Kraft Heinz and Kellogg’s breakup signals Big Food is shrinking

Big Food is slimming down.

As both consumers and regulators turn against ultra-processed foods, companies that make them are splitting up or selling off iconic brands. last year, unilever The ice cream business was spun off as The Magnum Ice Cream Company. Kraft Heinz Warren Buffett’s Berkshire Hathaway and private equity firm 3G Capital are scrapping most of the merger they forged over a decade ago and preparing to dissolve later this year. and Keurig Dr Pepper plans a similar split after completing its acquisition of JDE Petes.

By 2024, nearly half of all merger and acquisition activity in the consumer products industry will be through divestitures, according to consulting firm Bain. A Bain study found that 42% of M&A executives in the consumer products industry are preparing to sell assets over the next three years.

Of course, this trend is not limited to the consumer packaged goods industry. Industrial companies such as GE and Honeywell have been breaking up their companies in recent years. It’s happening in legacy media as well. Comcast spun off many of its cable assets to the owners of CNBC. VersantMeanwhile, Warner Bros. Discovery plans to spin off its cable network later this year as Netflix acquires its streaming and studio divisions.

“Many of the fields where you see this kind of activity have very intense competitive pressures that make it difficult to operate,” said Emily Feldman, a professor at the Wharton School at the University of Pennsylvania.

The pressure on packaged food and beverage companies is being driven by reduced demand, which has led to volume reductions for many products. They are looking to shed underperforming brands to rebuild their businesses and win back investors.

February will bring quarterly earnings reports and presentations at the annual CAGNY conference, giving investors more opportunities to hear about food executives’ portfolio plans. Companies to watch include Kraft Heinz, which may share details about a future split, and Nestlé, which is considering selling multiple brands in its portfolio.

For more than a decade, consumers have been buying fewer groceries in the inner aisles of grocery stores, turning instead to the outer aisles for fresh produce and protein. With the exception of the pandemic, many consumers returned to familiar brands. But rising prices and “shrinkflation” as life returns to normal have all but erased that change in behavior.

In recent years, regulators, encouraged by Health and Human Services Secretary Robert F. Kennedy Jr.’s “Make America Healthy Again” agenda, have put more pressure on processed foods and given them more attention. And with the rise of GLP-1 drugs to fight diabetes and obesity, some of food companies’ key consumers have lost their appetite for the sweet and salty snacks they used to eat.

As a percentage of total spending, the consumer packaged goods industry maintains its market share. But Peter Horsley, a partner at Bain, says big companies are losing customers to emerging brands and private label products.

On average, about 35% of large consumer goods companies’ portfolios are in categories that have grown more than 7%, Horsley said. By the way, more than half of private label brands are in high-growth categories such as yogurt and functional drinks, and this is even higher for rebel brands.

For Big Food, the result was a slowdown and even decline in sales, followed by a decline in inventory. In some cases, activist investors will ask companies to focus more on their core business and eliminate so-called distractions.

“There’s a lot of pressure from a valuation standpoint, especially in these listed companies,” said Raj Konanahalli, partner and managing director at Alix Partners. “One way to reset expectations is to focus more on core businesses and divest or divest slower, capital-intensive or non-core businesses.”

Konanahalli said the expansion of food companies has helped them expand their scale, enter new markets and increase sales, but it has also made their operations more complex. When you get too big, it becomes very difficult to make quick decisions and decide where and how to reinvest in your business.

To be sure, some of these sales and dissolutions follow deals that may have been unwise to begin with. In 2018, Keurig Green Mountain and Dr. Pepper Snapple Group merged to form Keurig Dr. Pepper.

“Frankly, what came as a surprise to us was Keurig Green Mountain’s decision in 2018 to acquire Dr. Pepper Snapple Group in an $18.7 billion deal to create Keurig Dr. Pepper in the first place,” Barclays analysts Patrick Foran and Lauren Lieberman said in a note to clients in August, when the breakup was announced. “At the time, this was seen as a strange and very left-field deal that involved questionable logic in combining coffee and (soda) drinks.”

(When the merger was announced in 2018, Lieberman said on a conference call with executives from both companies that he was still “wrapping over the logic” of the companies’ deal.)

Keurig Dr Pepper stock has increased 37% since the merger. The S&P 500 index rose 150% over the same period.

Like many industries, the packaged food industry experiences cycles of expansion and contraction, Feldman said. For example, Kraft spun off its snack business, which includes Oreos. Mondelez In 2012, just three years before merging with Heinz.

