The F&D sector has shown an impressive level of resilience throughout the COVID-19 period, but we expect the backdrop to become more challenging over the next year as a range of P&L pressures align. Input cost pressures, increased overheads and the introduction of new legislation could intensify issues around sector profitability over the coming months. A focus on balance sheet liquidity remains important, as does ensuring an adequate buffer between forecast liquidity and committed loan facilities. In the wake of COVID-19 and Brexit, an appropriate balance needs to be maintained between supply chain resilience and efficiency.
Input cost pressures
The sector is vulnerable to significant near-term gross margin pressure from ingredients inflation. Food cost pressures may potentially have long-term momentum and many businesses are likely to be exposed to double digit commodity price inflation near term. Annualised year-on-year percentage increases in soft commodities has been significant, with input staples such as corn, coffee, sugar, soya beans and palm oil all seeing sustained price uplifts greater than 50% over the last year.
In such an unusual economic environment, it should be cautioned there may be an element of financial speculation driving this uplift. That said, we have also seen the emergence of some real physical market-based issues. For example at the time of writing, Brazil’s recent droughts have pushed up corn prices while damaging frosts have significantly pushed up the price of coffee futures. Prices of soyabean oil and palm oil have in part seen prices pushed higher by the demand for biofuel. In addition to soft commodity cost pressures, we would also highlight sustained increases in energy costs and across the board cost pressure in packaging including plastic wrapping, cardboard and aluminium cans.
The fight across the manufacturing base to maintain volume throughout the COVID-19 pandemic has helped to hold back price increases with many FDM companies absorbing the cost increases. Indeed, the CPI for food inflation has remained relatively stable throughout 2021 in stark contrast to the trend in imported food material costs over the period. However, this position is not considered to be sustainable and we expect pricing pressure to emerge at the retail level as well as continued pressure on FDM margins. Exacerbating the situation, by the Autumn, we would expect short-term commodity hedges within the Food & Drink sector to be renewed at far less favourable rates.
Operating cost pressures
If that wasn’t enough to deal with, operating costs for the sector are also under extreme pressure. New additional regulatory initiatives, higher distribution costs and ongoing COVID-19 health and safety measures have increased operating costs across the sector.
There’s been well-publicised issues around staff shortages in key areas of the food and drink supply chain, from harvesting and picking fruit and veterinary checks at meat processing plants all the way through to HGV drivers delivering finished goods. Each of these are complex multifactorial issues – the latter, for example, reflecting ageing demographics of UK drivers, the departure of many non-UK workers, as well as a COVID-19-originated backlog of driving tests. In short, a quick fix to many of these is unlikely.
Aside from Brexit, the sector is facing a multitude of regulatory initiatives (and associated cost burdens) ranging from a plastic packaging tax (to be introduced in April 2022) to a proposed Deposit Return Scheme for drinks containers two years later. Both will increase operational complexity and demand production changes.
HFSS (High Fat, Salt and Sugar) legislation is likely to have a substantial impact for certain companies within the Food and Drink sector from October 2022. HFSS products, such as chocolate and ready meals, will be banned from store entrances, aisle ends and checkouts. Retailers will also be prohibited from offering multi-buy promotions. The legislation will impact key promotion-led impulse categories and is likely to have a dramatic impact on the demand for certain product lines.
Looking further ahead, there may be a sustained impact from the recently published Dimbleby’s National Food Strategy report. Dimbleby proposes a £3/kg tax on wholesale cost of sugar and a £6/kg tax on salt used by manufacturers. Manufacturers have already reformulated many HFSS products in the light of consumer demands, but there may be practical limits on how these can be further adapted.
Managing supply chains and costs
We expect prices to consumers will eventually have to rise in order to protect profitability. For a sector that has historically operated on slim margins, passing on these cost pressures will be critical. When negotiating with major retailers who are facing their own cost pressures, this is potentially easier said than done.
That said, there are some actions that the sector can take in order to improve both operational and financial performance -
Firstly, the pandemic has thrown into stark relief the critical importance of dependable supply chains across all inputs. With the economic outlook looking uncertain for the foreseeable future, supplier risk management has never been more important. Gaining clear oversight of the financial performance of the supply chain and developing robust operational continuity plans to mitigate supply chain failure should be a clear agenda item.
Operators may seek to undertake a broader strategic review of their supply chains, making subtle interventions that boost resilience whilst minimising the impact on cost and efficiency. These could include identifying critical weak points in the chain and taking proactive steps. This may include reducing transport distance/complexity for inputs through to diversifying supplier range.
Secondly, some businesses may need to take some tough operational decisions in order to drive costs down further. There’s less room than ever for underperforming product lines, wasteful production processes or poor cash controls. Non-critical spend needs to be assessed thoroughly, with the return on investment tracked effectively. For some, business combination or divestment may help generate further economies or support a strategic focus on core competencies.
Finally, the pandemic has reinforced the importance of managing liquidity closely. As support schemes fade away and the threat of further economic ‘bumps in the road’ remain, businesses in the sector will need to ensure that they manage a suitable buffer between their forecast liquidity and their available loan facilities.
Support from Interpath
We have advised a host of companies in the F&D sector, from global corporates to smaller privately owned businesses, on a wide range of matters from supply chain and procurement to margin enhancement and working capital optimisation. Our extensive experience is supported by a proprietary kitbag of innovative analysis tools meaning that we are able to assist our clients to get a comprehensive understanding of their commercial and operational performance and help them to formulate strategies and solutions to enhance business resilience and improve profitability.
Our proprietary Economic Profit tool offer clients a unique perspective on their cost base and core profitability drivers. It analyses information at detailed product level as well as managing multiple data sources enabling us to help management teams formulate optimal decisions for profitability based on industry best practice in relation to a range of variables such as gross margin, cost allocation, pricing, promotions and merchandising and product range.
