.0% 2.4% 0.0% 0.0% 0.0% Other Grains 0.0% 0.0% 2.0% 7.0% 0.0% 2.7% 0.5% 0.0% 0.0% Vegetable Oil 9.8% 0.7% 1.6% 3.6% 0.0% 1.6% 7.7% 5.0% 4.4% Sugar 0.5% 1.5% 3.2% 0.6% 5.5% 6.0% 3.3% 3.0% 8.3% HFCS 3.0% 2.0% 3.0% 4.7% 0.0% 1.1% 1.4% 0.0% 0.9% Cocoa 0.0% 0.5% 2.4% 0.0% 22.0% 4.3% 0.0% 0.0% 7.6% Coffee 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 3.3% 25.0% 7.9% Eggs 0.7% 0.6% 0.4% 0.0% 0.0% 0.8% 1.4% 0.0% 0.0% Cheese 0.0% 0.0% 0.3% 0.0% 0.0% 0.0% 8.1% 0.0% 2.8% Milk 1.6% 1.4% 2.5% 1.0% 11.0% 0.0% 2.3% 3.0% 3.0% Tomatoes 4.1% 9.4% 0.7% 7.0% 0.0% 0.0% 0.0% 1.5% 0.0% Potatoes 0.0% 0.0% 0.0% 3.9% 0.0% 0.0% 0.0% 0.0% 0.0% Peanuts 0.0% 0.0% 0.0% 0.0% 5.5% 1.5% 0.0% 15.0% 0.0% Tree Nuts/Almonds 0.0% 0.2% 0.0% 0.0% 1.7% 0.4% 1.6% 0.0% 3.5% Pork 6.6% 3.4% 2.3% 1.8% 0.0% 0.3% 4.1% 0.0% 0.0% Beef 1.8% 1.7% 0.1% 0.8% 0.0% 0.0% 2.1% 0.0% 0.0% Chicken 3.8% 1.7% 0.5% 0.7% 0.0% 0.0% 0.0% 0.0% 0.0% Other 12.3% 10.6% 14.2% 9.9% 9.4% 14.4% 7.3% 9.5% 11.6% Packaging Paper Packaging 6.9% 4.0% 10.2% 5.5% 5.2% 11.9% 12.0% 2.0% 13.0% Plastic Packaging 6.9% 4.0% 3.4% 5.5% 5.2% 3.4% 5.0% 7.0% 5.0% "Metal" Packaging 5.9% 12.0% 3.4% 11.0% 2.6% 1.7% 3.0% 0.0% 2.0%
Overhead Freight / Crude 9.0% 7.0% 9.0% 8.0% 7.5% 10.0% 10.0% 5.0% 5.0% Energy (Nat Gas) 1.0% 3.0% 3.0% 3.0% 3.0% 3.0% 5.0% 3.0% 5.0% Labor 19.0% 32.0% 31.0% 24.0% 21.5% 30.0% 20.0% 18.0% 15.0%
Total Grains 6.9% 4.4% 8.7% 9.0% 0.0% 9.6% 2.4% 3.0% 5.0% Source: Company data, Credit Suisse estimates
2014 Packaged Food Preview 70 09 January 2014
Exhibit 80: Packaged Foods Ingredient Cost Index and Year-Over-Year Inflation Note: Assumes six month lag in grain, protein, and packaging costs due to forward buying/hedging 2009A 2010A 2011A 2012A Q1 13 Q2 13 Q3 13 Q4 13E 2013E Q1 14E Q2 14E Q3 14E Q4 14E 2014E ConAgra -6% 4% 12% 2% 3% 4% 5% 3% 4% -3% -2% -3% -3% -3% Campbell -2% 4% 6% 1% 3% 4% 5% 3% 4% 0% 0% 0% 0% 0% General Mills -4% 5% 8% 0% 3% 4% 4% 2% 3% -1% 0% -1% 0% -1% Hershey -1% 7% 3% -1% 1% 1% -1% -2% 0% -1% 0% -1% 1% 0% Kellogg -3% 5% 8% 2% 1% 3% 2% 1% 2% -2% -2% -3% -1% -2% Kraft Foods -9% 8% 12% 0% 1% 3% 3% 0% 2% -2% 0% -2% -1% -1% Mondelez -4% 8% 15% -3% -2% 1% -2% -3% -2% -4% -2% -2% 0% -2% Smucker -7% 3% 28% -3% -4% -2% -9% -9% -6% -8% -6% -3% 0% -5% YoY Inflation -4.7% 5.6% 11% 0% 1% 2% 1% -1% 1% -3% -2% -2% 0% -2% Source: Company data, Credit Suisse estimates The Bull Case These are resilient and predictable business models. Despite all the challenges, packaged food is still a safe haven for investors during times of market stress. In 2008 when the markets crashed and the cyclical stocks cratered, the packaged foods business models held up relatively well. Volume declined and the stocks fell. But the weakness wasn’t nearly as bad as the overall market. In fact, despite all of its faults, the U.S. food group has generally lived up to its reputation for delivering modest but steady shareholder returns over time. U.S. food companies have outperformed the S&P 500 significantly over the past six years and only modestly underperformed versus the S&P consumer staples sector (SP 477) despite having a decidedly slower growth profile.
