Case study · FMCG and retail · Private equity · Frozen savoury foods · 13 min read
Source: Pricing Insight due diligence reports to Pacific Equity Partners of 22 April and 19 May 2016; Patties Foods ASX announcements of 2 June and 19 August 2016. The A$5.6m and the trade spend returns are identified, not realised. None is a benchmark for another business.
A$5.6m a year of EBIT upside, found before the bid was signed. In April 2016 Pacific Equity Partners was preparing a takeover offer for Patties Foods, the ASX-listed maker of Four'N Twenty, Patties, Herbert Adams and Nanna's pies. The deal team asked Pricing Insight one question: how much earnings could better pricing and smarter trade spend add, and how safe was that upside? Before the bid was signed, Pricing Insight modelled the Patties profit and loss, analysed trade spend by brand and channel, read two years of supermarket scan data, surveyed shelf prices and ran an algorithmic price analysis across every branded SKU. The review sized A$5.6m of annual EBIT upside, within a modelled range of A$4.0m to A$7.0m, and showed where it sat: in promotions that had grown deeper without selling more, and in an Out of Home channel where Four'N Twenty held pricing power the business was not using. Pacific Equity Partners signed the scheme implementation deed on 1 June 2016.
| Client | Pacific Equity Partners, an Australian private equity firm, on its acquisition of Patties Foods Limited, a Bairnsdale, Victoria, manufacturer of frozen and chilled savoury and sweet bakery products, then listed on the ASX. |
| Service | Pricing due diligence: profit and loss modelling, trade spend return analysis, scan data and price elasticity review, store price survey, and algorithmic price analysis by SKU and channel. |
| Status | Identified. A$5.6m a year of EBIT upside sized in due diligence, within a range of A$4.0m to A$7.0m, with a further A$1.0m to A$1.5m from supermarket price architecture. Not realised by Pricing Insight. |
| Scope | About A$190m of branded revenue across In Home (supermarket) and Out of Home (petrol and convenience, food service and events) channels. Private label contract manufacturing and the frozen fruit business were excluded. |
| Period | April to May 2016, before the scheme implementation deed of 1 June 2016. The scheme was implemented on 22 September 2016. |
The brief
Tell us how much EBIT better pricing and trade spend could add to Patties, and whether the brands can carry a price rise.
01A pie maker with category-leading brands and earnings below its brand strength
Fifty years, four leading brands, one factory town. Patties Foods began in Bairnsdale in 1966 and bought Four'N Twenty, Herbert Adams and Nanna's from Simplot in 2003. By 2016 it sold frozen pies, pastries and desserts through Woolworths, Coles and Metcash, and hot pies and sausage rolls through petrol and convenience stores, cafes, stadiums and work sites. In the 2016 financial year its core bakery business earned A$233.5m of revenue, and Out of Home made up 38 per cent of company revenue.
The brands were strong; the earnings were not. Pricing Insight's modelling found that Patties pricing delivered EBIT returns well below many other food manufacturers, even though Four'N Twenty led its category and competitors looked to Patties on price. A frozen berry recall in February 2015 had hit profit, and the business was exiting frozen fruit. Pacific Equity Partners' offer of A$1.65 a share valued Patties at about A$231.8m, 9.5 times its underlying 2015 EBITDA, so the case for the deal rested on how much more the brands could earn.
02What the due diligence found: promotions were funding the retailer, not the brand
Three findings, one for each pillar of the Pricing Periodic Table.
Value
The brands held pricing power. A leading Four'N Twenty line had taken 18 per cent of price rises over three years with no visible loss of baseline sales. When the main rival, Sargents, ran a promotion, Four'N Twenty lost little volume, but when Four'N Twenty was on promotion it drew Sargents buyers across, so shoppers saw it as the brand to trade up to. The two top-selling supermarket pies sold at about A$3.80 and A$8.50 to A$8.60, more than 100 per cent apart, which pointed to two different pie buyers with their own value drivers. Consumer research put price third or lower in the purchase decision for at least 60 per cent of buyers.
People
Promotions were set by habit and retailer deal, not by analysis. Average promotional discounts on a leading line deepened from 26 per cent to 36 per cent by 2015 for the same sales uplift. In the week of 16 May 2016, Patties products were on shelf at up to 55 per cent off the recommended price, with the same percentage cut across sweet and savoury lines, a sign of a supplier deal rather than a category plan. Retailers were also setting shelf prices independently: price gaps of about 10 per cent between Woolworths and Coles on iconic lines limited Patties' ability to lead a category price rise.
