CCRED POLICY BRIEF

Industrial Development Research Programme (IDRP): Food sector1

July 2017 Introduction and Nedcor with significant shares in 5 of The food processing sector in the 13 firms considered. The Government has grown more rapidly with a real value- Employees Pension Fund (GEPF) and add of 34% more in 2014 than in 2004, and Public Investment Corporation (PIC) have compared to 15% in the manufacturing the largest shareholding in two of the sector as a whole. The sector is also the largest companies in the sector; Pioneer largest manufacturing employer in the Foods through GEPF (10.9%) and Tiger South Africa, accounting for 13.6% of total Brands through PIC (11.3%). It is important manufacturing employment. Given the to note however that the PIC and GEPF potential of the sector to drive employment have shareholding across a very broad set and growth, this policy brief identifies the of firms in the economy and will generally main trends in terms of investment and not seek to exercise control and be performance of the firms listed under the involved in the strategic direction of the food producers sector on the investee firms except on certain cross- Johannesburg Stock Exchange (JSE). The cutting issues such as compliance with assessment considers the period 2010 to BBBEE requirements. 2015. A key question is understanding these investments and the orientation of Structure of the sector the largest food producers as it relates to The sector is highly concentrated with the industrial development in South Africa. different companies holding significant market share in a number of segments in The firms considered are: AH-Vest, Astral the food sector. For instance, RCL Foods Foods, AVI, Clover, Crookes Brothers, and Astral have a combined 46% market Oceana Group, Pioneer Foods, Quantum share in the broiler meat production market Foods, RCL Foods, Rhodes Food, (poultry); Rhodes Food group has a 66.3% Sovereign Foods, Tiger Brands and market share in canned meats; Tiger Tongaat Hulett. These firms are involved in Brands has 48.6% market share of the various levels of the agricultural value retail value in the sugar confectionery chain from farming, poultry production and market etc. fishing to production of processed foods. The sector also has high barriers to entry Ownership structure that include: high capital requirements, The ownership structure of most of the high levels of coordination through the firms in the food sector is largely comprised value chain, and vertical integration. of nominee companies of the large banks Entrants face difficulty in accessing including Standard Bank which has a stake customers and there is a history of strategic in 10 of the firms, FNB with ownership in 8 behaviour by incumbents through

1 This policy brief draws from an underlying working paper forming part of the Industrial Development Research Programme (IDRP) funded by the DTI. See Nhundu et al. (2017), ‘Growth and Strategies of large and lead firms - Food Sector’, CCRED Working Paper No. 10/2017.

1

anticompetitive conduct e.g. bread cartel Replacement capital expenditure more involving Pioneer Foods and Tiger Brands, than doubled from R1.6 billion (2010) to amongst others. An important means of R3.7 billion in 2015 reflecting strategies to entry and expansion into the sector has adopt the latest technology in order to been through acquisitions to access new lower production costs and improve and niche markets. efficiency and effectiveness. Furthermore, since 2010, investment in mergers and Key performance metrics acquisitions (M&A), although vastly Assets different from year to year, has been Tongaat Hulett, Tiger Brands, Pioneer increasing on average while expansion Foods and RCL Foods are the largest capital investment has been decreasing. companies in the food processing sector in This suggests that firms are now more terms of total assets accounting for 25%, inclined to expand operations through 21%, 14% and 12%, respectively. Tongaat acquiring other existing businesses rather Hulett’s assets consist of a very large than expanding their own existing capacity. portfolio of estate property and growth is Overall, replacement capital, expansion underpinned by further acquisitions of capital and M&A constituted 38%, 24% and Xinavane sugar mill in , and 38% of expenditure, respectively. Major various downstream investments. RCL M&A transactions in the period include Foods exhibited the highest assets growth RCL Foods’ acquisition of Foodcorp largely through major acquisitions that (2014), Tiger Brands’ acquisition of include those of Foodcorp, Senn Logistics Dangote flour mills, Oceana’s 2015 (largest logistics firm in Botswana) and acquisition of US-based Daybrook. TSB Sugar (top 3 sugar producer in South Africa). Overall total assets in the food Profitability processing sector doubled between 2010 The largest companies in the sector in and 2015 with a CAGR of 15%. terms of share of total revenue, as with total assets, are Tiger Brands (54%), Pioneer Retention rates (18%), RCL Foods (12%) and Tongaat One of the key determinants of investment Hulett (12%). Over the period under review is the portion of the profits that a firm total revenue in the sector grew by 70% retains within the company after paying (CAGR 12%) driven by RCL Foods (CAGR dividends (retention rate). High retention 28%), Tongaat Hulett (13%), Oceana rates (above 50%) are indicative of firms in (13%) and Tiger Brands (10%). a growth phase, or firms with growth capacity and potential to make further The sector reported consistently poor investment in new projects and expansion. profitability figures relative to the average Low retention generally shows firms that of all firms listed on the JSE. On average prioritise paying out dividends to the net profit margin of the food producers shareholders. In this regard, the food was 5% lower than the JSE benchmark. producers sector exhibited mixed results This could be explained by the poor with only 6 of the large established entities performance of poultry firms (Astral, RCL retaining significant proportions of profits Foods, Sovereign and Quantum Foods presumably with a view to reinvest. which together account for 24% of total revenue of firms in the sector), affected by Capital expenditure and investments imports, amongst other factors. Positive results were observed from firms with

