Thanks to a recovery in the second quarter, sweets and drinks producer Cadbury Schweppes looks set to post sales growth at the top of its forecast range for the year but margin growth remains below expectations. Katy Humphries reports.
A relatively upbeat trading update issued ahead of its half-year results saw shares in Cadbury Schweppes rise but concerns about margins remain, while some analysts have suggested a lack of focus may undermine its investment value. Furthermore, speculation regarding a possible demerger of the group is likely to continue at least until October when the management is expected to clarify its position on the subject.
In spite of these worries Cadbury Schweppes, which is three years into its four-year Fuel for Growth cost-cutting programme, said sales had picked up in the second quarter after a slow first quarter, the result of difficult trading conditions in Europe, the Middle East and Africa. Cadbury, which will publish its half-year results at the beginning of August, added that it expects sales growth to fall in the upper end of its 3% to 5% range for the year.
However, crucially the company warned that it was unlikely to deliver margin growth for the year within its target range of 50-75 points, originally outlined in the Fuel for Growth plan, because of the impact of the continuing rises in oil prices. CEO Todd Stitzer said the company still expects full-year margins to show an improvement on the previous year, but would not comment on whether it will be better than the 30 basis point rise seen last year, when the underlying operating margin was 15.9%. Analysts are forecasting a margin improvement of between 30 and 40 basis points. Stitzer added that the company would also be waiting until its October update to give further details on its margin expectations.
Notwithstanding the reservations about margins, the company’s shares rose on news of the projected revenue growth which was generally welcomed by analysts. Sanford Bernstein reiterated its ‘outperform’ recommendation and 630 pence price target on the stock following the trading statement, adding that while the reduction in margin guidance was “a disappointment”, it was widely expected by the market, while sales guidance at the top-end of the target range was “a positive surprise”.
Cadbury spokesperson Sara McDonald-Smith attributed the revenue growth primarily to a number of investments the company has made over the past few years. Throughout the last financial year and following on into fiscal 2006, Cadbury has focused on allocating capital to the highest return opportunities, disposing of non-core businesses and assets, such as Bromor and Monkhill.
“Our strategy is a combination of investment in both acquisitions and new product development,” McDonald-Smith told just-food, adding that in 2005, the company’s combined growth-related investment of GBP40m was split fairly evenly, divided approximately 60/40 in favour of NPD.
While product development and innovation have been “key” to sales growth, Cadbury Schweppes has also been pursuing a fairly aggressive acquisition strategy which has included reinforcing its presence in Africa with the purchase of South Africa’s largest chewing gum manufacturer Dan Products in June for an estimated GBP33m. The company also upped its stake in Cadbury Nigeria, the country’s leading confectionery and gum producer, in February from 46.4% to 50.02% at a cost of GBP19.7m. In the UK, Cadbury acquired a majority stake in the fast-growing premium chocolate manufacturer Green & Blacks.
“We are always actively seeking acquisitions to facilitate growth,” McDonald-Smith said. “This can be geographically expanding our presence in a market or, less frequently, breaking into new categories through strategic acquisitions.”
With this relatively high level of investment across the board, McDonald-Smith said that Cadbury had not identified any one category in which to focus investment. “We haven’t singled out any particular category that we want to grow through higher rates of investment.” However, she continued, “gum is definitely important and over the confectionery category it is growing the fastest.”
Likewise, McDonald-Smith said that the company did not prioritise any one market above another, but recognises the particular importance of emerging markets which offer the highest growth rates.
However, the scope of Cadbury Schweppes’ expansion strategy has itself become a concern to analysts. Merrill Lynch has suggested that as the company embarks on an ever more ambitious investment strategy, it may become too broad to represent a good investment opportunity.
In a note issued following the trading update, Merrill Lynch analyst Nicolas Sochovsky said that with the 15% sell-off over the last couple of months, shares represent good value at its 575 pence price target.
However, were the company to announce the demerger of its beverage business in October, this would act as a catalyst to push forward share value. “The catalyst is set to be Cadbury’s October conference and the update on whether management are set to demerge beverages from confectionery,” Sochovsky said.
Cadbury Schweppes is looking to strike a balance in terms of focus with a strategy that combines the sale of non-core businesses with re-investment in new markets and acquisitions. But it is adamant that the way forward is continued investment to drive revenue growth.
Through a two-pronged investment policy, Cadbury Schweppes hopes to extend its market-leading position in confectionery. It maintains that product innovation, backed by marketing investment, will produce strong organic growth. Simultaneously, the company believes that an aggressive acquisitive approach will ease its expansion into new markets, increase its participation in core categories and facilitate its entry into other categories.
While Cadbury may not be hitting the margins that some would like, the company’s impressive revenue growth is proof that this plan is allowing it to tighten its grip on the global confectionery industry.