Friday, August 28, 2009

Thoughts on Brands and Private Label

The earnings season is behind us with some of the retail companies finishing up their quarterly reporting (for the benefit of our readers, such as my only regular-- hi-- who comes from the NYC law firm of P------n B-----p, retailers usually end their year in January after the Christmas shopping season so their reporting lags the other corporate names). One of my take-away points from this reporting season is that despite the fact that people eat more at home, sales at the branded packaged foods companies (Kraft, Heinz, ConAgra, Sara Lee, General Mills, Kellogg, even Nestle and the like) have not done very well. I am not talking about earnings, EBITDA or anything like that, simply sales.

I think the main reason is that the brands these companies have are not what everyone thought they were. A brand theoretically has the power to make you pay more and/or use more of a certain product because of the brand equity. Brands are in your face with their ad jingles, glossy magazine ads, in-store displays, and so on. Many of the companies I list above for many years have been spending extraordinary amounts of money on brand building, brand awareness, brand extensions, brand promotion, brand this and brand that. In short, The Brand was/is The King. As a matter of fact, if you have any sort of corporate ladder inspirations there, you have to start in a brand-related part of the company.

What is happening now, because of the pressure on the consumers, the old humble private label is literally kicking... and taking names. I am not a brand expert (I was a marketing major as an undergrad so I am heavily skeptical on brands, i.e. I do not have "brand relationships" with any) but I have dabbled around enough to know factually that in most CPG categories there has been a substantial (more than 30% dollar volume) private label presence even before the crisis hit. The number is much higher in categories such as milk and meats, and very low in booze, cigarettes, gum, candy and breathmints. I have not seen any recent data but I have to think that private label has been taking share across all channels, measured and non-measured. Frankly, there are plenty of what I call "non-brands" out there that are functionally 100% identical to the private label products, often made on the same conveyor line. Milk, bread, meats, frozen vegetables, flour, fats and oils, pasta, canned vegetables, etc. are often identical across labels.
How can one play this? Unfortunately, it is a very limited universe. TreeHouse Foods (ticker THS) is one big player, another one is Ralcorp (ticker RAH). Dean Foods (ticker DF) and Flowers Foods (ticker FLO) also have substantial private label businesses. Of these, DF is probably the riskiest player because they are in a 100% commodity business. FLO is the only large public bakery (there is also TAST but they are tiny). Ralcorp is an old spin-off from RalstonPurina. I think it is a relatively well-run business. They scored a homerun two years ago when they did an RMT with the Post cereal division of Kraft. Their shares went wild on the announcement which made me think that this was a big wealth transfer from the KFT shareholders to the RAH shareholders. The only problem with RAH is their investment in Vail Resorts (MTN), which is a company that I am excessively pessimistic on. Finally, you have THS which arguably has one of the best management teams in the packaged food space: a bunch of sharp former Keebler guys that took over a crappy DF spin-off, and have been adding high-quality, fat-margin privately held businesses over the last few years. Unfortunately-- for an investor, their stock has run up drastically this summer. They are also one of the few food companies that do not pay dividends: the money goes for debt paydowns and acquisitions. But I am pretty comfortable that the acquisitions they do are smart which not something I say with ease.

The implications for the branded players could be serious: think how much goodwill is on the balance sheets. Think how much of a higher multiple their EPS "deserved" because of the brands. We'll see how it turns out. I think there might be some brand casualties.

What I said about brands applies strictly to packaged foods. There are areas where brand performance is real: the $19.99 Starter sneakers from WalMart will not perform as well as the $99 Nike AirMax. Of course, Nike will never tell you that they owned Starter for years but this is a different story. Both the Mustang and the MurciƩlago are sports cars and yet one commands a 10-15x price premium. Why? Part of it is performance (you also have cost, fit/finish, exclusivity and other tangible and non-tangible factors). Of course, Lamborghini will never fess up to being owned by Volkswagen (= people's car in Deutsch), and, previously, by Chrysler.

Update (9/13/2009): Yahoo has a Consumer Union story on branded foods vs. PL. PL wins on average.

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