Kraft Heinz Pivots to Emerging Markets

28 February 2017

Backed by Berkshire Hathaway and 3G Capital, the Kraft Heinz Company made an offer to buy European-based Unilever for $143 billion that was quickly rebuffed. The prize was not a specific brand, but a foothold into the emerging markets driving growth for many consumer packaged goods (CPG) companies that Kraft Heinz desperately lacks.

Emerging markets have recently been the source of most sales growth for many CPG companies. Kraft Heinz will not be deterred by this setback as it eyes other companies to gain access to South America, Africa, southeast Asia, and the Middle East. That strategy could include a reunion of sorts between Kraft and Mondelez International, formerly Kraft Foods Inc.

The Art of a Merger

Recent mergers and acquisitions in the food space have mostly centered around bigger companies acquiring smaller, more innovative brands with high growth rates in an effort to better capitalize on consumer trends. This includes the incorporation of more natural ingredients and better sourcing transparency—think Kellogg’s and Kashi, General Mills and Annie’s Organics, or Danone and WhiteWave Foods, best known for its assortment of dairy-free brands.

When it comes to mega-mergers though, motivations are multifaceted. Sometimes they’re driven by prospective cost savings or the potential for expanding market access, while other times it’s a combination of the two. In fact, these were two of the main drivers of Kraft’s merger with Heinz in 2015.

This latest merger attempt by Kraft Heinz featured a little bit of everything. Kraft Heinz was rumored to expand its international impact, which was supported by reports of funds being raised by 3G in January. The news of the merger spread Feb. 17 along with Unilever’s rejection of the proposal due to what it deemed an undervaluation from Kraft Heinz. Unilever has attempted to establish itself as an ethical company, even as it faces challenges regarding its use of palm oil, while simultaneously expanding its brand portfolio to include clean living brands like Seventh Generation. Even though only about half of Unilever’s sales come from food products, the two companies would have many synergistic brands.

A merger between the two behemoths would also offer strategic benefits for improved commodity sourcing. For example, dairy—which is heavily used by both Kraft Heinz and Unilever in everything from Unilever’s Ben & Jerry’s ice cream to Philadelphia cream cheese from Kraft Heinz—may be able to be sourced even more efficiently by a combined entity. Back in 2007, average milk prices soared to the highest on record at that time, and Kraft had to raise prices 5 to 12 percent. Since then, milk prices have become even more volatile. Having even more leverage on the dairy market could help both companies better weather market fluctuations.

New Markets, Increased Growth

Emerging markets are increasingly becoming attractive drivers of growth, especially as the business climate for major CPG companies in more developed markets become tougher to weather. Denise Morrison, CEO of Campbell’s Soup, expects emerging markets to deliver 70 percent of the food industry’s growth over the next decade. It’s a projection that doesn’t seem so far fetched when one considers Latin America, southeast Asia, Africa, and the Middle East with their rising populations and wealth are growing markets with increasing demand for processed products.

Over the last 15 years, all four markets have at least tripled their imports of processed products. It’s an increase that was accompanied by a correspondingly steep rise in GDP.

Some CPG conglomerates have done a better job than others at capitalizing on this trend. Nestlé drove double digit sales growth in emerging markets for years, and last year more than 40 percent of their revenues were derived from emerging markets. Unilever does more than half of its business, 58 percent, in emerging markets. Conversely, just 10 percent of Kraft Heinz revenues can be attributed to emerging makerts. Although emerging markets' sales growth for Unilever and Nestlé has been slowing, rates in these markets were more than quintuple and triple, respectively, that of their developed market sales growth in 2016.

Major international CPG companies like Procter & Gamble, Nestlé, and Unilever have succeeded in emerging markets by employing a myriad of unique strategies. For starters, they choose their entry markets carefully, in many cases targeting major cities across these regions instead of whole countries. When they do attempt to penetrate more rural regions, these companies adjust their product offerings to be at an accessible price point, often selling products in single-servings, be it food or laundry detergent.

To really dominate in emerging markets, even as a new entrant, CPG firms will conduct intensive market research and adapt their products’ formulations to better suit distinct markets. Lastly, to drive profitability in emerging markets, conglomerates will invest in local production and sourcing where it is feasible.

Over-developed

Kraft has built an impressive reputation and brand loyalty—North American household penetration is at 98 percent. but its popularity is centralized. Whether it’s Oscar Mayer, Kraft Singles, Jell-o, or Heinz Ketchup, the company’s offerings have become staples in the vast majority of homes. After Mondelez International was spun off from Kraft Food Group, with the former retaining Ritz, Oreo, Nabisco, and Cadbury, the latter’s international presence is weak.