Exhibit 81: U.S. food stock price appreciation has averaged 4% per year since 2006, only slightly below the overall consumer staples group (SP 477) 2006 2007 2008 2009 2010 2011 2012 CAGR CPB 100 92 77 87 89 85 90 -2% CAG 100 88 61 85 84 98 109 1% GIS 100 99 105 123 124 140 140 6% HNZ 100 104 84 95 110 120 128 4% HSY 100 79 70 72 95 124 145 6% K 100 105 88 106 102 101 112 2% KFT 100 91 75 76 88 105 113 2% MKC 100 98 83 94 121 131 165 9%
Avg 100 95 80 92 103 115 127 4%
SP50 100 104 64 79 89 89 101 0% SP477 100 112 92 102 113 125 134 5% Source: Company data, Credit Suisse estimates Better management teams in place. Our view of the group has evolved as management teams adopted more realistic expectations for growth and manage their businesses for cash and value rather than volume. Many of the CEOs in place today seem to “get it.” The perennial underperformers in the space like ConAgra and Heinz streamlined their portfolios, upgraded information systems, and upgraded their marketing capabilities so that they can manage through an increasingly dynamic marketplace. Sara Lee broke itself up and sold its parts. Potential for further consolidation and private equity bids. With borrowing costs so low, the potential for leveraged buyouts is higher. The strong cash flow characteristics of these companies make them attractive targets for private equity shops
2014 Packaged Food Preview 71 09 January 2014
These companies have pricing power over time. Investors should take comfort in the fact that food companies are still the ones that dictate pricing, not grocers. The branded companies do a pretty good job over time of passing through commodity costs to consumers. The dialogue created with consumers through advertising campaigns gives them the power to do this. Pricing tends to lag inflation for six months or so, but history indicates that it always catches up.
Exhibit 82: Long Term CPI Index and PPI Index For Food at Home
Source: Bureau of Labor Statistics The eating away from home trend is slowing structurally. Consumers have more time on their hands and re-learning how to cook. They also view cooking at a home as a way to improve their health.
Exhibit 83: Restaurant Same-Store Sales Growth versus Packaged Foods Retail Sales Growth 8%
6%
4%
2%
0%
-2%
-4%
Packaged Food Retail Sales Growth Restaurant SSS Growth
Source: Credit Suisse Restaurant Team, Nielsen Data, FDM+Wal-Mart, 62 categories. Among the packaged foods companies, ConAgra, McCormick, and Heinz have the most exposure to foodservice. But the protein producers all have more exposure than the packaged foods companies.
