The Kraft Heinz and Kellogg spin-off shows that big food companies are getting smaller

Big Food is slimming.

As consumers and regulators push back against ultra-processed foods, the companies that make them have split up or divested popular brands. last year, Unilever She split her ice cream business into Magnum Ice Cream Company. Kraft Heinz The company is preparing to separate later this year, undoing much of the merger more than a decade ago between Warren Buffett’s Berkshire Hathaway and private equity firm 3G Capital. and Keurig Dr Pepper It plans a similar split after completing its acquisition of JDE Peet’s.

In 2024, nearly half of the M&A activity in the consumer products industry came from divestitures, according to consulting firm Bain. Over the next three years, 42% of M&A executives in the consumer products industry are preparing assets for sale, a Bain survey found.

Of course, this trend is not limited to the consumer packaged goods industry only. Industrial companies such as General Electric and Honeywell have sought to break themselves up in recent years. It also happens in older media; Comcast has split many of its cable assets to owner CNBC Versantwhile Warner Bros. plans to Discovery to spin off its cable networks later this year as Netflix acquires its streaming and studio division.

“In many of the fields where we see this kind of activity, there are many very intense competitive pressures that make the work more difficult,” said Emily Feldman, a professor at the Wharton School at the University of Pennsylvania.

The pressure on packaged food and beverage companies comes from falling demand, which has led to many of their products shrinking in size. In order to turn their business around and win back investors, they rely on getting rid of underperforming brands.

February will bring quarterly earnings reports and presentations at CAGNY’s annual conference, providing investors with more opportunities to hear about food executives’ plans for their portfolios. Companies to watch include Kraft Heinz, which can share more details about its upcoming split, and Nestle, which is considering selling several brands in its portfolio.

For more than a decade, consumers have been purchasing fewer groceries from the interior aisles of the grocery store, instead focusing on the exterior aisles containing fresh produce and protein. The pandemic was the exception, as many consumers returned to the brands they knew. However, rising prices and “deflation” as life returns to normal have largely erased this shift in behaviour.

More recently, regulators, encouraged by the “Make America Healthy Again” agenda espoused by Health and Human Services Secretary Robert F. Kennedy Jr., have been putting more pressure and a greater spotlight on processed foods. The advent of GLP-1 drugs to combat diabetes and obesity has meant that some of the major consumers of food companies have lost their appetite for the sweet and salty snacks they used to eat.

As a percentage of total spending, the consumer packaged goods industry maintained market share. But larger companies are losing customers to emerging brands or private-label products, according to Peter Horsley, a partner at Bain.

On average, about 35% of the portfolios of large consumer products companies are in categories with growth above 7%, Horsley said. By comparison, more than half of private label brands are in high-growth categories, such as yogurt and functional drinks, and for insurgent brands, it’s even higher.

For big food companies, the result has been slowing — or even declining — sales, followed by falling stocks. In some cases, activist investors push companies to focus more on their core offerings and eliminate so-called distractions.

“You’re seeing a lot of pressure from a valuation standpoint, especially for these publicly traded companies,” said Raj Konanahalli, partner and managing director of AlixPartners. “One way to reset expectations is to focus more on core offerings and divest or divest slower, capital-intensive or non-core businesses.”

While expansion has helped food companies develop scale, enter new markets and increase their sales, it has also made their businesses more complex, according to Konanahalli. When a company becomes very large, it becomes very difficult to make decisions quickly or decide how and where to invest back into the business.

To be sure, some divestments and corporate breakups follow deals that seem ill-advised from the start. Look no further than the merger of Keurig Green Mountain and Dr Pepper Snapple Group in 2018 to form Keurig Dr Pepper.

“Frankly, what came as a surprise to us was the decision made in 2018 when Keurig Green Mountain acquired Dr Pepper Snapple Group in an $18.7 billion deal to create Keurig Dr Pepper in the first place,” Patrick Fullan and Lauren Lieberman, analysts at Barclays, wrote in a note to clients in August when the separation was announced. “At the time, it was seen as a strange and very left-wing deal with the questionable logic of combining coffee and coffee. [carbonated soft drinks]”.

(When the merger was announced in 2018, Lieberman said on a conference call with executives from both companies that she was still “perplexed” about the logic of the deal for both players.)

Shares of Keurig Dr Pepper have risen 37% since the merger. The S&P 500 rose 150% over the same period.

