Rising costs are a growing challenge to the food and beverage industry but investors are still showing a healthy appetite for M&A. Here’s what happened in food and beverage in the first quarter of 2022 as our experts analyse the investment trends and macroeconomic headwinds. We also look at how F&B firms can build resilience to ride the economic storm.
IN THIS REVIEW
Announced M&A activity in food and beverage - quarterly
Deal volume holds steady
There’s a sharp contrast between Q1 2022 deal volumes with those of Q1 2021 when post-COVID-19 deal catchup was in full swing. Since that flurry of 63 deals, quarterly volume figures have hovered in the mid-30s, which is where Q1 2022 sits with 35 transactions.
Though numbers have yet to return to pre-pandemic levels, they remain respectable, given the increasing number of challenges facing the sector, including record inflation, squeezed household incomes, supply chain disruption and geopolitical forces.
Deal values improve
Of the 35 deals completed in Q1 2022, 11 disclosed financial details, totalling £489.5 million. In Q4 2021, disclosed deal value was £1.4 billion – a total inflated by mega-deals, such as the Morrisons take-private. Stripping these large deals out, Q1 fared better than Q4’s £396.5 million.
There were no mega-deals this quarter reflecting growing investor caution about headwinds facing the sector.
Q1’s biggest deal
March 2022 – Tate & Lyle acquired Chinese prebiotics manufacturer Quantum Hi-tech for £180.5 million. The deal demonstrates the increasing appetite for health and beauty focused F&B companies and strengthens Tate & Lyle’s position in the dietary fibre market.
Private equity (PE) remains very active
PE continues to be very active in F&B and was responsible for 45.7% of Q1 2022 deals (compared to 27% in Q4 2021). Private equity investors were particularly focused on early-stage high growth companies, where there is often less competition from large trade buyers that prefer to innovate internally or acquire more established businesses.
High demand for growth
Domestic (UK and Ireland deals) dominated in Q1, accounting for 69% of activity, compared to 54% in Q4. Some 5.7% of transactions were overseas acquisitions of UK&I entities, and 25.7% were UK&I companies buying overseas.
Bakery took the top spot in Q1 2022, representing 17% of deals. Meat and plant-based companies (somewhat ironically) competed for second place.
Bakery’s positioning is perhaps a surprise at a time when wheat prices have soared due to adverse weather, rising costs for farmers, supply chain disruption and the war in Ukraine (bakers accounted for seven out of 14 administrations in Q1).
It’s no surprise however that Q1 bakery deals were grounded in strong strategic focus, such as securing supply chain capability. Increased demand for luxury or indulgent baked goods during the pandemic also drove deal activity, perhaps inspired by the success of Exponent’s 2021 acquisition of Gü.
Backing the bakers
How F&B is riding the storm
What's next for the food and beverage sector in 2022? F&B has proved resilient against external pressures, from Brexit to a global pandemic. This year will be a test of how companies can ride the storm. Here are three ways that F&B is staying resilient in the face of larger macroeconomic challenges.
The Food and Drink Federation (FDF) has asked to partner with the UK government to create a short-term COVID-19 recovery visa, which will help alleviate the labour shortages caused by Brexit. In the meantime, they want to create a package of measures to support the sector with skills and career progression and develop long-term recovery.
Dr Lisa Jack, Professor of Accounting at Portsmouth University and R+D research panellist at CIMA told me that “the sector lacks a cushion for investing in labour and skills because of the squeeze on margins”.
Accountancy in the food and drink sector is highly complex and very different to its counterparts in other industries. Huge variables, marginal costing, and over-reliance on dated tracking systems are further impacted by the fact that once a strategy for standardisation has been put forward and approved, everything has already changed.
Lisa goes on to say that “there are organisations experimenting with benchmarking and activity-based costing, but we are far from an industry-wide solution”.
Accountancy thus has a profound effect on how the industry operates, and these challenges cause frustration and high rates of attrition within finance teams.
Investing in financial talent
Skills development programmes, such as apprenticeships in both early careers and experienced hire up-skilling, bring a lot of value to a company, but technical apprenticeships can help people move from the ‘shop floor’ to head office.
To really address these challenges, businesses need to invest in industry-specific training in accountancy and data analytics. Understanding complexities and working towards creating effective algorithms, and analysing the right data are critical, as well as wider concerns such as tracking waste and environmental impact.
Finance functions in larger organisations need to give individuals broader experience so that they're empowered to affect change, pull data together, and break out of silos. This could also help retain talent.
It's important to know the extent to which data analysis can help, including how arduous tracking can be automated and planning scenarios for achieving Net Zero goals.
People want to gain skills and be developed. They’re not just number crunchers and if we empower future talent with the confidence to ask the right questions, plan for different scenarios, interpret findings, and collaborate with colleagues and utilise each other’s knowledge of the industry – then we are off to a good start.
The latest ONS inflation figures show that food and non-alcoholic beverage prices have increased by 5.9% year on year in March 2022. This continues the trend from January, when sector inflation stood at 4.3% and March’s F&B inflation out-turn is the highest since May 2011. This stands in marked contrast with the previously stable level of F&B price inflation; for example, there was no increase in average F&B inflation between October 2020-September 2021.
