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November 16, 2009

INSIGHT: Chocolate makers face “tough” 2010

The world's chocolate makers face a challenging next 12 months as they try to balance facing higher cocoa and sugar prices with weak consumer confidence.

The world’s chocolate makers face a challenging next 12 months as they try to balance facing higher cocoa and sugar prices with weak consumer confidence.

That is the verdict of Kepler Capital Markets analyst Jon Cox, who in a report on the global chocolate sector, said the twin pressures could lead to M&A activity in the sector.

On Friday (13 November), Cox’s report cited Lindt & Sprungli as the most “obvious” takeover target in the sector and predicted Nestle and Mars Inc as potential suitors for the business.

Other industry watchers have cast doubt on whether Nestle, which has publicly stated its ambition to build its business in the health and wellness category, would bid for Lindt.

The doubters have also suggested that Lindt’s share structure, with a pension fund holding a 15% stake in the business, could provide too high an obstacle for a sale of the business.

Nevertheless, chocolate makers of all hues do face a tight cost environment. Cocoa and sugar prices remain volatile and brand-owners may find it tricky to pass on cost increases with retail customers facing nervous consumers.

“Cocoa products can account for 70% of the cost for an average milk bar, rising to over 90% for some dark chocolate varieties,” Cox said. “Producers can either increase prices to offset the impact of higher cocoa prices, which would likely trigger a deterioration in volume, or they can leave prices unchanged, which would lead to a deterioration in operating margins. We expect luxury chocolate firm Lindt to be the hardest hit followed by Hershey and Cadbury.”

Private label has had less success in gaining a foothold in the chocolate category than in other parts of the food business but Cox also argued that a round of price hikes from brand-owners could lead to some consumers looking to retail brands.

“We expect the focus of consumer attention to remain on value. A round of strong price
increases could enable private label to get a stronger foothold in the chocolate market,” Cox said.

However, the analyst argued that, as economies globally start to recover, there will be a return to longer-term trends seen in the sector before the credit crunch – growing demand for premium, single-origin and high-cocoa chocolate.

He also added that emerging markets offer “vast promise” to chocolate makers. “Asia accounts for less than 10% of the global market. While we acknowledge there are problems related to climate and culture, we believe these will ultimately be overcome. For example, Barry Callebaut has introduced a chocolate that is more resistant to melting,” Cox said. 

He continued: “Per capita consumption of chocolate in Japan is not far behind that of the Netherlands. Cadbury has built a successful chocolate business in India. Nestlé’s Kit Kat brand has been well received in China, a country where per capita chocolate consumption is one- tenth that of India, itself a country where per capita consumption is barely 1% of that in Germany or Switzerland.”

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