Focus: Why US baker Hostess went stale

US brands Twinkies and Wonder are so iconic they are known the world over, even in markets where the products are not sold. Yet despite having these cultural touchstones in its portfolio, US baker Hostess Brands has struggled over the last decade, entering Chapter 11 bankruptcy protection twice, most recently this month. Sam Webb looks at why this baking monolith has started to crumble.

On 11 January, Hostess Brands applied for Chapter 11 bankruptcy protection, with more than US$1bn in debts to creditors and a further $21m owed to its employees.

It makes it the second time the manufacturer of famous brands like Twinkies and Wonderbread has done so in its history. It applied for Chapter 11 for the first time in 2004, finally emerging from bankruptcy in 2009.

The move raised eyebrows across the industry. However, the company said it would continue operating its bakeries, outlet stores and distribution centres and it was confident about its future.

"Hostess has some of our industry's most powerful and resilient brands," said president and CEO Brian Driscoll. "With generations of loyal consumers, numerous iconic products and a talented and experienced workforce, Hostess Brands has tremendous inherent strengths to build upon."

The Missouri-based baking giant, which started life as Interstate Bakeries in 1930, grew rapidly and made a series of acquisitions throughout the next four decades to become the leading baker in the US. What is behind its current turbulence?

The bare numbers do not shed much light on the issue, showing sales growth for Hostess and the industry as a whole. Data from SymphonyIRI for the year to 25 December showed sales in the US fresh bread and rolls segment grew 1.4% to $10.3bn. Hostess, which accounts for $766m of the market, saw its sales increase faster, at 3.9% year-on-year.

Meanwhile, the US pastry and donuts segment grew 2.3% in the year to nearly $3bn. Hostess hit sales of $631m, an increase of 2%, only slightly below the growth of the segment.

Elsewhere, Hostess fared less well. The company's bakery snacks sales inched up 0.3% to $580m, but well below the growth seen in the segment as a whole, which saw sales increase up 4.4% to $1.8bn.

Hostess's sales fell at a faster rate other categories but ones that are more marginal for the business. The SymphonyIRI data showed its pie and cake sales dropped 4.5% to $5.1m; the category as a whole saw sales increase 0.74% to $1.1bn. The baker's sales of English muffins, meanwhile, fell 9.7% to $3m. As a whole the category rose 2% to $526m. 

However, Chris Schmidt, an analyst at Euromonitor, says Hostess has failed to adapt to an evolving market. The rise of food blogs and cookbooks focusing on traditional dessert dishes, TV shows such as Cake Boss, Ace of Cakes and Cupcake Wars and the growth of baking as a popular hobby have led to a renaissance in cakes and pastries. Hostess's brands, Schmidt argues, have lost their lustre.

"Consumer tastes are largely becoming more sophisticated and adventurous, two adjectives that absolutely no one associates with Twinkies," he tells just-food. "Hostess's once-iconic brands are increasingly viewed as cheap, unhealthy, and outmoded. Hostess's flavour innovation has concentrated almost entirely on new product launches, many of which haven't caught on well, and the company has been hesitant to make any sort of change to their top-selling brands. Add to this stasis the company sleeping through the health and wellness trends of fewer processed ingredients and lower calorie counts, and it is no wonder the company has struggled to increase sales."

Mary Gotaas Nanfelt, industry research analyst at IBISWorld, concurs that Hostess has failed to adjust to an America more tuned in to health matters.

She said: "Over the past few years consumer preferences regarding bakery products have changed. Americans are now more health conscious and are stirring away from goods high in sugar and fat, which has negatively affected many of Hostess's products. As for food staples, such as bread, consumers are purchasing more products that are higher nutrients like whole wheat bread instead of white bread."

Hostess has shown signs of beginning to adjust, Nanfelt says. It sells 100 calorie packs of some of their most popular products, a trend she says has proven successful for other snack companies such as Kraft Foods and Kellogg. The company also introduced a new product line called SmartBakes that are marketed as the company's "better-for-you" line of baked breakfast products.

However, along with changes in consumer preferences, analysts say the company is facing a host of pressures, such as increasing pension and medical benefit costs and competition from private label brands, a major growth category in the US as a result of the shaky economy. Nanfelt says this is unlikely to alleviate even as the economy recovers, as consumers will remain price-conscious.

Hostess is especially vulnerable to the shift to private label because of its bargain price level, according to Schmidt. Input prices have risen sharply, yet Hostess brands are among the cheapest options on the shelf, making it difficult to pass on price increases as even a slight rise could convince cash-stretched consumers to move along the shelf.

The company has also faced greater competition from Grupo Bimbo and Flower Foods, its largest competitors. In 2011, Grupo Bimbo held a market share of 16% in the Bread Production industry where Hostess held a market share of about 4.5%, based on IBISWorld estimates. Nanfelt says that these companies' larger acquisitions [Grupo Bimbo's acquisition of Sara Lee's bakery operations in the US and Flowers purchase of Tasty Baking] are likely to have hurt Hostess, while Schmidt says they definitely did.

Schmidt is equally gloomy - and blunt - about the firms long-term prospects, which he said "aren't good".

"This is the second time the company has filed in a decade, and it's products aren't positioned well looking forward. In addition to its snacks portfolio's unhealthy, unsophisticated image, Wonder Bread (despite being semi-fortified) is generally viewed as unhealthy, or at least less healthy than whole wheat varieties and fast-growing brands like Nature's Own," he said.

He also said divestments look likely because the iconic brands will still appeal to investors.

He continued: "If I had to speculate, I'd say the company doesn't have much chance of continuing on its own.

"I doubt any huge player like Kraft or Bimbo would be interested in the snack bakery portfolio, but I could see a middling company like McKee Foods bid for some of those brands, if it comes down to a real sell off.

"Flowers Foods was willing to take on a decent amount of debt for a seemingly unattractive Tastykake portfolio, so one would think they might also be interested in Twinkie and Co as well."

There are other grey clouds on Hostess' horizon. The powerful Teamsters Union, which represents 7,500 staff at Hostess, is angry with Hostess' assertions that high labour costs are behind its troubles.

"Our members made real sacrifices to help pull this company out of [the first] bankruptcy," said Dennis Raymond, director of the Teamsters Bakery and Laundry Conference. "It was not a failure of Hostess' workers that led to this bankruptcy, it was the inability of management to execute their business plan.

"In fact, one of the few areas in which Hostess achieved its forecast was in its labour costs, which remain entirely consistent with the original projections."

A sophisticated, healthier, yet cash-strapped public, product stagnation, powerful and bold rivals and the prospect of an ugly brawl with its own workers makes it difficult to see the maker of Twinkie as anything but a falling star.