Stories
It started with cars. Once people got cars, they started getting their groceries at big one-stop-shops at the edge of town.
The edge of town supermarkets were more convenient than local shops. And they were cheaper, because they used their size to extract better deals from suppliers. The local greengrocers, butchers and bakers couldn’t compete with them on price.
Then the supermarkets got really big. Local supermarkets got squeezed out by regional supermarket chains, which got pushed out by national chains, and then international ones. Now, a handful of international chains control almost all grocery shopping in Europe and North America.
With very-big grocery retailers came very-big food suppliers: Unilever, Coca-Cola, Nestle, Danone, Mondalez, Kelloggs and General Mills. Giant food companies were a direct response to the giant grocers. The grocers demanded low prices, so suppliers needed to get bigger to generate economies of scale. And the suppliers needed more heft if they were to negotiate with giant grocers.
To address the power imbalance, suppliers formed stables of brands, invested in R&D, and invested in advertising. Advertising was key.
If the big grocers owe their origin to the car, the big suppliers owe their origin to TV. TV advertising let suppliers create huge national brands. Unilever for example has spent a lot money on TV ads for Hellman’s mayonnaise. So Tesco customers don’t just want mayonnaise, they want Hellman’s. That gives Unilever bargaining power with Tesco. Only Unilever can supply Hellman’s, Colman’s, Flora, Ben & Jerry’s or Lyons tea. Unilever can then leverage Hellman’s to get shelf space for its smaller brands. This is why small companies find it hard to get a look in at Tesco, or negotiate a good price once they’re there.
In Michael Moss’ book Salt, Sugar, Fat, Oscar Mayer executive Bob Drane describes the virtuous circle of food industry R&D, marketing and retail:
“The volume goes up. The revenue goes up. The costs come down. The margins go up. The returns turn from red ink to black ink. You get what we call a platform, which becomes what we call a growth engine, and it goes on from there for a long, long time.”
For the food suppliers, shelf space in retail stores is everything. There’s the absolute number of product “facings”. After that, suppliers negotiate minutely over the positioning of their products: eye level sells better than knee level, the middle of the aisle sells better than the start. The end of the aisle does best of all.
Giant food companies have done very well from the arrangement. The grocers provide a steady stream of customers. The food and goods companies reinvest the cash into marketing and R&D ($750 million of R&D went into the Mach 3 razor, for example), which lets them charge more. So the CPG and food giants have high gross margins, offset somewhat by marketing costs and R&D spending.
The food giants are doing fine. But lately, the grocers are finding it tough. According to an analysis by McKinsey, a consultancy, more than half of grocers’ economic profit vanished in the five years after 2012. Grocers are under pressure from Lidl and Aldi on one side, and online stores on the other. McKinsey is forecasting that, in the 10 years to 2026, the German discounters will increase their market share in the US and Europe from 12 per cent to 36 per cent. In Ireland, the discounters already have 25 per cent market share.
Supplying food to supermarkets isn’t all brand recognition and big margins. A sizeable chunk of food sold by the grocers is unbranded, or is manufactured elsewhere and sold under the supermarket’s own brand. This is a wholly different type of food business. It’s tough. Margins are tiny, but if a contract can be secured with a big supermarket, volumes are huge.
Compared to the likes of Unilever, the unbranded suppliers have small gross margins. But they don’t have to spend anything on advertising or R&D. They’re focused on efficiency and cost-cutting.
The supermarkets, under pressure from the Germans, are leaning on these unbranded suppliers to find new ways to cut costs. One solution they’ve landed on is merging suppliers.
So there are multiple reasons why food companies are getting bigger. The branded ones want to build off their strong brands and manufacturing capacity. The unbranded ones want to cut costs. And both kinds want more leverage for negotiations with grocers.
Two new food giants
The private equity firm CapVest is in the thick of all this. From its headquarters in swanky Pall Mall in London, CapVest finds itself the owner of not one, but two growing food suppliers.
CapVest was founded in 1999 by Cavan man Seamus Fitzpatrick and his American partner Randy Shure. It’s invested in everything from nuclear imaging to pharmaceuticals. But its second-biggest focus, after pharma, is food.
CapVest’s first food company is is Dublin-based Valeo. The other is Eight Fifty Food Group, based in the UK.
Valeo and Eight Fifty have much in common. They’re food suppliers, with revenues over a billion euro. They supply the large grocers. And they’re on an acquisition spree. The difference between them is that Valeo is focused on high-margin branded foods. And Eight Fifty has a bigger contract manufacturing business.
Valeo was created by CapVest in 2010 as a vehicle to buy, and combine, Batchelors and Origin Foods. Batchelors and Origin made what’s called ambient foods — foods that can be stored on the shelf at room temperature. Valeo is run by Seamus Kearney, a veteran of the Jacob Fruitfield business.
Batchelors owned its bean and pea brands, Erin, Squeez juices, Amigo and Lustre. Origin Foods owned Odlums, Shamrock and Roma. In 2011 it added Jacob Fruitfield group, which owned Fig Rolls, Mikados, Fruitfields jam, Chef sauces, and Silvermints. In 2014 it began to expand overseas, with the acquisition of Rowse Honey in the UK. In 2015 it bought Balconi, an Italian biscuit brand, as well as Robert Roberts coffee and Kelkin health foods in Ireland. In 2017 it bought Tangerine, the maker of sticky sweets like Refreshers and Wham Bars.
