How does a bread company make money when has been caught in the crossfire of a marketing war between Woolworths (ASX: WOW) and Coles, owned by Wesfarmers (ASX: WES)?
That's the question exercising the minds of senior management at food manufacturer Goodman Fielder (ASX: GFF) as it battles the impact of house brand loaves of bread being sold for $1 (and at the head offices of dairy businesses battling $1 litres of milk) – especially in light of yesterday's announcement of a second consecutive full-year loss.
What's good for consumers isn't necessarily good for suppliers, and in this case, Goodman is feeling the pinch.
Bread is a high-penetration category, meaning the vast majority of households already buy it, and the vast majority of those already serve it for lunch and often breakfast. That reality means that lower prices rarely do much for sales volumes — they simply crimp margins instead.
With Woolies and Coles having a 'lock' on the local grocery market, Goodman Fielder and major competitor George Weston Foods have little option other than simply doing as the retailers tell them.
Throw in rising commodity costs, and it's an unenviable position.
Facing significant margin pressure, Goodman Fielder has resorted to cutting jobs, slimming down its product portfolio, closing plants and looking to sell off parts of the business to allow it to focus on its main product categories.
Of course, the company isn't just a bread business, having significant diversification across product categories, but few if any of those categories present the company with the pricing power that allows suppliers to make a healthy margin on products sold in Australian supermarkets.
We saw Coca-Cola Amatil (ASX: CCL) and Woolworths at loggerheads for a few months in the past year as they negotiated on pricing and support — a situation that cost the drinks manufacturer considerable sales and profit. Coke is probably one of the few brands with the strength and consumer loyalty that allows it to go toe to toe with its retailers.
In a sign of the challenges facing the company, Goodman Fielder declined to pay a final dividend, as it continues to reinvent itself and amid still-falling profits.
Foolish takeaway
Investors need to combine two different skills to give themselves the best chance of success – being able to understand how a company makes money, and then being able to assess and pay a reasonable price. In the case of buying shares in grocery suppliers, having a considered opinion about the competitive dynamic and supplier (cost) and customer (price) pressures are essential.
Time will tell whether Goodman Fielder can solve that problem, itself.
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Scott Phillips is an investment analyst with The Motley Fool. He owns shares in Woolworths and Coca-Cola Amatil and has previously been employed by Goodman Fielder. You can follow Scott on Twitter @TMFGilla. The Motley Fool's purpose is to help the world invest, better. Take Stock is The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it's still available. This article contains general investment advice only (under AFSL 400691)