2014 Packaged Food Preview 72 09 January 2014
Exhibit 84: Food Service As a Percent of Sales Protein Companies Packaged Foods Pilgrims Pride 55% ConAgra 27% Tyson 36% McCormick 21% Hormel 26% Heinz 16% Smithfield 20% General Mills 9% Campbell 8% Kraft 6% Kellogg 5% Source: Company data, Credit Suisse estimates. More cash for shareholders. Having de-leveraged their balance sheets significantly since 2008 and sold off non-core assets, the management teams of food companies have been making a greater effort to return more cash to shareholders. Dividend increases in the space averaged 10% over the past year and dividend payout ratios are generally higher since 2007.
Exhibit 85: Dividend Increases Averaged 10% Over The Past Year Dividend Payout Ratio Most Recent Dividend Increase Current 2007 +/- % Increase Date BGS 77% 135% -57% HRL 17.6% Feb-14 KRFT 66% NA NA HSY 15.5% Sep-13 GIS 53% 45% 8% GIS 15.2% Aug-13 HSY 46% 55% -9% MJN 13.3% Apr-13 CPB 50% 41% 9% SJM 11.5% Sep-13 K 46% 43% 2% BGS 10.3% Oct-13 MKC 43% 43% 0% MDLZ 8.0% Oct-13 CAG 42% 51% -9% MKC 8.8% Jan-14 MJN 37% NA NA CPB 7.6% Oct-13 SJM 40% 40% 0% KRFT 5.0% Jan-14 MDLZ 34% NA NA K 4.5% Sep-13 HRL 35% 28% 7% CAG 4.2% Oct-12 AVG 43% 1% AVG 10.1%
Other HSH 42% NA NA HSH 40.0% Aug-13 TSN 11% 20% -9% TSN 50.0% Mar-13 ADM 29% 21% 8% ADM 26.3% Mar-14 BG 17% 11% 6% BG 11.1% Sep-13 Source: Company data, Credit Suisse estimates
2014 Packaged Food Preview 73 09 January 2014
Companies Mentioned (Price as of 08-Jan-2014) Campbell Soup Company (CPB.N, $42.59, NEUTRAL, TP $41.0) Church & Dwight Co., Inc. (CHD.N, $65.36) Clorox Co. (CLX.N, $88.99) Colgate-Palmolive (CL.N, $63.54) ConAgra Foods, Inc. (CAG.N, $33.62, NEUTRAL, TP $35.0) Danone (DANO.PA, €51.17) Dr Pepper Snapple Group, Inc (DPS.N, $47.72) Estee Lauder Companies Inc (EL.N, $73.08) General Mills (GIS.N, $48.57, NEUTRAL, TP $51.0) Henkel (HNKG_p.F, €82.175) Hillshire Brands (HSH.N, $33.04) Hormel Foods (HRL.N, $44.8, OUTPERFORM, TP $49.0) J.M. Smucker Co. (SJM.N, $98.17, NEUTRAL, TP $108.0) Kellogg Company (K.N, $60.18, UNDERPERFORM, TP $62.0) Kimberly-Clark Corporation (KMB.N, $103.28) Kraft Foods Group (KRFT.OQ, $53.25, OUTPERFORM, TP $61.0) L'Oreal (OREP.PA, €123.75) McCormick & Company (MKC.N, $68.14, NEUTRAL, TP $70.0) Mead Johnson Nutrition Co. (MJN.N, $84.26, OUTPERFORM, TP $92.0) Molson Coors Brewing (TAP.N, $55.22) Mondelez (MDLZ.OQ, $34.82, NEUTRAL, TP $37.0) Nestle (NESN.VX, SFr66.45) PepsiCo, Inc. (PEP.N, $83.24) Pilgrims Prid (PPC.OQ, $16.12) Procter & Gamble Co. (PG.N, $80.24) Reckitt Benckiser (RB.L, 4683.0p) Starbucks (SBUX.OQ, $78.03) The Coca-Cola Company (KO.N, $39.94) The Hershey Company (HSY.N, $97.74, OUTPERFORM, TP $109.0) TreeHouse Foods (THS.N, $68.6) Tyson Foods (TSN.N, $33.92) Unilever (UNc.AS, €28.78) Wal-Mart Stores, Inc. (WMT.N, $77.83)
Disclosure Appendix
Important Global Disclosures I, Robert Moskow, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.
