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TAKING STOCK

SA’s food product sector has seen robust growth locally but is cautiously looking towards the rest of the continent in terms of expansion

TAKING STOCK

To some extent, food producers don’t have to chase growth markets in the fashion of motor dealerships and real estate developers. Even beyond staple foods, customers – for richer or poorer – always yearn for little treats. Still, these companies risk becoming ‘journeymen’ if they don’t take a measure of risk to pursue the upside and, indeed, protect themselves against the slide of the SA economy.

There is a limit to how much the sector can grow higher margins through product innovation and branding in a damaged economy. Ultimately, the food industry needs higher economic growth and markets with bigger populations to grow.

At home, food producers – who are facing rising maize prices, a key ingredient in many food categories – have their work cut out. A weakening currency and severe drought in the east of the country will likely add to costs.

For Tiger Brands, which was the only firm to aggressively invest in the rest of Africa, the most resilient geography has proved to be its local market of SA.

Despite sluggish growth, in the six months to March 2015, Tiger Brands managed to achieve real sales growth in SA, with volumes rising 2%, compared to the same period in the previous year. Including internal inflation of 6%, revenue was up 8%.

Market share growth did not come at the expense of lower profit margins, as Tiger Brands was able to pass on price increases. In fact, operating profit at Tiger Brands’ domestic business grew marginally faster than sales.

Derek Engelbrecht, Africa consumer products leader at EY, says low economic growth in SA is a reality for the short and medium term, adding that if the drought persists, food imports will increase in a period of weak currency. This will exacerbate the normal tensions in the grocery supply chain.

‘It’ll be fascinating to watch the power struggle between consumer product companies and retailers as they position themselves, again, as the “friend of the consumer”. I think it is very unlikely that the broader supply chain will be able to isolate the consumers from price increases in the affected product categories,’ he says.

Overall at Tiger Brands first-half group attributable profit more than doubled to R1.34 billion, after the massive R849 million impairment to its Nigerian flour business (in the prior comparable period) was not repeated.

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Despite the potential of the rest of Africa, accompanied by economic growth rates that remain higher than in SA, Tiger Brands has experienced first-hand two of the biggest risks on the continent. These are foreign exchange volatility in commodity-reliant countries and a lack of reliable market intelligence.

In Nigeria, which has seen the naira plummet as a result of the oil price plunge, the group’s US dollar debt became expensive to service.

Tiger Brands, which in 2012 bought a majority stake in pasta maker Dangote Flour Mills (DFM) for R1.5 billion, is an importer of wheat. Even before the recent exchange rate problem at loss-making DFM, the acquisition had also proved to be a poor one in the best of times.

The DFM debacle indicates the challenge of doing due diligence in very different markets where hands-on experience counts for more than projections based on unreliable statistics. More than that, it shows the risks of making a big acquisition of a new company that is yet to be fully established in the retail supply chain.

At the time of the (above) first-half results announcement in May 2015, Tiger Brands said it would continue pumping cash into DFM. But since then (in November 2015) Tiger Brands has done an about-turn, saying it would no longer fund DFM and would ‘explore various alternatives with respect to its shareholding’. This suggests DFM is unlikely to survive in its current structure.

To compound matters, founder and chairman Aliko Dangote resigned from the board. Furthermore, Tiger Brands’ CEO Peter Matlare stepped down at the end of December 2015.

The best news to emerge about DFM is that in the first-half of financial 2015, Tiger Brands did not again take a write down on the DFM investment. In the previous period, it was a massive R849 million. But Tiger Brands is not out of the woods yet, after warning it would have to pump more cash into DFM (and that it would reassess the need for another impairment at year-end).

While the DFM acquisition was unarguably a failure, it has provided an important lesson for Tiger Brands and its competitors.

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By way of contrast, Tiger Brands rival AVI was considered by some as overly cautious with regard to expansion during the SA boom, years before the global financial crisis. For AVI, this prudent approach has paid off over the last five years as it has focused on fine-tuning local operations, including what the company says is rigorous cost management.

While AVI has no large factories in the rest of Africa, it does earn 12.5% of it operating profits from exports – a lower-risk strategy to seek revenue in faster-growing markets. The data has started to support this strategy. In 2012, Africa overtook Europe to become SA’s biggest food export market.

AVI’s internally focused growth plan still has to be executed. That it was able to pay a special dividend of R639 million in April 2015 – a rarity in any sector in the current climate – suggests it has done so. In the year to June 2015, AVI increased both its profit margins and sales after successfully raising prices to offset the weakening rand.

However, the company warned that the continued weakening of the rand would make it more difficult to increase selling prices further, given the rough spot consumers are in. While operating profit was up 11.9% to R1.92 billion, attributable profit growth was muted after a significant once-off item in the previous year. By this measure, attributable profit was up 1.3% to R1.33 billion.