Prior to its merger with Heinz in 2014, Kraft derived just 2 percent of its sales revenue from outside of North America. This was one of the more attractive points of Kraft’s merger with Heinz, with the latter’s stronger global brand recognition. Nearly two-thirds, 61 percent, of Heinz’s sales revenue comes from outside of North America and between 2005 and 2014, Heinz was able to grow revenue from emerging markets from 9 percent to 25 percent of total sales.

Despite many of the United State’s CPG conglomerates focusing on the domestic market, the United States has actually already established a strong foothold within the export market of prepared food products. The category is one of the country’s top five exports by value.

Processed and prepared food, as a category, has been growing rapidly, with the value of US exports more than tripling between 2000 and 2016. The last four years have seen a leveling off of sorts, with growth down to less than 10 percent. Solid growth to be sure, but nothing like what was experienced just a few years earlier.

On the other hand, Europe, with historically better access to emerging markets, has seen even steeper growth with exports of prepared foods quadrupling over the same sixteen-year period. In contrast to the US, their export growth doesn’t appear to be leveling off. Unilever, with its main operations situated in Europe has been able to capitalize on this growth, in 2016 their turnover in emerging markets was up, while sales in developed markets were down. Conversely, Kraft-Heinz sales growth has been much flatter and even declined, but their profits continue to rise due in significant part to strict budget management under 3G.

As of 2014, global retail sales of packaged foods was estimated at $2.4 trillion. That figure is expected to rise to over $3 trillion by 2020 with emerging markets being the primary driver. In many of these countries, a declining food deficit has been accompanied by a steep increase in imports of processed products, particularly prepared foods. For instance, throughout many countries in southeast Asia, food deficits have been shrinking steadily over the past 25 years, which has been accompanied by rapid growth in imports of prepared foods. This is a trend that Unilever has been capitalizing on with annual sales growth of over 10 percent between 2009 and 2014—a figure more than double that of the company’s average annual sales growth. Currently, southeast Asia alone makes up more than 10 percent of Unilever’s revenues. This success has likely been observed by Kraft Heinz, which comparably, derives less than 10 percent of its total sales revenue from all of Asia and the Pacific (including major markets, such as China and Australia). It’s not surprising that they would target companies that have already done much of the leg work to enter these emerging markets.

Conclusion

While emerging markets are expanding, more traditional developed markets are contracting. Worldwide, consumers are passing on traditional processed foods and are doing so more rapidly in places like the US, Canada, and Europe. It’s not that processed foods are being shunned completely, but, globally, markets are demanding more wholesome and nutritious products. A whopping 77 percent of global respondents in a Nielsen survey said that all natural ingredients were a very or moderately important factor in their snacking choices. While Kraft Heinz has been adapting—late in 2015, Kraft covertly reformulated their famous mac & cheese to exclude all preservatives, artificial flavors, and synthetic dyes—they’re still losing market share to competitors that have crafted more authenticity in the burgeoning natural food space.

The slowing revenue growth in these developed markets, is a big reason why emerging markets have become so attractive. In 2014, Nielsen estimated that nearly $375 billion was spent on snack foods globally each year. Even though Europe and North America made up more than three quarters of that figure, Latin America and Middle East/Africa were the fastest growing markets, with sales up 9 and 5 percent respectively.

Unilever, with its sights set on making emerging markets 75 percent of its revenue stream by 2020, has also buoyed its sales in developed markets by better embracing new consumer preferences, even ones that transcend food. While corporate CSR has become increasingly trendy, Unilever has gone above and beyond to increase the integrity of their agricultural supply chains. They released their first human rights report in 2015 and have pledged to halve their environmental footprint by 2020. This is not to say these efforts were completely altruistic, they’re strategically used as a marketing tactic.

Some of the buzz behind the attempted Unilever - Kraft Heinz partnership was that the hypothetical conglomerate would outsize even Nestlé as the world’s largest food company. About 40 percent of Nestle’s sales come from emerging markets with a target to hit 45 percent of sales from these regions by 2020. A hypothetical Unilever - Kraft Heinz would almost hit that benchmark.

While Kraft Heinz may have backed away from an acquisition for now, it’s likely they’ll soon be after another CPG acquisition. Mondelez International has been discussed as a potential target along with Kellogg and General Mills. We’re willing to bet it’ll be one that is already deriving a substantial part of its revenues from the lucrative emerging markets.

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