Premier wants to "unlock value" from bread business and reports claim it could sell unit

Premier wants to "unlock value" from bread business and reports claim it could sell unit

UK company Premier Foods had already hinted it had plans to shake-up its bread business and, this week, the Hovis manufacturer underlined it would "fix" that part of its operations. The company decided to walk away from an own-label contract worth GBP75m but the move is a wise one; status quo in bread is not an option. But what options are out there for Premier in bread?

Given the way in which CEO Michael Clarke has looked to freshen up Premier's wider grocery business, investing in a select basket of brands and offloading others, it is little surprise he has now rolled up his sleeves and set about trying to improve its bread operations.

The bread market in the UK is very competitive, dogged by promotions and has excess capacity. Premier and its two main rivals Associated British Foods and Warburtons find it tough to grow profits. Some would argue it will always be difficult to make a decent return out of bread in the UK but, one thing is for sure, it cannot be business as usual and, this week, Premier announced the first tangible move that emphasised it is serious about improving returns from the business.

Premier announced the end of an own-label contract with an unnamed UK retailer earlier this week. It said the contract accounted for around GBP75m of annual sales but Clarke insisted it was of an "unusually very low margin". The company, which also supplies brands including Oxo gravy and Loyd Grossman cooking sauces, said the end of the deal would "not affect" its 2012 performance.

"I would always like to retain contracts but I want to retain contracts on a basis that is both sustainable for us and the retailer," Clarke said.

"Following a recent business review, and consistent with our approach to improve sustainable profitability in bread, we've been unable to agree on the renewal of our bread contract with one of our retail customers from mid 2013. This contract represents approximately GBP75m in annual sales but has a very low margin and is costly to serve."

Neither Clarke nor Premier announced the identity of the retailer with which the company had failed to find agreement. However, today it emerged the retailer in question was The Co-operative Group, which announced ABF would now supply it with own-label bread.

The Co-op, the UK's fifth-largest grocer, said the switch to ABF had "been made in the best interests of our customers and members". ABF said the deal was expected to create new jobs in its supply chain to enable it to service the additional stores.

However, Premier's Clarke, speaking to analysts on Tuesday after the company had announced the end of the contract, insisted it was not making money from the deal. "Our bread business is very similar to other people's bread business. This is an unprofitable business for us and if somebody else is putting more money on the table to take that business than we wish everyone well," he said.

Bread is one of the most challenging categories in UK grocery, with retailers using the product to drive footfall into its stores. And the recent weather-fuelled increases in wheat costs is putting further pressure on the business. "The impact of weather on the harvest in the UK and other parts of the world has led to a significant increase in the cost of wheat," Clarke told analysts. "While we've been successful in delivering price increases to offset this inflation, our supply chain efficiencies have been impacted by the low quality of the UK harvest. We're currently managing the situation and continue to review our wheat procurement strategies to make sure we can maintain the right quality of product across our range."

The renewed pressure on Premier's commodity bill could have been a factor in the end of its contract with The Co-op but, even without the higher cost of wheat, the company is correct to be more pragmatic about its contracts. The question is: where does Premier go from here?

To make Premier's bread business more profitable, Clarke is likely to look at making its supply chain and production more efficient, although, of course, to supply bread nationwide a significant distribution network is needed. Plants could be closed, especially now it has one fewer contract to serve.

On Tuesday, one City analyst asked Clarke if Premier had looked a joint venture on distributing the product. Clarke did not respond directly, instead saying Premier had "piloted a number of exercises on how we could improve our bread business".

However, he added: "We have not been sitting on our hands in bread. We have spent a lot of time on working through different business models, what parts of the business are essential. I don't want to get into more detail than the generics that I am using in this conversation. We have worked out what our preferred solutions."

Clarke cited the recent appointment of former Uniq chief executive Geoff Eaton as Premier COO. He said Eaton had "experience" in bread and "running businesses going through tough situations". Clarke also pointed to Bob Spooner, the head of Premier's supply chain, who is "very focused on the bread restructuring and addressing how we are going to unlock value in bread".

And perhaps the ultimate solution to "unlock value" could, of course, be to sell off bread completely. Sky News reported today Premier had appointed Goldman Sachs to conduct an auction of its bread business. Premier could not be reached for immediate comment. Few obvious buyers, however, spring to mind. ABF and Warburtons, for instance, would face anti-trust concerns.

In any case, as Clarke put it on Tuesday: "In the same way we have fixed or hopefully fixed grocery, we are now going to fix bread."