Structures
Trade spend returned less each year. In 2012 every dollar of trade spend returned A$1.18 of gross margin; by 2015 it returned A$0.94. Over those years A$20m of revenue growth had added only A$1.8m of gross margin. In the latest year of shipment data, gross margin grew about A$4.0m, but about A$2.5m was lost by not recovering cost increases in price. The pricing approach was cost plus mark-up, with no planned route to recover commodity costs such as beef.
Six priorities followed.
Cut promotional depth and frequency.
Move discounts away from 30 to 55 per cent and align Woolworths, Coles and Metcash on one promotional calendar.
Lead the category on shelf price.
Take a category value plan to the retailers, moving the Four'N Twenty four-pack from A$8.00 towards A$8.95, then A$9.95.
Price Out of Home for convenience.
Lift Out of Home price per kg to at least 10 to 15 per cent above In Home, where buyers pay for the hot pie now.
Redirect trade funds to what returns.
Shift trade spend towards Four'N Twenty and Herbert Adams in Out of Home, the only combinations where more spend lifted gross margin dollars.
Recover costs on a plan.
A price increase process that flags commodity moves early and passes them on before margin is lost.
Price by SKU, not by average.
Set each SKU price from brand position, price bandwidth and category architecture, tested in a pilot before scale.
03What Pricing Insight did: a pricing due diligence in five steps
Five steps, each building on the one before, delivered as an initial report on 22 April 2016 and an analysis pack on 19 May 2016. The work ran alongside the deal team and its advisers, who supplied shipment and scan data.
Model the profit and loss.
The Patties profit and loss by brand and channel, excluding frozen fruit, to set the addressable revenue and the EBIT base.
Can these brands carry a price rise, and what is it worth?
Measure trade spend returns.
Gross margin earned per dollar of trade spend by brand and channel, 2012 to 2015.
Read the shopper response.
Two years of scan data in four-week blocks: baseline sales after price rises, promotion uplifts and cross price elasticity with Sargents.
Survey the shelf.
Prices per kg at Woolworths, Coles and a Caltex site, comparing Four'N Twenty and Mrs Mac's with other ready-to-eat products.
Price every branded SKU.
An algorithmic price analysis by SKU and channel, using brand position, price bandwidth, percentile rank in the category and net price realisation.
The shelf survey framed the opportunity in buyer terms. A Four'N Twenty pie sold for 97 per cent more per kg in convenience than in the supermarket, against 65 per cent for Mrs Mac's. A hot pie in a warmer cost A$4.70 to A$6.00, while four frozen pies cost A$8.00. Buyers of convenience products such as bottled water and salty snacks routinely pay 100 to 300 per cent more out of home, so the supermarket four-pack looked under-priced rather than the hot pie over-priced.
04What the review sized: A$5.6m a year of EBIT upside, identified
A$2.2m In Home plus A$3.4m Out of Home. The algorithmic price analysis, run on about A$190m of branded revenue, put the mid estimate at A$5.6m of annual EBIT, about 2.9 per cent of the revenue addressed, within a range of A$4.0m to A$7.0m. Out of Home carried the larger share because prices there are less visible to buyers, purchases are on impulse and many sites have a single supplier. A further A$1.0m to A$1.5m was available from getting the supermarket price architecture right with the retailers, sized on the Four'N Twenty meat pie four-pack alone.
The promotion arithmetic showed why trade spend had to change before price. At a 35 per cent gross margin, a 25 per cent discount leaves 10 cents of margin per dollar of full price, so a promotion needs 3.5 times normal units to earn the same gross margin dollars. Pie promotions were lifting sales about two times. Every deeper promotion moved margin from Patties to the retailer and taught shoppers to wait for the deal.
Status: identified. Metric: annual EBIT. The A$5.6m mid estimate and A$4.0m to A$7.0m range come from Pricing Insight's algorithmic price analysis of 19 May 2016 on about A$190m of branded revenue, excluding private label and frozen fruit. An earlier estimate of A$5.29m on wider revenue, in the initial report of 22 April 2016, is superseded by it and not added. The A$1.0m to A$1.5m of price architecture upside is separate and not added to the A$5.6m. Trade spend returns are from Patties shipment data supplied in due diligence. This page reports the opportunity sized in due diligence and claims no realised result. Not independently audited.
Pacific Equity Partners signed the scheme implementation deed on 1 June 2016. Its offer of A$1.65 a share, including a special dividend of up to A$0.25, was a 31.5 per cent premium to the one-month volume-weighted share price. Shareholders approved the scheme on 26 August 2016, and it was implemented on 22 September 2016.