Valeo has stepped up its dealmaking lately. In 2019 it acquired the European arm of Kettle Chips, IAG which makes tortilla chips for the UK market, Matthew Walker which makes cakes, and, this week, it announced the acquisition of the German marzipan and chocolate maker Shluckwerder. The company made €942 million last year, and expects to make €1.2 billion revenue next year.
Valeo has expanded out of Ireland. But especially in its early 2010s incarnation, when it was focused on Irish brands, it looked to me like Eason booksellers. Eason has survived in part because the Irish market is distinctive from the UK. So there’s a space for a bookseller who understands the Irish customer – even if it doesn’t have the scale of its foreign competitors. Valeo, likewise, has a stable of Irish brands. It might not be as big as Unilever, but Irish customers have a stronger relationship with Roma tomatoes than the Unilever or Nestle equivalent.
In 2020, Valeo made €289 million in Ireland. That number has grown a bit since 2017, when it made €162 million. But in that time, revenue from the UK has grown from €162 million to €433 million, and revenue from Europe has grown from €63 million to €285 million (if the most recent acquisitions are included – and they’re not included in the chart below).
The chart above shows the way the wind is blowing. The big opportunities are in Europe and the UK. A note in the 2020 account says the company is expecting the Irish business to grow by 2.9 per cent, the UK to grow by 4.4 per cent and Europe to grow by 8 per cent.
The company spent €105 million on acquisitions in the 2018 financial year, €117 million in 2019 and €149 million in 2020. Valeo’s 2020 financial year ended in March, so the IAG, Schluckwerder and Matthew Walker acquisitions aren’t included. Combined, they’re expected to lift Valeo’s 2021 revenues by €258 million. So it’s likely Valeo’s acquisition spree has topped €500 million.
Done right, you’d expect a growth-through-acquisitions strategy to boost margins and lower a company’s debt burden. And that’s what we see: Valeo’s gross margin grew from 37 to 39 per cent between 2017 and 2020. This indicates Valeo’s manufacturing got more efficient in those four years. Ebitda margins, too, grew from 12.1 per cent to 15.7 per cent. The gold-standard food company Nestle, by comparison, had a 49 per cent gross margin and a 15 per cent Ebitda last year.
Ebitda – which excludes depreciation, amortisation, interest and tax – has grown steadily as you’d expect, given the acquisitions. It rose from €71 million in 2017 to €148 million in 2020. The encouraging thing from Valeo’s perspective is that Ebitda has risen faster than net debt. So the company’s acquisitions have paid out more in earnings than the debt required to finance them.
The idea is that the Valeo whole is greater than the sum of its individual brands. By bolting on smaller brands, Valeo has been increasing its leverage with customers and building economies of scale in production.
Eight Fifty Group
Valeo, then, is acquiring companies in order to extract better terms from the big grocers.
Meanwhile CapVest’s other big food business, Eight Fifty, is pursuing a similar strategy. Albeit for different reasons.
Eight Fifty started out with CapVest’s acquisition of Karro. Karro is one of the three biggest pork producers in the UK. Between them, these producers control 70-80 per cent of the UK market for pork processing.
You’ll note that pork processing isn’t a branded food business. Karro makes pork for supermarkets, who sell it under their own brands. This is a very different dynamic to Valeo. They care more about lowering costs than achieving higher prices.
Next, CapVest acquired Young’s Seafood in 2019 (having bought and sold it years before). Youngs and Karro were combined to create the Eight Fifty Group.
Then in 2020 Eight Fifty acquired M&M Walshe, an Irish pork producer specialising in Sous Vide meats, and Carroll’s Cuisine, the Irish pork processor. Also in 2020, Eight Fifty bought Greenland Seafood, a German producer of own-label seafood products.
What’s Eight Fifty’s angle here? There aren’t big economies of scale in pork and seafood processing; the two are quite different. Their combination, as ever in the food industry, is about the grocers.
According to one industry participant, the big grocers are looking to deal with fewer, bigger suppliers. They’re under pressure from the Germans and they want to wring every drop of inefficiency out of their supply chains. The grocers want these diversified protein groups because they’re more efficient, more stable, and have cash to reinvest in capex.
In 2017 Tesco asked one of the other two big pork processors, Hilton, take over a seafood processor called Icelandic. And the other big pork processor, Cranswick, has moved sideways into poultry. Pork producers like Eight Fifty, Cranswick and Hilton want to diversify because it is one of the few avenues to growth that’s open in a mature business like pork processing.
After the latest acquisitions, Eight Fifty will have about £1.9 billion in revenue. Cranswick is a good comparator with Eight Fifty. It’s of roughly the same size (£1.4 billion in revenue), and it’s also a diversified pork producer. The following chart shows how Cranswick’s margins compare to those of Valeo, to give you sense of how the branded and unbranded ends of the market differ:
Eight Fifty is setting itself up as one of the grocers’ most important meat suppliers. And, being a concoction of a private equity fund, it’s preparing itself for a sale. Since October there have been rumours that Eight Fifty is to be floated on the public market.
No such rumours have attached to Valeo yet. But the firm is part-owned by a private equity company. CapVest has a reputation for patience, but it has owned Valeo for ten years now and at some point it will need an exit.
The options here are an IPO, a sale to another food group, or a sale to another finance house. The IPO market is as hot as it has been in 20 years. If CapVest ever do plan on listing Valeo, now would be the time to do it.