2

greater diversity in terms of product to enter and compete effectively in the categories which could be largely a result sector. of the ability to mitigate losses and risk in one product category against profits in Besides entering new markets through another. acquisitions, some food producers introduced new product lines (e.g. AH-Vest Emerging trends launching a low salt additive tomato sauce Three main trends could be observed from for health conscious customers) or the firms’ investment activity: the engaged in joint venture and partnership consolidation of the firms, their entrance deals (e.g. Future Life/Clover). The into niche markets (diversification) and partnership deals have the potential to expansion internationally. further increase the large firms’ market share and raise barriers to entry in various Consolidation and integration food product lines. Out of the 92 total investment transactions made by the 13 firms investigated International expansion (identified from company documents), 32 Of the 13 firms investigated, 10 expanded transactions (35%) were purchases of into other countries between 2010 and shares or an increase in existing 2015/16. For the period under review, 56% shareholding in other companies to of the total value of investments by firms in consolidate ownership and influence in this sector were outside South Africa and existing investments. There was also the the remaining 46% within the country. Of integration of internal divisions within the the 35 international investments that took firms. Some of the reasons provided by place, 54% were in southern Africa, 34% in firms for consolidation and integration are the rest of Africa and 11% outside Africa. that the firms wanted to benefit from The move towards international expansion operational synergies, and take control and appears to be largely due to the saturation ownership of core divisions such as and low demand in the local market. distribution and warehousing. Policy considerations Niche market entrance High concentration in the sector points to A number of the firms diversified their the needs for measures to encourage product offering and entered niche entry. markets. Their primary means of entry into these markets was the acquisition of While there have been a number of policy established companies. For instance, interventions in the sector, they have not Clover acquired Nkunzi Milkway (Pty) Ltd, had the objective of encouraging new entry an Ayrshire milk supplier of niche dairy and competition in the sector. The products to Woolworths. Entrants in the conditions the competition authorities have new market segments are likely to have placed on the merging parties in the sector, lower cost efficiency, financial capability however, have done much to reduce anti- and scale initially and are likely to competitive behaviour and to encourage experience some difficulty in establishing the entry of new participants by their brands such that the firms are emphasising supplier development vulnerable to acquisitions by larger programmes targeted at supporting black incumbent rivals. Additionally, high entry entrants and their access to the final barriers also make it difficult for new firms market. The conditions placed on the

3

Walmart/Massmart merger, for instance, producers in the region, particularly smaller resulted in the creation of a fund that firms that may be looking to start exporting. benefited entrants such as Lethabo Milling. The Competition Act and authorities are A key constraint for new firms relates to therefore a useful tool to open up for black funding for multi-level entry in various agro- entrants. There might be scope for the DTI processing and food production value to cooperate in the formulation of chains. Firms face challenges in accessing conditions for problematic mergers in the government incentives or funding from the food processing sector that would continue private sector. The extensive presence of to not only create funding for industrialists nominee companies of the large banks in but also support programmes. the ownership structure of food producers and public information from the banks It is also important for the competition suggests that they view the sector as a high authorities in South Africa to consider as a growth sector. This may point to priority the long-term effects of mergers in opportunities for partnerships with financial South Africa to the extent that they result in institutions to set up more easily accessible increased concentration in the sector. This loans and funding for entrants into the is especially important given high barriers sector. An arrangement could be made in to entry (reinforced by vertical integration) which the government could provide and a notable absence of new, black- guarantees to industrialist to ensure they owned rivals that are able to contest these have access to necessary funding to either markets not only in South Africa, but in the start or grow their businesses. It is southern Africa region as well. Demand in important to note however that there may the region for processed food products be low incentives for financial investors, from South Africa has grown considerable, already earning good returns from interests and constitutes as large proportion of held in the large incumbent food producers, manufacturing exports. to support new challenger firms as well.

In this regard, collaboration with the DTI is Lastly, there are important dimensions at important given extensive incentive and the sub-sector level which should be funding programmes currently in effect in considered. For example, the poultry the sector, which may not succeed if industry which contributes about 25% of entrants cannot actually access markets total revenues in the sector has and grow their businesses. Drawing from experienced increasing costs and CCRED’s extensive work on agro- competition from foreign imports. The processing value chains in South Africa solution has been to provide various forms and the region, there are also other of protection from cheap imports. However, possible interventions that can increase there may be opportunities to increase the access to markets and integration of new cost competitiveness of domestic suppliers into concentrated food value producers relative to imports, through chains. These include addressing encouraging and developing capacity for constraints to supplying regional markets regional sourcing of key inputs into such as poor transport networks, non-tariff production such as soya from Zambia. This barriers and border delays in transiting includes projects to upgrade regional between South Africa and neighbouring sources where there are quality issues with countries. These constraints decrease the the products produced, and agreeing on cost competitiveness of South African appropriate standards.

4