Mondelez International has delivered a lacklustre set of 2016 numbers but the snacks giant, which has been buffered by a challenging operating environment, stressed it continues to improve adjusted operating margins. With the entrance of 3G Capital into the food sector, margins have become a key metric for a number of the major names in the industry but Mondelez’s results left some wondering if a focus on margins can hamper top-line growth. Katy Askew reports.

Mondelez International boasts an extensive global presence, which is typically modelled as a positive for the group, benefiting from the stable revenue base of developed markets in Europe and North America and access to faster-growing developing economies in Asia, the Middle East and Latin America. Last year, however, was one of unusual challenges marked by economic and political instability. 

As chairman and CEO Irene Rosenfeld noted during an analyst call to discuss the group’s performance yesterday (7 February), Mondelez is “not immune” to challenging global conditions. “It’s clear that an unprecedented number of economies are facing significant disruption and uncertainty. Slower GDP growth, currency and commodity volatility, the uncertain impact of the Brexit vote, market shocks like the recent demonetisation in India, and complex developments in the political landscape, including a backlash against globalisation,” she noted. 

Rosenfeld stressed Mondelez is aware of, and preparing to defend itself against, these issues. “We’re dealing with these realities with a sense of urgency: to control what we can and create contingencies for what we can’t,” she noted. 

Mondelez’s sales performance – revenue decreased by 12.5% in 2016 – was dented by a number of regional challenges. The company flagged demonetisation in India, the Brexit vote in the UK, price pressure in the US biscuits sector, economic contraction in Middle Eastern markets and competition in Brazil as being particularly detrimental to its top line.

“We saw good results in a number of our largest countries, including Germany, China, Russia, and Mexico. But overall revenue growth was lower than our expectations, as India demonetisation had a negative impact of approximately 60 basis points, and we saw weaker category growth in US biscuits, the UK, and across the Middle East,” CFO Brian Gladden said. 

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In the US and UK, Mondelez lowered prices in order to defend its market share. However, Rosenfeld suggested the company would pull back from this activity because it had failed to stimulate the category and had affected margins. 

“There’s a lot of trade spending dollars. It didn’t do very much to drive the category and, in fact, all it did was sort of margin down the business. And again, we chose to participate in that to defend our shares, but that’s not the right way to build the business for the long term. And I think as our customers experience the reality of that spending, we’re going to be able to get back to a more disciplined focus on innovation and brand marketing and price pack architecture,” she noted. 

Euromonitor International analyst Jack Skelly says Mondelez should be able to push through price hikes to shore up its UK margins. “I think Mondelez are fairly committed to a strengthening profit margins and raising costs is a sure-fire way of doing that. There may be some increase in cost of doing business in the UK which would likely mean most manufacturers could increase their prices. However, I think Mondelez is probably the most rigorous when it comes to bolstering its margins and, given how iconic their brands are to UK shoppers, it may be noticed more than other brands,” he suggests. 

However, Pablo Zuanic, an analyst with Susquehanna International Group, believes a more aggressive attitude on pricing could come at the detriment of volumes. “We do not share the notion that the 4Q challenges are temporary (macro, competitive, FX cost pressures, political uncertainty), or that it will be so straightforward to dial back trade spending in key markets without hurting top line,” he writes in an investor note today.

Looking to the coming year, Gladden said Mondelez expects “continued economic and geopolitical uncertainties” in emerging markets and in “places like the US”. Working on the assumption the category environment will remain consistent with the fourth quarter, the company said it expects to deliver organic net revenue growth of “at least 1%”.  

Sanford Bernstein analyst Alexia Howard suggests Mondelez’s growth forecast for 2017 comes as something of a disappointment. “Mondelez continues to see sluggish sales growth,” Howard notes today. “For 2017, the company expects at least 1% organic sales growth globally, which is weaker than the 2% the company was guiding to this time last year, so it still feels as though we are wading through treacle.”

Mondelez’s outlook represents a slowdown on the company’s 1.3% organic growth rate in 2016, which has itself slowed over the past three years. Mondelez’s organic sales were up 3.7% in 2015 and 2.4% in 2014. 

“This outlook is built on a category growth rate as we see it today, and includes both the benefit of new white space launches, as well as our continued revenue management efforts,” Gladden suggested. 

On a more upbeat note, Gladden said Mondelez anticipates further margin expansion next year, building on its continued improvement in adjusted operating margin this year. During 2016, Mondelez expanded its adjusted operating profit margin to 15.3%, compared to 13.7% in the prior year. Over the coming year, Mondelez anticipates adjusted operating profit margins rising to the “mid-16% range”. 

This improvement – and the expectation for continued gains – reflects the importance that Mondelez’s management has placed on building profitability. “Given today’s market realities, we’ve sharpened our focus even more on reducing costs and you can see the impact on our expanded margins,” Rosenfeld said. 