3-Year Price and Rating History for Campbell Soup Company (CPB.N)
CPB.N Closing Price Target Price Date (US$) (US$) Rating 24-May-11 35.20 35.00 N 02-Sep-11 31.46 33.00 09-Jul-12 32.72 R 23-Aug-12 34.70 35.00 N 01-Oct-12 35.04 35.00 U 25-Feb-13 39.98 40.00 16-May-13 47.85 44.00 26-Jul-13 47.07 48.00 N 30-Aug-13 43.18 47.00
15-Nov-13 42.42 46.00 NEUTRAL 19-Nov-13 39.20 41.00 REST RICT ED UNDERPERFORM * Asterisk signifies initiation or assumption of coverage.
2014 Packaged Food Preview 74 09 January 2014
3-Year Price and Rating History for ConAgra Foods, Inc. (CAG.N)
CAG.N Closing Price Target Price Date (US$) (US$) Rating 24-Mar-11 23.40 25.00 N 04-May-11 25.51 R 19-Sep-11 23.39 25.00 N 20-Dec-11 26.19 27.00 21-Sep-12 27.51 29.00 27-Nov-12 29.63 32.00 20-Feb-13 33.65 36.00 28-Jun-13 34.93 37.00 10-Sep-13 31.54 36.00 19-Sep-13 30.80 34.00 NEUTRAL REST RICT ED 19-Dec-13 33.47 35.00 * Asterisk signifies initiation or assumption of coverage.
3-Year Price and Rating History for General Mills (GIS.N)
GIS.N Closing Price Target Price Date (US$) (US$) Rating 23-Mar-11 36.24 40.00 O 05-Jul-11 37.16 40.00 N 15-Dec-11 39.96 41.00 20-Sep-12 40.44 42.00 20-Dec-12 41.57 44.00 21-Mar-13 47.86 46.00 27-Jun-13 48.34 50.00 18-Sep-13 50.15 51.00 * Asterisk signifies initiation or assumption of coverage. OUTPERFORM NEUTRAL
3-Year Price and Rating History for Hormel Foods (HRL.N)
HRL.N Closing Price Target Price Date (US$) (US$) Rating 23-Feb-11 26.75 27.00 N 22-Nov-11 28.82 32.00 24-May-13 41.53 39.00 29-Jul-13 42.24 46.00 O 26-Nov-13 44.95 49.00 * Asterisk signifies initiation or assumption of coverage.
NEUTRAL OUTPERFORM
2014 Packaged Food Preview 75 09 January 2014
3-Year Price and Rating History for J.M. Smucker Co. (SJM.N)
SJM.N Closing Price Target Price Date (US$) (US$) Rating 13-Nov-13 107.93 115.00 N * * Asterisk signifies initiation or assumption of coverage.
NEUTRAL
3-Year Price and Rating History for Kellogg Company (K.N)
K.N Closing Price Target Price Date (US$) (US$) Rating 04-Feb-11 53.42 57.00 N 04-May-11 56.76 64.00 05-Jul-11 55.14 60.00 03-Nov-11 49.91 53.00 15-Feb-12 52.87 56.00 23-Apr-12 50.70 54.00 01-Nov-12 53.50 55.00 16-Jan-13 57.03 55.00 U 06-Feb-13 58.99 57.00 02-May-13 63.42 62.00 NEUTRAL UNDERPERFORM * Asterisk signifies initiation or assumption of coverage.
