I by accident discovered a very clear way for any initial research/coverage on Food & Beverage (F&B) sector, regard:
- What drivers are shepherding this industry?
- What qualitative & quantitative factors should we care if intending to invest into any F&B business? and
- How to valuate a F&B business?
You can read it full here: https://www.mergersandinquisitions.com/food-beverage-investment-banking/
Q: What are the key drivers that influence this sector (F&B)?
A: According to Amherst Partners, changing demographics, ethnic diversity, and household income are some of the key drivers for the food and beverage sector.
Changing Demographics: Longer lifespans and higher income levels lead to an interest in low-fat / diet grocery items.
You might even say that gender distribution affects the in-demand products: think about all the nutrition bars geared toward the female population.
Ethnic Diversity: A more heterogeneous population leads to broader segmentation categories, as well as more substitutes when popular items are sold out.
Household Income: A family of multiple income earners doesn’t have much time to cook – or to shop.
That trend has made prepared foods, such as the kind you might find in a food court-style marketplace section, more popular.
Choosing the right target audience also makes a big difference for your value proposition.
As seen from Very Small Array, there is a strong correlation between income brackets and particular grocery chains.
Q: Great. So how do you move from these broad trends to companies in the sector growing their revenue and increasing their margins?
A: Sure – I’ll start with restaurants and grocery stores, since those are bit easier to think through.
From an organic perspective (that is, everything but M&A), firms have a couple of levers for increasing sales:
Open stores in new and existing markets: All else being equal, more stores in more different locations will equal more revenue… at least until the region is saturated (see: Starbucks).
Capitalize on consumer trends: If restaurants are serving kale, customers at the grocery store will start asking for kale. So you need to watch those trends and respond to consumer demand. But you also have to be careful to distinguish between trends and fads.
Improve up-sells and cross-sells: Could you position items in the store to encourage more impulse purchases? Or get consumers to “upgrade” to something higher-priced?
Increase labor productivity: This involves syncing up training at the grassroots level and the persona of the target customer. You want your employees to interact directly with customers in order to boost loyalty to the store’s location (read: increase labor productivity).
Localize product mix: For some companies, the customer relationship begins before he/she ever walks in the door: the items on the shelf already match the customer’s identity.
I’ve personally seen this with hair care products catered to the African community, aguas frescas for the Latino community, and household decorations for the Asian community.
Q: And what about improving margins?
A: Right, this one’s important since so many financial sponsors and lenders rely on EBITDA…
…But most food and restaurant businesses tend to be low-margin, so even a small margin increase can make a big difference.
A few ideas:
Centralized warehouses: I have seen companies invest in a central warehouse in order to facilitate distribution across its target geography – you’ll also see IT systems becoming streamlined or more seamless to reduce costs.
Renegotiate and consolidate vendor relationships: Essentially, you stack up all your expenses by vendor and see who the top vendors are – and then you use that information as leverage to seek out purchase discounts based on volume.
Improve price perception: All else being equal, it’s easier to earn a higher margin on higher-priced products – just compare Whole Food’s margins to Safeway’s.
So increased prices not only increase revenue, but may also potentially increase margins. And it’s amazing just how much grocery prices can vary.
Getting Technical: Organic, or Genetically Enhanced?
Q: So moving beyond revenue growth and margins, what are the key metrics you would look at when analyzing a company in the food and beverage sector?
A: I’ll start with the key operating metrics:
- Net Sales per Store. To calculate it, net sales = gross sales – discounts to customers – returns from customers – allowance for missing or damaged goods, and then you divide by the total # of stores.
- Net Sales per Square Foot (or Square Meter). This metric excludes real estate used for operations or warehousing inventory. Maintaining a brick & mortar store is a big expense for any retail company – so this calculation provides a sense of how much money is coming in as a result of that spending. [nota bene: Yes, there can be outside factors that influence a store’s profitability as well]
- Store Contribution Margin = Sales – Cost of Goods Sold – SG&A. This metric tells you how much an individual store adds to a company’s operating income – if you compare this metric at different stores, you can tell if the general price level is too high or too low, as well as the demand for individual products (if you calculate this at the product-level).
- Sales Growth and EBITDA Margins. Just like with any other company.
- Number of Owned Stores [or Restaurants]. More stores = higher potential revenue and profits… to a point.
Q: …and valuation methodologies?
A: Nothing unusual – you still use the same valuation multiples (EV / EBITDA, EV / Sales, P / E, and P / BV) and you still use public comps, precedent transactions, and the DCF.
You’ll also use EBITDAR and EV / EBITDAR if you’re working with a set of companies where some own their own stores/restaurants and others rent, and you need to normalize EBITDA for comparative purposes.