The Pacific Equity Partners deal team described the work as “good quality work in a compressed timeframe”.
05The Pricing Periodic Table elements this review assessed
Eight elements assessed, four identified as open priorities. The Pricing Periodic Table maps 61 elements of pricing capability in nine domains across three pillars: Value, People and Structures. A pricing due diligence tests the elements that decide how much earnings a buyer can add after completion, and how quickly.
| Value | 10 Pp Pricing power, 08 Sg Segment and channel strategy: brand pricing power in scan data and the In Home and Out of Home channel economics. |
| Analysis | 41 Ci Market price intelligence, 44 Or Override and discount analysis, 45 Pr Cost to serve and profitability, 46 Pm Price modelling, 47 Ps Price position and key value items: the store survey, promotion analysis, trade spend returns and the algorithmic price model. |
| Architecture | 52 Rl Price relativities and volume breaks: the gap between the supermarket four-pack and the hot pie, and the price spread between the top-selling lines. |
| Open priorities | 16 Rb Rebate and incentive design, 43 Pi Price increase process, 38 Pv Price-increase negotiation, 56 Bc Buy-price and cost management: trade terms that reward the retailer for category value, a planned route to recover cost increases, and the retailer negotiation to carry a category price rise. |
06Three lessons for a private equity buyer
Test pricing power before you pay for it
Scan data showed 18 per cent of price rises over three years with no visible loss of baseline sales, and little volume lost to Sargents promotions. That is evidence a buyer can put in the investment case, rather than a hope.
Measure trade spend by what it returns
Revenue grew A$20m while gross margin grew A$1.8m, and each dollar of trade spend returned A$0.94 in 2015 against A$1.18 in 2012. Promotions that look like growth can be the margin leak.
Price each channel for what buyers pay there
Out of Home buyers pay for a hot pie now, and A$3.4m of the A$5.6m sat in that channel. One national price logic would have left most of the upside unpriced.
07Questions this case study answers
What does a pricing due diligence look at for a private equity acquisition?
It tests how much earnings better pricing can add after completion, and how reliable that upside is. For Pacific Equity Partners on Patties Foods, Pricing Insight modelled the profit and loss, measured trade spend returns by brand and channel, read two years of scan data for price elasticity, surveyed shelf prices and priced every branded SKU with an algorithm. The review sized A$5.6m a year of EBIT upside, within a range of A$4.0m to A$7.0m. It was delivered before the bid was signed.
How do you know whether an FMCG brand can take a price rise?
Look at what happened to baseline sales after past price rises, and at how much volume moves when competitors promote. At Patties, a leading Four'N Twenty line took 18 per cent of price rises over three years with no visible loss of baseline sales. Sargents promotions took little volume from Four'N Twenty, and the top two pies sold more than 100 per cent apart, a sign of separate buyer segments.
How do you measure whether trade spend and promotions are working?
Divide the gross margin earned by the trade spend that bought it, by brand and channel, over several years. At Patties each dollar of trade spend returned A$1.18 of gross margin in 2012 and A$0.94 in 2015, while promotional discounts deepened from 26 to 36 per cent for the same uplift. At a 35 per cent margin, a 25 per cent discount needs 3.5 times normal volume to break even.
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How much earnings sits in the pricing of the business you are about to buy?
A first conversation covers the target, its channels and the data room, and whether a pricing due diligence fits your timetable. Ron Wood, +61 410 534 099.
Ron Wood is the Founder and Managing Director of Pricing Insight, an Australian pricing strategy consultancy he established in 2007. He has worked in pricing for around 30 years, first as a pricing and commercial manager in consumer goods, building materials and capital equipment, and since then across 160+ pricing engagements. He also founded Pricing University, which has trained more than 5,000 executives.
To discuss a pricing due diligence, contact Ron Wood at info@pricinginsight.com.au or on +61 410 534 099, or visit Pricing Insight.
Figures are from Pricing Insight's due diligence reports to Pacific Equity Partners: the initial report of 22 April 2016 and the analysis pack of 19 May 2016, using Patties shipment data, supermarket scan data, consumer research and a store price survey supplied or carried out during due diligence. The A$5.6m, its A$4.0m to A$7.0m range and the A$1.0m to A$1.5m of price architecture upside are identified, not realised, and are not independently audited. Transaction terms are from Patties Foods' ASX announcement of 2 June 2016 and the Australian Taxation Office class ruling CR 2016/79; revenue and channel figures are from the Patties Foods full year results of 19 August 2016. Figure 4 is illustrative arithmetic. No figure on this page is typical or guaranteed.
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