3-Year Price and Rating History for Kraft Foods Group (KRFT.OQ)
KRFT.OQ Closing Price Target Price Date (US$) (US$) Rating 02-Oct-12 45.42 50.00 O * 03-May-13 53.11 57.00 01-Aug-13 57.14 61.00 * Asterisk signifies initiation or assumption of coverage.
OUTPERFORM
2014 Packaged Food Preview 76 09 January 2014
3-Year Price and Rating History for McCormick & Company (MKC.N)
MKC.N Closing Price Target Price Date (US$) (US$) Rating 26-Jan-11 44.74 50.00 N 27-Mar-12 54.22 56.00 27-Jun-12 59.09 59.00 28-Sep-12 62.04 61.00 03-Apr-13 71.60 70.00 * Asterisk signifies initiation or assumption of coverage.
NEUTRAL
3-Year Price and Rating History for Mead Johnson Nutrition Co. (MJN.N)
MJN.N Closing Price Target Price Date (US$) (US$) Rating 19-Apr-11 61.49 70.00 O 28-Apr-11 65.15 74.00 28-Jul-11 71.76 80.00 10-Oct-11 71.34 82.00 26-Apr-12 86.53 98.00 18-Jul-12 73.01 86.00 26-Jul-12 70.69 84.00 25-Oct-12 63.53 76.00 16-Jan-13 66.96 76.00 N 07-Aug-13 79.05 90.00 O OUTPERFORM NEUTRAL * Asterisk signifies initiation or assumption of coverage.
3-Year Price and Rating History for Mondelez (MDLZ.OQ)
MDLZ.OQ Closing Price Target Price Date (US$) (US$) Rating 06-May-11 34.08 37.00 O 30-Jun-11 35.23 39.00 04-Aug-11 33.78 41.00 20-Jan-12 38.67 45.00 02-Oct-12 28.00 31.00 17-Apr-13 29.84 33.00 08-Aug-13 32.70 34.00 17-Sep-13 31.98 36.00 * Asterisk signifies initiation or assumption of coverage. OUTPERFORM
2014 Packaged Food Preview 77 09 January 2014
3-Year Price and Rating History for The Hershey Company (HSY.N)
HSY.N Closing Price Target Price Date (US$) (US$) Rating 02-Feb-11 48.61 55.00 O 28-Feb-11 52.32 56.00 18-Mar-11 53.87 58.00 26-Apr-11 57.27 64.00 21-Oct-11 60.26 70.00 27-Oct-11 57.46 68.00 24-Apr-12 66.00 75.00 26-Jun-12 70.00 78.00 11-Dec-12 73.31 82.00 01-Feb-13 80.14 90.00 OUTPERFORM 24-Apr-13 89.34 103.00 24-Oct-13 96.41 109.00 * Asterisk signifies initiation or assumption of coverage. The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark*over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ra tings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; Austr alia, New Zealand are, and prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, 12-month rolling yield is incorporated in the absolute total return calculation and a 15% and a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the +10-15% and -10-15% levels in the Neutral stock rating definition, respectively. Prior to 10th December 2012, Japanese ratings were based on a stock’s total return relative to the average total return of the relevant country or regional benchmark. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances.
Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.
Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cov er multiple sectors.
Credit Suisse's distribution of stock ratings (and banking clients) is:
Global Ratings Distribution Rating Versus universe (%) Of which banking clients (%) Outperform/Buy* 43% (53% banking clients) Neutral/Hold* 40% (49% banking clients) Underperform/Sell* 15% (42% banking clients) Restricted 2% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, an d Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdin gs, and other individual factors.
