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How the Food Industry is Turning Into a Game of Monopoly

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What does it mean to dominate an industry? Do we live in a day and age where that market power can come simply from an innovative idea and calculated execution, or are those days over?

Within the food industry in particular, what we’re beginning to see more and more of is the industry equivalent of when LeBron James joined two other superstars on the Miami Heat in 2010 instead of continuing on his own with the Cleveland Cavaliers. Granted, he changed his mind a few years later, but the business world doesn’t have that kind of flexibility.  

With large companies merging together and forming conglomerates, will we see the food industry replicate the oligopolistic competition of the media world? Let’s take a look at the implications of what we’ve seen so far, and if outlook is really what it seems to be.

But Mom, Everyone’s Doing It!

Just today, Hershey (HSY - Free Report) surged on reports that it could be bought by Mondelez International (MDLZ - Free Report) , the company that makes products like Oreos and Ritz crackers. If the acquisition is to happen MDLZ promised to move their headquarters to Hershey, PA and take on the Hershey brand name as their own. An acquisition of HSY could prove to be very lucrative, considering it has and remains a very well-recognized firm around the world.

According to the Food Institute, 2015 saw 410 M&A (Mergers & Acquisitions) deals. The most notable of them was the H.J. Heinz Company merging with the Kraft Foods Group. They became the Kraft Heinz Company (KHC - Free Report) , and according to our research is the fifth-largest branded food and beverage company in the world.

Coca-Cola Enterprises , an independent bottler of Coca-Cola’s (KO - Free Report) beverages merged with two other Coke bottlers last year as well. Other news included packaged foods company Post Holdings (POST - Free Report) acquiring MOM Brands Company, which is the fourth largest breakfast cereal company in the U.S.

These deals are a just a few of the many M&A deals that have happened in recent years. The fact of matter is that the “cool” kids are continuing to build up their playground gangs, but why?

What’s the Point?

In order to illustrate the benefits that these M&A deals provide, let’s continue our look at the Kraft Heinz Company. Currently sitting at a Zacks Rank #2 (Buy), KHC has been subject to lower spending by U.S. shoppers and a shift towards healthier products. However, analysts agree on upward estimate revisions, changing estimates for this fiscal year to $3.07 per share, up from $2.94 60 days ago.

Since the merger, KHC has been able to implement many cost saving initiatives. As per our report, the company plans on saving $1.5B in annual costs by the end of 2017 by focusing on work-force reductions, factory closures and consolidations. By using resources from both the Kraft and Heinz businesses, KHC has managed to realize $125M of savings in 2015 and $225M of savings in Q1 of 2016 alone, which has served as a driving force to the aforementioned estimate revisions.

KHC also beat earnings estimates in Q1, pulling in an EPS of $0.73, beating the Zacks Consensus estimate by 19.7%. Reported sales of $6.57B also beat estimates and represented a rise of 165.1% year over year.

The food industry is subject to heavy competition, and by merging, companies get to maintain their share of market presence. The reality is that these companies can create scale economies in key parts of their business, such as within their supply chain, marketing, and general purchasing power, all of which can help save costs and maintain margins. The ages old phrase “If you can’t beat ‘em, join ‘em” holds significantly more credence than people give it credit for.

According to PricewaterhouseCooper’s report on the food industry, volatile commodity prices noticeably impact already thin margins. Along with this, sluggish growth in already developed markets can put companies in danger. Mergers help to offset this danger through such perks as brand diversity and increased presence in developing economies.

The benefits that KHC has reaped from its merger is in no way unique, and represents part of the essential motivation behind the current trend in the industry as a whole.

Will the Trend Continue?

PwC mentions another notable shift in the food industry, the ability for smaller companies to compete with established, mammoth firms. By developing relationships with larger grocery chains, these companies have access to almost as large a market share as their larger competition. The little guys on the playground are putting up a better fight against the “bullies,” so the bullies just need to get in bigger groups.

I believe that the trend will continue, because the mergers make a lot of sense. Merger strategies are guided by a company’s specific needs, and generally the benefits they receive significantly outweigh the costs. As an example, a company can purchase competition that offers a similar product in another geographical location, merge, cut costs, and now have presence in that region.

Mergers are proving to be a surefire method to expand and reduce both costs and risks in the process. Another possibility is that if larger companies see something innovative in smaller competition, they can buy them, incorporate the idea, and in the process scale the innovation into a much larger framework.

Investors should keep an eye out for further acquisition rumors moving forward. HSY is today’s news, but there is no doubt there will be more to come.

Bottom Line

Although there is reason to argue that “bigger is not always better,” that doesn’t seem to be the case in the food industry. Although growing up, your parents may have never appreciated the argument that something is worth doing because “all of your friends are doing it too.” Here, everyone appears to be doing it for good reason, and will continue to do so.

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