Pioneer Foods, after a rocky start as a listed firm, has raced ahead over the last five years, attaining a market cap of R44 billion and even overtaking AVI. The maker of Weet-Bix cereal and White Star maize meal said in an October 2015 trading update that it had continued to expand the operating profit margin in the year to September 2015. Indeed, the group has achieved margin expansion annually over the last four years. Sales too were up in the year to September 2015, notwithstanding an industry-wide market contraction in the quarter to September 2015. According to Pioneer, it also gained market share in the first-half (to March 2015) of the year.

Like Tiger Brands, Pioneer too has a pronounced Africa acquisition strategy, but it’s unlikely to jump-start that with a big deal. In March last year, Pioneer bought a majority stake in a mid-sized Nigerian baker for $7 million, thereby forming Food Concepts Pioneer Limited (FCPL).

‘FCPL provides an ideal opportunity to leverage our expertise to grow the bread category and to establish a national bread brand over time in a gradual low risk manner,’ Pioneer CEO Phil Roux said at the time. The company has since sought to increase its already significant market share in the local breakfast cereal category through the purchase of a 50% share in Futurelife health products.

Taking stock

‘It is very unlikely that the broader supply chain will be able to isolate consumers from price increases’

DEREK ENGELBRECHT, AFRICA CONSUMER PRODUCTS LEADER, EY

The group that talks the most about African expansion is dairy firm Clover Industries. Fresh milk is one of the continent’s scarcest commodities. As it is perishable, African countries cannot easily be served by imports, creating an opportunity for Clover to establish milk-processing plants.

There are also prospects to export basic preserved dairy products, such as milk powder and cheese, from SA. In Africa, which has the world’s highest birth rate, the opportunity to feed into the baby formula market is particularly juicy.

Clover has a two-pronged plan to achieve continental expansion. The first is also a low-risk, on-the-ground approach. CEO Johann Vorster says the firm aims to start making small investments
in budding African dairies that have the capability to expand. Clover will lend its expertise and then have the opportunity to increase the investments.

Back home in the KwaZulu-Natal Midlands, the group is considering a big investment in what Bloomberg describes as ‘South Africa’s first dairy megafactory’, at a cost of R890 million.

While the plant would supply the local market with fresh milk, it also plans to export milk powder into Africa.

Rhodes Food Group, which listed on the JSE only a year ago, has already seen its share price almost double, and the group is quickly becoming one of the major grocery players.

The maker of basic canned foods and high-margin Woolworths-branded prepared meals is continuing with its strategy of making small acquisitions and then scaling them up. While Rhodes is already a meaningful exporter, its acquisition of Boland Pulp (the maker of Squish convenience baby food) also aligns the company with Africa’s high birth rate. Squish is already a rival to Tiger Brands’ Purity label.

Sugarcane processors Tongaat Hulett and Illovo, who lean more towards the production of commodity sugar than heavy investment in branded sugar products, have been hit by the severe drought in the eastern part of Southern Africa. This has been exacerbated by the low global sugar price, resulting in a fall in profit at both companies.

At Tongaat, however, this has been mitigated by the land development unit. The company sells sugarcane land gradually, located alongside Durban, as demand for urban land increases.

The expansion of both Rhodes and Pioneer as JSE-listed firms has resulted in increased competition among listed players. In the rest of Africa, recent investments from global players Procter & Gamble, Unilever, Kellogg’s, Mondelez and Danone suggest this is also the case.

The fact that many of these multinationals are often dominant in their strongest categories in developed countries makes them formidable competitors. However, in parts of Africa where they are still starting out they may struggle to understand the myriad of local conditions and tastes, including how to get their products promoted in the massive informal retail market.

In East Africa, established Asian-African manufacturers, such as Vimal Shah’s dominant food oil firm Bidco Africa, will be difficult for SA producers to take on. After decades of trading, Shah and his family have the experience to tap into both the informal and formal supply chains.

East Africans, along with their SA counterparts are also well aware that the biggest market to play in is often not the middle class but rather the emerged consumer class, who may not own cars but are regularly buying basic branded groceries for the first time.

Thomas Verryn, research manager for sub-Saharan Africa at Euromonitor, says some foreign investors have had their fingers burnt by a lack of market data, including the much-debated size of the middle class. He argues there is too much emphasis on the middle class.

‘The bulk of the market shops through informal retail channels, including open-air kiosks. Consumers have personal relationships with their grocers and manufacturers have to tap into the informal distribution networks [supplying traders],’ says Verryn.

While the spread of the oil and mining price crises to other business sectors is certainly a setback for grocery manufacturers, it will not stop the rapid rate of urbanisation that makes grocery retail so appealing.

What the food products companies really need is a measure of stability in African markets, which is by no means guaranteed. Quick recoveries in the prices of oil and copper will be an added bonus.

By Tom Robbins
Image: Andreas Eiselen/HSMimages