Biscuits account for 20 per cent of profits at Northern Foods, the biggest supplier of own label food products to the British retail sector, with margins generally higher than for the company's other product ranges (pizzas, speciality bread, ready meals, cakes, desserts, etc.). But rising raw material costs, combined with other more nebulous factors such as an increasingly health-conscious consumer base and a relative lack of investment have started to bite heavily into Fox's profitability and could be the sign the company was looking for to offload the increasingly non-core business, the financial analysts suggest.
But if the company decides to take this route, it must do so quickly, GS argues. Consolidation among the retail trade (Morrisons buying Safeway, for example) and the recent portfolio shake-up announced by Northern's top customer, Marks & Spencer, could mean a significant reduction in potential volumes.
GS highlighted the recent results announced by United Biscuits, one of Fox's chief rivals in the UK market, as evidence that time could be running out for the biscuit business. Gross operating profit at the company, which makes the McVities brand among others, was down by 12 per cent in the first half, while margins dropped by 160 percentage points during the same period.
But UB is in a better position to ride out the storm than Fox's. It is already the country's biggest biscuit maker with a share of around 20 per cent of the branded market, and is about to strengthen its hand even further with the acquisition of Jacob's Bakery from Danone - adding a further 6 per cent to its market share.
GS suggests that the merger of UB and Jacobs will lead to considerable improvements in profitability at the latter group (as much as 40 per cent), thus increasing the pressure on Northern, whose market share is around 7 per cent. "With a history of relatively low level of capacity utilisation in the UK biscuit industry, this proposed consolidation (between UB and Jacobs) could lead to an intensification of competition," the analysts said.
Northern clearly understands the need to cut costs, having recently merged Fox's with its Elkes unit, a move which it said would deliver cost savings of £2 million per annum from the current financial year. But GS suggests that Northern will have to use these cost savings to invest in greater marketing support for its brands - vital if it is to maintain its market share. Increased promotional expenditure was cited by United Biscuits as the main reason for its lack of profit growth.
To make matters worse, there has been a general shift towards lower-priced products - at least according to UB - not good news for biscuit makers seeking to offset higher input costs through price increases.