Like many industries, the packaged food industry has gone through cycles of expansion and contraction, according to Feldman. For example, Kraft created a snack company that includes Oreos Mondelez In 2012, just three years before it merged with Heinz.

However, in recent years, expansion through acquisitions has required more sophisticated thinking and execution.

“If you go back to the glory years before 2015, the rules of the game in consumer products seem fairly simple, at least if you’re a global company,” Bain’s Horsley said. “You bought another company that was relatively similar to yours. You merged them together, took advantage of the cost synergies…and then that gave you good growth in bottom line and income. But the rules of the game have changed.”

Around 2015, startups like Chobani or BodyArmor started stealing market share from legacy brands. As a result, food giants had to become more thoughtful about what they were acquiring and how they managed their portfolios, according to Horsley.

For a cautionary tale, look no further than Kraft Heinz, which was created through a massive merger in 2015. Investors were initially cheering the deal, but their enthusiasm waned as the combined company’s U.S. sales began to decline. Then came the delistings of several of its iconic brands, such as Kraft, Oscar Mayer, Maxwell House, and Velveeta, as well as a subpoena from the Securities and Exchange Commission regarding its accounting policies and internal controls.

With the benefit of hindsight, analysts and investors blamed much of Kraft Heinz’s downward spiral on the brutal cost-cutting strategy imposed after the merger. The company’s leadership was too focused on cutting costs and not enough on investing back in its brands, especially at a time when consumer tastes were changing.

Since Kraft Heinz began trading as a single company, its shares have fallen 73%.

But not everyone believes that getting rid of underperforming brands will benefit shareholders.

“If you don’t fix the core capability, it doesn’t matter how many brands you sell or don’t sell,” said Nick Moody, an analyst at RBC Capital Markets. “They’re not addressing the root problem. It’s just something that makes investors happy because it looks like they’re making a difference.”

One split that Modi agrees to is a spin-off of Kellogg, which splits into snacks-focused Kellanova and cereal-focused WK Kellogg in 2023. Last year, chocolate maker Ferrero acquired WK Kellogg for $3.1 billion, while Mars completed its $36 billion acquisition of Kellanova.

In Moody’s view, the breakup created more value for shareholders than the combined company. Kellogg’s high-growth snacks business was more viable as an acquisition target without its sluggish cereal division attached. In addition, both strategic buyers are private companies and do not have to worry about sharing quarterly profits with the public.

Some investors hope to achieve the same result with Kraft Heinz.

“The view held by many is that the best way to create value is to split companies and hope you can create Kelanova 2.0 where both entities are acquired at some point, and that’s where value creation happens,” said Peter Galbo, an analyst at Bank of America Securities.

Kraft Heinz has appointed Steve Cahillan, formerly CEO of Kellogg and then Kellanova, as its CEO. Once the company separates, Cahillane will serve as CEO of Global Taste Elevation, the placeholder name for high-growth brands like Heinz and Veladia.

But an acquisition of either company resulting from a Kraft Heinz split would be too large a takeover, making it unlikely that either would be taken over, according to Galbo. Perhaps the uncertainty of creating value from a breakup is why Berkshire Hathaway, the company’s largest shareholder, is preparing to exit its 27.5% stake in Kraft Heinz.

A month into the new year, the divestment trend is unlikely to slow down.

Tuesday, General Mills It announced that it is selling its Muir Glen organic tomato brand to focus on its core brands. Last week, Bloomberg reported that Nestlé was preparing to sell its water unit; The Swiss giant is also said to be considering divesting from premium coffee brand Blue Bottle and its underperforming vitamin brands.

If major food companies make any acquisitions, the deals will likely include “insurgent brands,” according to Bain. The company said that over the past five years, acquisitions worth less than $2 billion represented 38% of all consumer product deals, up from 16% from 2014 to 2019. For example, last year, PepsiCo It bought prebiotic soda brand Poppi for $1.95 billion Hershey LesserEvil bought popcorn for $750 million.

Larger deals are harder to come by due to the current regulatory environment, Konanahalli said. The buyers may not be strategic players, but instead private equity firms with plenty of cash on hand. For example, in January, L. Catterton bought a majority stake in startup Good Culture.

But a divestiture or flashy takeover may not be the answer to the food group’s problems – or a surefire way to lift the share price. Sometimes, good old fashioned elbow grease can work better.

“Just because it seems like the wind is blowing your way, doesn’t mean you can’t put in some hard work and turn things around,” AlixPartners’ Konanahalli said.