But in recent years, expansion through acquisition has required more sophisticated thinking and execution.

“If you look back at the glory days before 2015, the rules for consumer products felt pretty simple, at least if you were a global company,” Bain’s Horsley said. “You acquired another company that was relatively similar. You integrated it and extracted cost synergies…and that led to good top and bottom line growth. But the rules of the game have changed.”

Around 2015, startups like Chobani and BodyArmor started taking market share from traditional brands. As a result, food giants need to be more careful about what they acquire and how they manage their portfolios, Horsley said.

For alarm bells, look no further than Kraft Heinz, which was created in a mega-merger in 2015. Investors initially welcomed the deal, but their enthusiasm waned when the combined company’s U.S. sales began to slow. Subsequent write-downs of a number of iconic brands, including Kraft, Oscar Mayer, Maxwell House, and Belvita, resulted in subpoenas from the Securities and Exchange Commission related to accounting policies and internal controls.

With the benefit of hindsight, analysts and investors blame much of Kraft Heinz’s downward spiral on the harsh cost-cutting strategies imposed after the merger. The company’s management focused too much on cutting costs and not enough on reinvesting in the brand, especially at a time when consumer preferences were changing.

Since Kraft Heinz began trading as a company, its stock price has fallen 73%.

But not everyone believes it is in shareholders’ interest to let go of underperforming brands.

“It doesn’t matter how many brands you sell or don’t sell unless you fix the fundamental capabilities,” said Nick Mody, an analyst at RBC Capital Markets. “They’re not addressing the fundamental problems. They’re just pleasing investors because they look like they’re making a difference.”

One split that Prime Minister Modi agrees to is the split of Kellogg’s into snack-focused Kelanova and cereal-focused WK Kellogg’s in 2023. Last year, chocolatier Ferrero acquired WK Kellogg for $3.1 billion, while Mars completed its $36 billion acquisition of Keranova.

From Mr. Modi’s perspective, the split created more value for shareholders than the combined business. Kellogg’s high-growth snack business would have been a more viable acquisition target had it not been accompanied by an underperforming cereal division. Additionally, both strategic buyers are privately held companies and don’t have to worry about sharing their quarterly profits with the public.

Some investors are hoping for the same results as Kraft Heinz.

“The view held by many is that breaking up the company is the best way to create value, and the hope is that at some point in the future both entities are acquired and we can create Keranova 2.0, where value creation occurs,” said Peter Garbo, an analyst at Bank of America Securities.

Kraft Heinz has hired Steve Cahillane, former CEO of Kellogg Co. and then CEO of KeraNova, as its chief executive officer. If the company is split, Mr. Calilene will become chief executive officer of Global Taste Elevation, an alternative name for the spinoff with high-growth brands such as Heinz and Philadelphia.

However, acquiring either company as a result of the Kraft Heinz split would be a much larger acquisition, making it less likely that either would be acquired, Garbo said. And the uncertainty about value creation created by this split may be why the company’s largest shareholder, Berkshire Hathaway, is preparing to relinquish its 27.5% stake in Kraft Heinz.

A month into the new year, the sell-off trend is unlikely to slow down.

on tuesday, general mills announced that it will begin selling Muir Glen brand organic tomatoes to focus on its core brands. And last week, Bloomberg reported that Nestlé was preparing to sell its water unit. The Swiss giant is also reportedly considering selling luxury coffee brand Blue Bottle and its underperforming vitamin brand.

Additionally, if Big Food were to make an acquisition, the deal would likely involve “rebel brands,” Bain said. Acquisitions totaling less than $2 billion accounted for 38% of all consumer product deals over the past five years, up from 16% from 2014 to 2019, the company said. For example, last year, pepsico Acquired prebiotic soda brand Poppi for $1.95 billion; hershey Got Lesser Evil popcorn for $750 million.

Konanahalli said the current regulatory environment makes it difficult to achieve larger deals. The buyer may not be a strategic player but a private equity firm with deep pockets of cash. For example, L. Catterton bought a majority stake in cottage cheese startup Good Culture in January.

But flashy sales and acquisitions may not be the solution to food conglomerates’ woes, nor are they a surefire way to boost their stock prices. In some cases, good old elbow grease may be even more effective.

“Just because the wind seems to be blowing doesn’t mean you can’t try and turn things around,” says Konanahalli of Alix Partners.