Food and beverage are, of course, just a subset of more general inflation drivers and concerns, accounting for 9.3% of the overall consumer shopping basket. Economy-wide inflation in March 2022 was 5.5%, the highest since 1992. Recent forecasts from the Office for Budget Responsibility (OBR) expect economy-wide inflation to peak at just under 9% in Q4 2022. These OBR forecasts only expect inflation to return below the Bank of England target rate of 2% in Q3 2024, highlighting the fact that consumers are in for a rough ride over the next 12-18 months.
OBR economy-wide inflation expectations (%)
Whilst the dynamics of contracts and high levels of competition have meant that inflation in the F&B sector is slightly lower than the economy as a whole (5.9% compared to 6.2%), these constraints on prices are unlikely to last. The sector is particularly exposed to current economic and political instability affecting global supply chains, and production and labour costs can expect higher inflationary pressures over a longer period than for other goods.
Concerns over inflation have, of course, increased considerably following the terrible events in Ukraine. Approximately 20% of forecast inflation is due to the war in Ukraine, and the F&B sector is likely to follow a similar (or potentially more challenging) path.
What's driving inflation in the F&B sector?
1 Government spending and global supply chains
The most benign version of the drivers of inflation is pandemic-related. Following the COVID-19 pandemic, inflation has been impacted by government spending (effectively boosting the money supply and more broadly, spending to support firms and workers), and a period where the interconnectivity and interdependence of global supply chains have been stretched.
Whilst the first of these points holds across the economy, food and beverage supply chains raise specific concerns. The latestFood Security Report(updated December 2021) shows that the UK imported approximately 46% of the food it consumed in 2020. Food imports, especially in vital categories such as fruits and vegetables, are very important for food consumption in the country. The supply chain bottlenecks and disruptions due to the pandemic have increased the costs of imports and have significantly contributed to the observed price rises.
Nevertheless, if the drivers of inflation were limited to these factors, then inflationary impacts in the F&B sector would be transitory and after a matter of months of trading, prices could have returned to previous levels.
2 Labour shortages
For the UK, supply chain bottlenecks have clearly been exacerbated by labour shortages, which provide a potential longer-term driver of inflation. While the most commonly cited example is the significant reduction of HGV drivers following Brexit, the problem is more widespread and profound.
ONS datashows the F&B sector’s reliance on EU migration. Around 10% of agriculture, food and drink manufacturing, food wholesaling and food retailing workers came from the EU27 member states and 32% of employment in food and drink manufacturing. Alongside this, the UK domestic labour market is in a very healthy state with unemployment already at low pre-crisis levels, severely limiting alternative sources of labour at current wage levels unless wider visas are issued.
3 War in Ukraine
Alongside these issues for supply chains, the Ukrainian conflict will inevitably create further challenges within the global commodities markets as supply is disrupted in a number of key commodities. In many cases, the impacts on the UK food and beverage directly are relatively limited in the short term due to trade patterns, but an increase in global prices will lead to price inflation in the medium term. For example, Russia and Ukraine combined were responsible for 28% of global wheat exports in 2021, and while the UK currently domestically provides 90% of its own wheat, prices for export are increasing rapidly and hence domestic prices will inevitably adjust.
Similar patterns are also being experienced in a number of commodities, particularly metals and chemicals used within the F&B supply chain. Economic sanctions are expected to dramatically limit exports in sectors where Russia has a higher market share of exports, and forward-looking prices have peaked at over 100% higher than that seen prior to the conflict. It seems inevitable that the conflict will further expose the challenges to the interconnected global food and beverage supply chains that have suffered across the pandemic.
4 Present and future energy prices
The other key inflationary driver impacting the F&B sector is, of course, energy prices, as they drive up the costs of food production, storage, and distribution. Energy is in high demand throughout the whole supply chain: from the fuel needed to operate the agricultural machinery to the electricity required to operate refrigerators and freezers for storing food; to the fuel needed to distribute the food. Alongside this, higher energy costs are also driving up household costs and hence a driver for wage inflation within the economy.
Even prior to the Ukrainian conflict energy prices were already being driven upwards through a combination of political instability, weather and market-based issues. For example, the OBR expectationsfor gas prices more than doubled and for oil increased by 30% between October 2021 and prior to the war in Ukraine. However, following the invasion of Ukraine, current and, more importantly, futures prices of energy have rapidly increased as market makers have considered the effects of present and likely potential future sanctions imposed on Russia.
The most immediate impact has been felt on gas prices. While the UK is not directly reliant on Russian gas, again it is interconnected to the global and European wholesale market. The nature of gas is such that it is extremely difficult (and where possible costly) to change supply and so consequently, we have seen prices increase significantly. Further, European governments have mostly chosen to forsake Russian gas.
The price of oil also increased significantly before partially falling back. While the nature of the oil market does allow for greater point-to-point replacement of Russian exports in a shorter time, such turbulence will likely continue to place pressures on international prices higher for an extended period.
Where does this all take us? How long will high inflation last?
The next 12 months seem to have general price inflation in the region of seven per cent, with peaks of nearer 10% due to the current conflict built-in. There is little reason to expect the UK food and beverage sector to be immune from this. Indeed, the nature of the shocks facing supply chains at present may mean that this inflationary period lasts longer, perhaps an 18-month time period, and has a longer-term impact on the sector relative to others. Key to the path for inflation in the F&B sector and inflation more generally will be whether inflation expectations become entrenched. This is important because it can reinforce inflationary pressures are baked into expectations and lead to further inflationary pressures through higher wages as workers seek to protect real incomes.