She flagged Mondelez’s “runway of opportunity ahead” as the company aims to place more investment behind its higher-return “power brands” and hopes to continue to reap the rewards of its zero-based budgeting and supply chain initiatives. “As a result, we’re well on-track to deliver our adjusted operating income margin target of 17% to 18% by 2018. And we have good visibility to expand margins beyond that,” Rosenfeld insisted. 

However, Mondelez’s sales performance left some industry watchers to question whether the company’s focus on improving margins had hindered its ability to grow sales.

Andrew Lazar, an analyst at Barclays, said Mondelez’s fourth-quarter numbers and its outlook for 2017 raised “a broader question that we believe will be increasingly relevant for the company and industry as a whole – that is, have margin targets shifted from providing investor visibility to becoming a bit restrictive?”

Lazar said: “To be fair, we understand why many large-cap companies have provided specific multi-year margin targets, many of which are anchored to fiscal 2018. With a challenged demand environment, not to mention a 3G Capital-led entity significantly raising the profitability benchmark, frankly, a more explicit cost-cutting agenda has certainly seemed sensible — and we have been in favour. That said, with industry volume trends worsening, it seems to us that the drivers to achieving these margin targets are increasingly more difficult.

“While we don’t diminish the importance of the 2018 margin target to Mondelez’s investment case, we do wonder if it could limit Mondelez’s flexibility to take steps required to not only capture market share, but also lift overall category growth rates. We do not see this as a Mondelez-specific issue, but rather a dynamic that many in the food industry are likely to grapple with in the coming quarters.”

On the call with analysts yesterday, Rosenfeld said Mondelez did “recognise great companies simply cannot cut their way to long-term growth” but added: “We haven’t lost sight of the need to invest in our business, to support sustainable top-line growth… Our top line is not yet where we want it to be. Some of this is due to factors outside of our control, some is due to mixed execution on our part, and some reflects deliberate actions we’ve taken to run a more profitable business.”

Nevertheless, some investors may be questioning whether Mondelez’s efforts to improve margins in some areas did have an impact on sales and its performance in the US biscuits market will give fuel to any concerns.

Mondelez saw its share of the US biscuit market fall year-on-year in the fourth quarter. Rosenfeld said Mondelez had “made terrific progress in our US biscuit business in terms of margin expansion over the last couple of years”, adding: “At the same time, over these last couple of years, we’ve been able to continue to grow our share.”

However, she conceded some of Mondelez’s moves to make changes to its distribution had the unit’s “execution” in the fourth quarter. “I would say with hindsight, some of the optimisation we did, for example, in our DSD selling organisation had more of an impact on the execution than I would have liked. And so we did see some impact in the short term,” Rosenfeld said. “And as I mentioned in an answer to some of the earlier questions, we have seen a very challenging retailer environment, which has really caused a lot of promotional spending, which hasn’t necessarily helped the overall category.”

Asked by just-food today to clarify if Rosenfeld was suggesting Mondelez’s optimisation efforts had hit its ability to grow sales, a spokesperson said the CEO’s comments were “an acknowledgement that, while we continued to invest in growth, some of our investments just didn’t play out as expected because of the challenging environment in some markets”. Nevertheless, as Lazar’s comments suggest, the issue is a live one for the whole sector.

As it works to invest in areas that deliver the highest returns, Mondelez will continue to put its money behind its so-called “power brands”, which make up 70% of group revenue. Mondelez said those brands grew “faster” than their categories in 2016, with sales up 3% on an organic basis. 

“Over time, as they continue to grow faster because that’s where we’re making our investments, we should see that growth pick up and they will be a larger portion of our overall portfolio. But they are growing faster than our categories and we expect that that will continue,” Rosenfeld explained. 

Mondelez is also bringing its power brands into what management described as “white space”, including the launch of Milka chocolate in China and the launch of Milka Oreo and Green & Black’s in the US

As well as moving its brands into new markets, Mondelez is targeting consumer “white spaces” – notably health and wellness. Flagging its Good Thins and Belvita Soft Baked innovation, as well as the launch of GMO-free Triscuits, Rosenfeld said Mondelez is attempting to address the growing consumer demand for better-for-you products. 

“Without a doubt, we continue to see a shift toward well-being products, and we are committed to participating in that shift,” she said. “We’ve made a commitment that by 2020, half of our products will be in the well-being space.”

However, for a company which has as its among its largest brands Cadbury chocolate and Oreo cookies, cashing in on demand for healthy products looks set to present something of a challenge. 

And, while Mondelez invests to address the challenges faced by its power brands, the remainder of its portfolio is likely to continue its descent to lower sales volumes and, in turn, lower returns. 

Mondelez’s non-power brands have witnessed an ongoing decline, with organic sales down 1.9% in the final quarter of the year. Stopping short of confirming Mondelez is overseeing the demise of its regional brands – such as Lacta in Brazil – due to under-investment, Rosenfeld confirmed tthey will not be an investment priority moving forward. 

“Our focus going forward is to continue to distort our spending behind these power brands. They have the best margins. They’ve got the best growth trajectory. And that will allow us to continue to offset some of the declines in the other brands,” she noted.