Australian investors may downplay Goodman Fielder’s “low growth” prospects and “mature markets” but overseas analysts see a company uniquely placed to benefit both from strong brands and the growth of own-label. David Robertson reports.

Goodman Fielder became Australia’s largest quoted food company at the end of last year when it was spun out of its parent, Burns Philp. But the AUD2.8bn (US$2.08bn) stock market listing has been significant for more reasons than simply creating another food company for investors to take a punt on.

The floatation of Goodman Fielder has raised questions about whether food producers in low-growth, mature markets can still attract significant investor interest. In recent years the old-fashioned makers of products like bread, dairy and spreads (Goodman Fielder’s core strengths) have been less favoured by investors than aggressive food retailers like Tesco and Wal-Mart or the manufacturers of snacks and ready meals. But with its share price up 15% in three months, Goodman Fielder is hoping to demonstrate that there are still opportunities in these food categories. It wants to show that it can make bread out of bread.

Until 2002 Goodman Fielder was a messy conglomerate that didn’t do anything particularly well. It had underperformed for years and institutional investors admitted that they only held the stock because their fund rules dictated they had to. Then, at the end of 2002, New Zealand billionaire Graeme Hart launched an audacious AUD2.6bn bid for Goodman Fielder.

Hart had already taken over Burns Philp, a deeply troubled yeast and spreads maker, in 1997 and was well advanced in turning that business around. However, Burns Philp was just a quarter of Goodman Fielder’s size and the bid was understandably controversial. Fortunately for Hart, investor dissatisfaction in Goodman Fielder meant that many shareholders were looking for an excuse to get out and the New Zealander was able to win the takeover battle.

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Goodman Fielder then underwent a radical transformation as Hart began a savage round of cost cutting that trimmed A$100m and 500 jobs within the first year. It worked. Between March 2003, when Hart finally took control of Goodman Fielder, and June 2005, the company’s earnings before income tax and depreciation rose 48% to A$414m.

With Goodman Fielder starting to look considerably healthier than when he bought it, Hart announced that he would refloat 80% of the company. It was a move that filled institutional investors in Australia with as much delight as an offer to help a Nigerian businessman transfer some money.

As Goodman Fielder chief financial officer Andrew Beck explained: “I think there was a lingering concern related to the Goodman Fielder of yesteryear when the company had been perennially disappointing. We had that baggage and we had to tell people that things had changed.”

But investor disinterest went further than historical ambivalence towards the stock. While most analysts agreed that Hart’s efforts had made the company more profitable they continued to question whether Goodman Fielder could offer much growth in the future as all it made was lacklustre products like bread.

“Nothing in the data released to date has changed our initial view that we struggled to see major value creation from the proposed deal,” Goldman Sachs JB Were analyst Rowan Wilke said at the time.

The decision by Burns Philp to hold on to the successful and popular Uncle Tobys and Bluebird brands, which had originally been Goodman Fielder’s, further strengthened the view that there was little left of interest in Goodman Fielder. This negative analysis of Goodman Fielder’s future was based largely on the assumption that the company’s upside was limited because demand for bread and dairy is, at best, flat.

However, there was potential for considerable downside as sales were under threat from supermarket own-label products. The two major Australian supermarket chains, Coles Myer and Woolworths, are both rapidly increasing their own-label offerings and investors were concerned that Goodman Fielder could lose out as consumers shifted to these cheaper products.

Deutsche Bank summed this up before the flotation saying that Goodman Fielder was exposed to “a low growth mature market with aggressive retailer consolidation and reduced shelf space as a result of the push for private labels.”

Phrases like “low growth” and “mature markets” usually make investors’ blood run cold as they are the opposite of the “there goes the house” excitement professional gamblers seek. But Goodman Fielder’s management believes that the analysts are underestimating the company’s potential and overplaying the own-label threat.

CFO Andrew Beck argues that own label is less of a problem than many people believe because just two companies control the AUD1bn bread category: Goodman Fielder with 35% of the market and George Weston with 31.5% (according to GF figures). Own label accounts for a further 25% of the market, but the supermarkets are buying their own-label bread from the only two companies capable of making it as sufficiently low cost: Goodman Fielder and George Weston.

Therefore, any growth in own label will continue to benefit Goodman Fielder. Beck also points out that growth in own label will allow Goodman Fielder to concentrate its marketing and investment budget on higher-value, branded products.

According to the company’s figures it is these high-margin products that are proving most popular with consumers. Sales at in-store bakeries in Australia have dropped 3% over the past three years while own label is up just 0.5% but branded breads are up over 5%.

“We don’t see private label as competition,” Beck said. “If people want to buy the standard white loaf of bread then they can but more people are moving towards premium products because they understand the health benefits of whole grains and so on.”

It is this confidence in the consumer’s appetite for value-added products (whole-grain bread, nutrient-rich milk and cholesterol-lowering margarines for example) that has allowed Goodman Fielder to forecast a 11% growth in earnings this year. “We are a good safe business,” Beck insists. “We have good management in place and good products.”

Overseas investors have been more accepting of this argument than local institutions, possibly because they do not remember the old Goodman Fielder. New York’s Eagle Capital Management picked Goodman Fielder as one of its stocks to watch in 2006. Eagle Capital said the company could be worth about AUD3 a share in two years, compared with its float price of AUD2 (that is share-price growth of 25% a year, which would normally be considered extremely attractive).

If Goodman Fielder gets anywhere near achieving this it will go a long way to proving that food companies can still provide excellent returns making products traditionally considered dull and boring by investors.