In a period characterized by intense competition, price fluctuations, and strict regulations, companies in the global packaged food industry are finding it challenging to maintain and improve profitability. Factors such as raw material procurement, volatile oil prices, focus on health and wellness (leading to an increase in the demand for organic raw materials), a need to reduce the time taken to commercialize a new product, to name a few, are contributing to the pricing pressure in the global packaged food industry, which directly impacts profitability.
New analysis from Frost & Sullivan, Financial Assessment of the Global Packaged Food Industry, an analysis of over 1050 public companies in the packaged food industry across the globe, reveals a decline in key ratios such as gross and earnings before interest, taxes, depreciation and amortization (EBITDA) margins in 2011-2012 in comparison to 2010-2011, indicating an overall slump in profitability. Return on assets declined from 8.5 percent to 5.1 percent during the same timeframe.
"As commodity risks in raw material sourcing pose a key challenge, companies specializing in packaged food use derivative financial instruments, such as futures and options, as well as engage in forward contracts to limit the downside risk of fluctuating prices," said Frost & Sullivan Financial Analyst Bharath M. "They design contracts in which the terms of the hedge instrument closely mirror the underlying of a derivative, thereby providing a high degree of correlation and risk reduction."
The economic slowdown has made it difficult for packaged food businesses to manage operations in emerging economies, and established western companies find expansion in emerging economies tough. Furthermore, the Eurozone downturn has lowered interest rates drastically, dissuading investments.
In the face of decreasing demand, exchange rate fluctuations can be a huge risk factor, more so for companies that have a high percentage of sales through exports. Industry participants are also exposed to interest rate volatility emerging from fixed or floating-rate debt issuances. To contain these risks, companies employ derivative instruments and look to strike a balance between fixed and floating rate exposures through interest rate swaps.
Evaluation of customer credit helps to maintain seamless operations, as it directly impacts the cash conversion cycle and working capital management. Assessment of credit risk is critical when signing off-the-counter contracts.
"Counterparty risks arising out of derivative contracts are managed through counterparty approvals, credit limits, and rigorous monitoring procedures," noted Bharath. "Effective implementation of risk management practices will ensure profitability, particularly for firms with sales in more than one country."
Cash-rich companies in developed countries can look for acquisition targets in the highly fragmented Asia-Pacific region. For instance, while North America has 90 public companies, Asia-Pacific has 642, providing packaged food enterprises with opportunities for geographic expansion, product portfolio diversification, and vertical integration.