2014 Packaged Food Preview 78 09 January 2014
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Price Target: (12 months) for ConAgra Foods, Inc. (CAG.N) Method: Our target price of $35 reflects a 13x P/E multiple against our 12-month forward EPS estimate. This represents a discount to peers reflecting our concerns related to the challenges of the consumer volume environment and the Ralcorp integration. Risk: Risks to our $35/share target price include challenges associated with the Ralcorp integration (including realization of synergies and issues related to the hybrid private label / branded business model), volatile commodity input costs (especially in vegetable oil and protein), market share losses to competition or private label, and future volume declines. Price Target: (12 months) for Campbell Soup Company (CPB.N) Method: Our target price of $41 is based on 15x our CY15 EPS estimate, a 12% discount to peers reflecting the risk of further reductions to estimates and the company's intrinsically below-peer EPS growth rate of 5-7%. Risk: Major risks to our $41 / share target price for Campbell Soup include competitive pressure in simple meals, inflationary pressure in major input costs like energy, steel, resins, and soybean oil, and the cost of failure if new product introductions do not resonate with consumers or retail customers. Price Target: (12 months) for General Mills (GIS.N) Method: Our 12-month target price of $51 is based on a 16x P/E against our 12-month forward EPS estimate to reflect the company's low single- digit growth profile in relation to its peers. Risk: Our $51 target price would be at risk if General Mills does not meet our assumptions that the company can grow sales at a rate faster than the packaged food industry average by introducing succesful new products, leveraging its strong brands, and participating in fast-growing categories like yogurt and snack bars, and that productivity savings help offset rising input costs. Price Target: (12 months) for Hormel Foods (HRL.N) Method: Our 12-month target price of $49/share for Hormel Foods is based on a 19x P/E against our FY 15 EPS estimate of $2.56. This may sound expensive at first glance, but we note that on an EV/EBITDA basis, it represents a multiple of 10.9x, which is essentially in-line with the average valuation of much slower growing large cap packaged food companies. Risk: Risks to our $49/share target price for Hormel Foods include: changes in agricultural (beef, pork, turkey, sugar) commodity prices, the impact of animal disease on meat demand, foreign exchange fluctuations, and Turkey margins returning to more "normalized" levels. Price Target: (12 months) for The Hershey Company (HSY.N) Method: Our 12-month $109/share target price is based on a 23.5x P/E against our 2015 EPS estimate. This is in-line with where the stock is trading today. Risk: Risks to HSY achieving our $109 target price are: (1) execution risk in the growing premium/dark chocolate category; (2) volatile cocoa, nuts and dairy commodity input costs; and (3) the risk of competitive incursion in chocolate from Mars. Price Target: (12 months) for Kellogg Company (K.N)
Method: Our 12-month target price of $62/share assumes a 14.5x P/E multiple against our CY15 EPS estimate. Risk: Risks to our $62/share target price include price pressure from competition in all of its major categories, volatile macro economic conditions in Latin America and Western Europe, and integration risk related to Pringles. Price Target: (12 months) for Kraft Foods Group (KRFT.OQ) Method: Our 12 month target price of $61 is based on a 17.5x P/E against our 1-year forward EPS estimate $3.49. This reflects higher multiples in the group and the probability of more positive earnings revisions. Risk: Risks to our $61/share target price include high financial leverage and a high dividend payout ratio reducing management's flexibility, a high need for reinvestment in the brands, and a spotty execution track record with main brands losing market share over the last ten years.
