Case study by Kepler Cheuvreux
There are a number of sustainability-related trends now affecting the food and beverage sector including:
- changes in consumer tastes;
- demand for greater traceability;
- sustainable purchasing preferences;
- rise in extreme weather events and climate change;
- water scarcity;
- distrust of overly manufactured and packaged food;
- channel shifts;
- emergence of 3G;
- mega M&As focused on cost-led earnings growth;
- risk of employing undocumented workers.
This can have repercussions across the value chain. For instance, governments across the world, concerned about obesity and rising healthcare costs, have started to introduce taxes on sugary drinks. They are due to be implemented in countries including South Africa, the UK and Ireland in 2017 and 2018. These taxes can be transferred down the value chain from beverage companies to consumers.
However, this tightening regulation also fuels market opportunities. For example, Euromonitor estimates the global size for health and wellness (artificially) fortified foods at US$165bn, with a broader specialty and wellness food market estimated to be worth US$700bn (<20% of the total food and beverage market).
|Country||Start date||Tax coverage||Tax type||SSB tax details|
|UK||2018||SSBs||Tiered volumetric||GBP0.18/litre, GBP0.24/litre|
|Ireland||2018||SSBs||Tiered volumetric||In line with UK|
|Portugal||2017||Soft drinks||Tiered volumetric||EUR0.08/litre, EUR0.16/litre|
|France||2012||SSBs and artificially sweetened beverages||Volumetric||EUR0.075/litre|
|Hungary||2011||Soft drinks and energy drinks||Volumetric||Soft drinks: HUF7/litre, selected energy drinks HUF250/litre|
Also, there is a gradual shift in focus to ethically source products such as soy, cattle, cocoa, and seafood that can provide investment opportunities.
Changes in weather patterns and water availability can also impact companies. For example, Aquaculture Breeding & Genetics companies Benchmark sales are highly dependent on the supply of brine shrimp; the Great Salt Lake represents 40-50% of global production. The supply and price depends heavily on external environmental factors (e.g. the algae the shrimp eat tend to disappear when lake salinity increases due to a drop in water levels). We already observed high variability in production levels in the past, leading to price volatility of 10-30%. The Great Salt Lake region, according to the World Resource Institute, is a medium-to-high risk to water scarcity, with projected changes of 1.4x by 2020.
Integrating ESG issues into company valuation
We believe that it is useful to match the risk characteristics with analysis tools to determine the most appropriate integration technique and variable. For example, we consider:
- whether it is short or long term;
- whether it will materialise through increased volatility or a longer-term trend;
- what the expected probability and severity is.
|Company||Type of risk/opportunity||Risk/opportunity characteristics||Integration technique/variable|
|ABF exposed to unhealthy food trends through its grocery business||Shift in customer preferences and demand||Already ongoing trend with long-term implications; severity and probability known and significant||Revenue growth rates in the specific cash flows (DCF model) and terminal growth rate to reflect long-term exposure|
|Coca Cola European Partners exposed to sugar taxes being passed in several jurisdictions||Shift in regulations (sugar tax)||Known event and known tax levels that will materialise through a shock at a specific point-in-time and increased volatility||Modelled cost implications in the specific cash flows (DCF model) taking into account product portfolio, geographical exposure, demand elasticity, pricing power and cross-product elasticity|
|Benchmark exposed to weather variability and its impact on artemia production||Market risk through the sourcing of raw materials||Unknown timing but potential severity and impact known based on past weather events||Modelled through growth rates in revenue and an increase of the discount rate to capture the relatively high risk profile with unknown timing|
|Monsanto exposed to several reputational and litigation risks linked to GMOs||Multiple||Risks that are hard to quantity and predict in terms of probability and timing. More of an overall “sentiment”||Modelled through the discount rate used in Monsanto-BASF takeover valuation.|
|Small and mid-caps in food and beverage supply chain with risks of employing undocumented workers||Regulatory risk and sentiment driven reputation risk||Risks that are hard to predict in terms of probability and timing. Both sentiment and legal enforcement driven by political environment.||Cost elements taking into account legal liability, staff replacement, loss of production and contract losses estimated with potential impact on net income|
Analysing the impact of sugar taxes on Coca Cola European Partners
More and more European countries are introducing taxes on sugary drinks, with prices rising as a result. This has a perceived negative impact on soft drink producers, with volumes and earnings potentially affected. We tried to quantify this threat for Coca Cola European Partners (CCEP).
CCEP’s operating profit in the UK could be impacted by 10% if a sugar tax goes into effect in 2018. As the company is geographically diversified, the impact at the group level will only be 2%. In CCEP’s case, there is now clarity about soft drink taxes in most of its key markets, certainly for the next few years. At the same time, the portfolio is gradually shifting to alternatives with less sugar, which currently already make up an estimated 30% of their beverage portfolio. All in all, we think the negative impact from sugar taxes is limited.
Examining risk profile after an acquisition
It can be argued that the planned acquisition of Monsanto by Bayer could increase their risk profile in several ways. For example:
- litigation (e.g. exposure to new regulation/ enforcement around genetically modified organisms, glyphosate and neonicotinoids);
- reputational risks such as Monsanto fs poor reputation attached to Bayer.
Coupled with a more difficult valuation for healthcare investors to value the combined Monsanto/Bayer entity, we used an 8.7% WACC (vs 7.7% used by Bayer). Together with lower modelled synergies and terminal growth rate, this results in a net value destruction of 10% of enterprise value offered (and 8% market cap) – vs Bayer communicating on a 7% and 5% value creation respectively.