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Who eats whom

Private labels challenge branded foods.
House-brand products are taking a bite from the brand premiums historically enjoyed by listed food processors. Image: Dean Hutton, Bloomberg

The current debate of whether inflation is transitionary or structural has a sub-argument that references rising soft commodity prices, food inflation, and struggling consumers – and argues that food producers will be caught in the middle.

This narrative makes some sense: rising input costs cannot be fully passed onto struggling end-consumers and someone is going to have to absorb this.

But is this view correct and what does it mean for our JSE-listed food processors?

Margin call

The ability for a business to sell a product (or service) for more than it cost to produce is fundamental in business. The better this ability, the higher the margin and, arguably, the safer the business as the stronger its pricing power is. We tend to measure this using the gross profit (GP) margin (what percentage of sales become gross profit).

Logically, we would assume that a GP margin analysis of the different businesses across the food supply chain (primary producer, food processor and end-retailer) should reveal who has the pricing power (i.e. high GP margin) and who has none (i.e. low GP margin).

Gross profit margins across the food supply chain

Food processor/primary producer/retailer Last reported GP margin (%)
The Spar Group Retailer 11.9%
Astral Foods Producer 18.3%
Pick n Pay Stores Retailer 19.8%
Massmart Retailer 20.4%
Quantum Foods Producer 21.5%
Libstar Processor 23.6%
Shoprite Retailer 24.0%
Crookes Brothers Producer 30.4%
Tiger Brands Processor 30.6%
Premier Fishing Producer 30.7%
Sea Harvest Producer 33.8%
Rhodes Food Group Processor 34.1%
Woolworths Retailer 34.2%
Oceana Group Producer 35.8%
AVI Processor 39.6%

Source: Various company reports, author’s own workings and assumptions

If the soft commodity narrative above were to be believed, we would expect to see all the food processor’s GP margins at the bottom.

Interestingly, the GP margins across the supply chain are quite spread out and many of the end-retailers have the lowest of them (relying on volume to generate returns on their capital rather than price).

Ironically, the highest GP margin in this sector is AVI, a food processor (with a fashion arm).

Zooming into two of the largest food processors (Tiger Brands and AVI) and the largest retailer (Shoprite Holdings), we see a more revealing picture of these GP margins over time (per the table above). Shoprite’s GP margins may be lower but they are steady while Tiger Brands and AVI are seeing their GP margins declining across years.

Tiger Brands, AVI & Shoprite Holdings gross profit margin history

Source: Koyfind, author’s own workings and adjustments

Why would this be?

The erosion of branded food processor margins arguably lies in the growing traction of private label/house brands across retailers’ portfolios (i.e. where the retailer sources a near-perfect substitute product, minus the fancy brand name).

Read:

House wins

While Woolworths has always had strong house brands, Shoprite’s house brands have been gaining traction (in FY17 house brands made up 14% of their sales, rising to 16.5% in FY19 and then 17.1% in FY20).

Spar and most other retailers offer various (and growing) house brand product ranges too.

In essence, these substitute products eat into the brand premiums historically enjoyed by the listed food processors and – rather than short-term soft commodity pressure – I would argue that this is the real threat facing these businesses.

Competing with their customers becomes even messier for the food processors as, to keep their volumes up and their unit costs down, they often manufacture these house brands themselves. (Indeed, Libstar has built an entire – if somewhat low-margin – business based solely on this service.)

In conclusion, while soft commodity pressures may drive some short-term margin contraction in the food processors, the real structural pressure comes from these businesses’ customers, the retailers, and their house brands.

In the longer term, the steady erosion of branded food processors’ pricing power will likely only make these businesses more vulnerable and, broadly, begs the question of how investable this sector is.

Keith McLachlan – Integral Asset Management investment officer.

COMMENTS   8

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Cross elasticity of demand will eventually kill the brand if the volumes are not managed . On GP% …the nett margin in retailers are the real number to look at. ie after rebates, advertising allowances and settlement discounts. A killer for producers in the 80’s which saw the rise of Spar. And we are greatful

House brands have come a long why from when they started with some even exceeding the quality of the top brands. Spar’s house brand is excellent value for money as its quality is on par with the best. Shoprite Checkers sells a lot of its own brands that masquerade as a brand name (usually imported by them) and they are good quality at a great price. As for Pick n Pay, they have yet to come to the party selling lower standard house brands just below the cost of a branded product. what is impressive is Shoprite Checker gross margin of 24% which is crazy high considering their sales volume. but then again they have mastered their distribution coupled with their on the ball sourcing division so it is no surprise that they are on top of the food market

I agree. Where retailers can do a better job is demonstrate the different tiers to customers, hence your confusion. For example, PnP No Name are a fit for purpose brand and typically compares with value rather than quality. The PnP brand compares with the brand leader and compares favorably with the quality but should beat it on price. Then, the Forage and Feast range in Checkers is aimed at high quality at a premium price. SPAR brands typically fit into equal or better than the brand leader at a competitive price. Woolworths promises you quality all roubdxat a premium price – indulgence.

Apologies……typo: quality all round at a premium price.

A disturbing trend with some brands is that quality is not consistent between different retail outlets.

Could it be that some retailers are pushing too hard and are being disadvantaged by received lower grade product?

This will also damage established brands.

These retailers are gouging people. If I look at how farm gate prices have changed, compared to the eye watering prices charged in supermarkets, for meat and vegetables specifically, then people are being ripped off.

12% SPAR
34% Woolies

that range seems improbable, there must be differences in what is included in COGS.

Private Label does leave significant room for margin for retailers, because the (marketing) cost for suppliers are greatly reduced. If a retailer balances this smartly with loss leaders, it becomes a volumes game and back end margin such as rebates, (where the real money lies) drives profitability successfully. Remember, Private Label products can drive customer loyalty.

End of comments.

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