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Price Target: (12 months) for Mondelez (MDLZ.OQ) Method: Our $37 target price is based on a 19.5x P/E multiple against our 2015 EPS estimate of $1.92. This represents an 18% premium to U.S. food companies and a 5-8% premium to global peers Nestle and Unilever. Risk: Risks to our $37 target price are the efficacy of increased investment and cost-cutting programs, pricing and mix offset continued commodity cost pressures, competition from value brands and private label, and continued weakening macro conditions in Europe and the U.S. Price Target: (12 months) for Mead Johnson Nutrition Co. (MJN.N) Method: Our target price of $92 / share for Mead Johnson Nutrition Co. is based on a 22.5x P/E against our FY15 EPS estimate The stock has traded in a P/E range of 17x to 26x over the past three years. Risk: Risks to our $92 / share target price for Mead Johnson Nutrition Co. are consumers trading down to private label products in the U.S., declines in China's growth rate, changes in the federally-funded WIC (Women, Infants, and Children) nutrition program, and input cost inflation predominantly for the company's largest input cost non-fat dry milk. Price Target: (12 months) for McCormick & Company (MKC.N)
Method: Our 12-month $70/share target price is based on an 19x P/E (price-to-earnings) multiple against our 1-year forward rolling EPS of $3.71 EPS. This represents a 13% premium to MKC's peer group. Risk: Major risks to McCormick's earnings base, long-term growth rate and our $70 target price include weak macro conditions in France (10% of sales), private label incursions, price competition in bulk commodity ingredients, and delayed new product launches by Industrial customers. Price Target: (12 months) for J.M. Smucker Co. (SJM.N)
Method: Our target price of $108 is based on a P/E multiple of 16x our calendar 2015 EPS estimate. This represents an approximate 5% premium to the current CY15 peer P/E, generally in-line with the five year historical average. Risk: Key risks to our $108 target price include intensified competition in key categories, downward pricing action in key categories resulting from falling commodity costs, margin compression from commodity inflation, a structural shift in consumer preferences, or changes to the long-term M&A strategy.
Please refer to the firm's disclosure website at https://rave.credit-suisse.com/disclosures for the definitions of abbreviations typically used in the target price method and risk sections.
See the Companies Mentioned section for full company names The subject company (CAG.N, CPB.N, GIS.N, HRL.N, HSY.N, K.N, KRFT.OQ, MDLZ.OQ, MJN.N, MKC.N, SJM.N) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (CAG.N, CPB.N, GIS.N, KRFT.OQ, MDLZ.OQ, MJN.N) within the past 12 months. Credit Suisse provided non-investment banking services to the subject company (CAG.N, CPB.N, GIS.N, KRFT.OQ) within the past 12 months Credit Suisse has managed or co-managed a public offering of securities for the subject company (GIS.N, KRFT.OQ, MDLZ.OQ) within the past 12 months. Credit Suisse has received investment banking related compensation from the subject company (CAG.N, CPB.N, GIS.N, KRFT.OQ, MDLZ.OQ, MJN.N) within the past 12 months Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (CAG.N, CPB.N, GIS.N, HRL.N, HSY.N, K.N, KRFT.OQ, MDLZ.OQ, MJN.N, MKC.N, SJM.N) within the next 3 months. Credit Suisse has received compensation for products and services other than investment banking services from the subject company (CAG.N, CPB.N, GIS.N, KRFT.OQ) within the past 12 months As of the date of this report, Credit Suisse makes a market in the following subject companies (CAG.N, CPB.N, GIS.N, HRL.N, HSY.N, K.N, KRFT.OQ, MDLZ.OQ, MJN.N, MKC.N, SJM.N). Credit Suisse has a material conflict of interest with the subject company (CPB.N) . Credit Suisse Securities (USA) LLC acted as financial advisor to Bolthouse Holding Corp in connection with the announced sale of the company to Campbell Soup Company. Important Regional Disclosures Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report.
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The analyst(s) involved in the preparation of this report have not visited the material operations of the subject company (CAG.N, CPB.N, GIS.N, HRL.N, HSY.N, K.N, KRFT.OQ, MDLZ.OQ, MJN.N, MKC.N, SJM.N) within the past 12 months Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit http://www.csfb.com/legal_terms/canada_research_policy.shtml. Credit Suisse has acted as lead manager or syndicate member in a public offering of securities for the subject company (CPB.N, GIS.N, KRFT.OQ, MDLZ.OQ) within the past 3 years. As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report. Principal is not guaranteed in the case of equities because equity prices are variable. Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that.
For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at https://rave.credit- suisse.com/disclosures or call +1 (877) 291-2683.
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