•  Hann-Ju Ho 

    Food and Drink sector Insight

    Author: Hann-Ju Ho, Senior Economist

    Publication date: 01.08.2010

    With output expected to return to previous peaks much sooner than within manufacturing as a whole, the UK food and drink industry has proved pretty resilient to the recession.
    UK food and drink has weathered the recession well. From peak to trough, production fell by about 6%, compared with more than 16% for manufacturing overall. What’s more, latest official figures show a surprisingly strong rebound this year, with production up more than 4% year-on-year.

    Despite downward pressure on output price inflation, a marked fall in input price inflation has helped support margins. Based on return on capital employed (ROCE), an indicator of medium-term profitability for listed food and drinks companies, long-term profitability has also recovered strongly this year and further improvement is expected in 2011.

     Food and Drink chart 

    Yet risks remain
    While the ongoing constraints to UK consumption from higher taxes and job insecurity are likely to support growth in products at the ‘value’ end of the spectrum and supermarkets’ own-label products, this will probably be at the expense of higher margin premium brands. This may be partly offset by substitution for spending at restaurants.


     Other risks to food and drink producers include:
    • Potential volatility in global agricultural prices, energy prices, foreign exchange rates and interest rates.
    • Smaller companies perhaps facing greater margin pressure than larger producers with more profitable global brands, leading to further consolidation or joint ventures with multinationals.
    The UK remains a net importer of food, with an annual trade deficit around £17bn. The deficit has stabilised since the start of the recession, as the weaker pound has supported exports. However, a significant part of the deficit is structural, meaning that higher import prices are not likely to lead to significant domestic product substitution in the short to medium term.



     Cost cutting
    Led by high global commodity prices and the weaker pound, input price inflation for food and drink producers soared during 2008 but fell back in 2009, helping to support margins, despite only moderate output price increases (see chart). ROCE fell to 9-10% over the past two years but has risen to more than 18% this year, with analysts expecting that to remain strong in 2011.
    However, domestic consumption prospects remain uncertain, especially given the likelihood of further tax increases and job insecurity. The potential for output price growth may therefore be limited, meaning that the impetus for companies to cut costs and improve productivity will remain strong.



    Foreign opportunities for UK firms
    While the UK’s trade deficit in food (offset to some extent by a small surplus in beverages) narrowed slightly during the past year, much of it is ‘structural’, meaning that domestic products cannot easily substitute imports, at least in the short to medium term.


    As most of the UK’s food and drink exports are to the rest of the EU, rather than to some of the emerging economies in Asia and Latin America, there may be potential for UK companies to exploit opportunities in these rapidly growing regions.


    Gauging market risk
    Clearly, the UK food and drink sector is exposed to financial market risks, including agricultural prices, energy prices, foreign exchange rates and interest rates. Volatility remains a risk, given the impact of investor sentiment on global prices, especially as low interest rates encourage the ‘search for yield’.
    Movements in global agricultural prices are further affected by foreign exchange activity, which also has an impact on export prices. In addition, the pound was generally considered to be overvalued in the years leading up to the credit crisis, boosted by strong growth in financial services.


     Looking ahead, Lloyds anticipates the following developments:
    • Downside risks for the pound against the US dollar in the near term (6- 9 months), but £/$ is expected to be around 1.50 over the medium term.
    • Changes in energy prices could also have a significant impact on transportation costs for companies in this sector.
    • Global oil prices are likely to trade between $70 and $80 in the next few years, owing in part to favourable supply-side conditions.
    • The food and drink sector is a net borrower, with a debt/deposit multiple of 3.0 in Q1 2010 — the highest in the manufacturing sector.


     We expect official interest rates to remain on hold at 0.5% until well into 2011. Swap rates have continued to drift lower, but we expect them to rise gradually over the medium term.

     Source: This article was first published in Lloyds Banking Group - Perspective Magazine, Edition 2

2/25/2018 1:16:06 PM