Here’s A Sign That Investors May Be Too Pessimistic About Brick And Mortar Retailers

A spoiled marketing deal between Campbell Soup Co. and an unnamed retailer -- likely Wal-Mart Stores Inc. -- warns of a looming price war in the grocery industry that may galvanize packaged-food giants to more seriously explore acquisitions, even if it means paying bloated valuations. 

Campbell announced late last month that it was unable to reach an agreement with a large customer over a promotional program for the upcoming "soup season." Said customer is widely speculated to be Wal-Mart, which accounts for 20 percent of Campbell's revenue, and so the news helped send the $14.5 billion company's shares tumbling. It's hard enough for Campbell to captivate food shoppers, given its heavy reliance on canned soup -- a product that, let's face it, is really only enticing when you have a cold, an empty fridge, or the Seamless app is down. Something like this only makes it worse.

But the setback may not be Campbell's alone. Rather, it may be an early sign of big retailers' willingness to exert more pressure on food suppliers in the face of escalating competition from Inc., which acquired Whole Foods Market Inc. on Aug. 28. Amazon has already begun slashing Whole Foods' prices, and although Wal-Mart remains far cheaper (about 50 percent cheaper based on a recent Bloomberg News survey), there will be pain for Amazon's brick-and-mortar rivals. These grocers are going to take it out on suppliers -- especially ones like Campbell that get prime real estate in the center grocery aisles but aren't doing enough to justify their ubiquitous presence.

All the biggest packaged-food manufacturers -- Kraft Heinz Co., General Mills Inc., Kellogg Co., Mondelez International Inc., etc. -- are already challenged in protecting shelf space. Products once considered tried and true are falling out of favor with shoppers, particularly the health-and-convenience-seeking millennials that seem to be roiling every aspect of the retail industry. Take cereal: The category is in decline, which means Kellogg and General Mills need to act more quickly to diversify their products. 


What's interesting is that despite the obvious growth hurdles that have resulted from this trend, Big Food has managed to maintain strong profit margins, with cost-cutter extraordinaire Kraft Heinz leading the way. Margins down the chain at the retailer level, meanwhile, are much tighter. If, as seems likely, one of the ramifications of Amazon buying Whole Foods is that Wal-Mart and others are forced to cut into suppliers' margins more, this will heighten the need for Campbell, Kraft Heinz and others to make their own acquisitions for revenue growth and cost savings. Just last week, Target Corp. announced price cuts on thousands of items such as cereal, another sign it's getting real.

I've speculated on some of the possible merger scenarios before, including Kraft Heinz buying Campbell or even any of its peers. That said, Warren Buffett -- whose Berkshire Hathaway Inc. provided financing for 3G Capital to weld Kraft Foods and H.J. Heinz together two years ago -- has downplayed talk of the company going after Mondelez or similar targets next. One candidate outside the food space that Kraft Heinz could look at, though, is Colgate-Palmolive Co. 

Hain Celestial Group Inc., the maker of organic and better-for-you foods, is another target that would make sense for any of the aforementioned buyers. But the risk in a deal for Hain and most other targets out there is overpaying. Larger targets are overpriced and smaller ones don't make enough of an impact on the bottom line. And then there are candidates such as J.M Smucker Co. and Hershey Co. that are controlled by insiders who won't be keen to sell unless the takeover offer is outlandish. 

Any big food mergers would be coming from a position of weakness, so investors shouldn't get too excited about the idea of a deal rush. But for price-conscious food shoppers and M&A bankers, it could be a feast. Bon appetit.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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