While the U.S. has averted a recession so far, slower economic growth has not translated into volume gains for U.S. packaged food companies. The sector had a negative bias in 2023, with downgrades outpacing upgrades 1.3 to 1. However, this represents an improvement relative to the 1.9 to 1 ratio in 2022. While we expect generally stable ratings trends for investment-grade packaged food companies, several speculative-grade issuers experienced profit erosion and tighter liquidity.

We expect a continued tepid organic top-line expansion during the next year, with uncertain volume recovery and fewer benefits from price increases as we lap the extraordinary inflation over the past few years. We expect price elasticities of demand will continue to increase as consumers remain stretched with high retail prices and lower savings and stimulus dollars.

Speculative-grade issuers with near-term maturities will likely continue to face refinancing challenges amid the higher-rate environment. Portfolio reshaping and M&A will continue but remain opportunistic and be limited to those companies with the balance sheets to support them.

S&P Global Ratings' Baseline Modeling Assumptions For 2024

We expect revenue, on average (excluding M&A), will be flat to increasing by the low-single-digit percent area, with similar increases in price and volumes. We expect tepid top-line growth due to the uncertain timing of a volume recovery and lower price increases as inflation moderates and companies raise their promotional spending to support volume growth.

Companies that participate in faster-growing categories, such as snacks, could experience more-rapid growth. This is consistent with industry expectations. We expect median comparable revenue guidance for the larger, investment-grade issuers in 2024 to increase by just under 1% (taking the midpoint of their guidance ranges). Our expectations range from modest declines to an increase of over 3.0%.

We expect profit margins will improve on lower costs and an increased focused on productivity, though we believe the gains may stall for some issuers because of their increased investment in promotions, marketing, and innovations.

We anticipate inflation will moderate to the low- to mid-single-digit percent area depending on the respective company's input baskets. Labor, sugar, butter, and cocoa prices remain elevated.

We believe cash flow will improve from lower inventory levels and easing inflation. This assumes no major disruptions in the supply chain, which currently faces heightened geopolitical risks.

We assume capital allocation consistent with historical financial policies.

Table 1

Revenue

Volume recovery will take longer

For 2024, we expect revenue will be flat to declining modestly due to lower volumes and less-favorable price increases amid moderating inflation. As indicated in chart 1, the large U.S. packaged food companies enjoyed favorable volume growth in 2020, with a median rise of 2.7% and 2.0% in 2020 and 2021, respectively, during the COVID-19 pandemic. In 2022 and 2023, volume declines accelerated, with median declines of 2.9% and 4.0%, respectively, as companies lapped periods of pantry loading and higher elasticities kicked in with increased prices. Still, elasticities held up better in 2022 and 2023 than historically, given the large price increases, hovering at about 50%. We expect elasticities to increase closer to historical levels of well over 50% in 2024.

Based on recent earnings releases by General Mills Inc. and Conagra Brands Inc., the volume recovery will likely take longer than we previously expected. Both companies reined in their top-line outlooks to about flat to down 1%-2%. Consumers have pulled back their purchases because prices at retail are 20%-30% higher than a few years ago when the inflation cycle hit. They are seeking value, buying closer to consumption, shopping in multiple channels, and increasing their shopping frequency with smaller basket sizes.

We expect promotions to increase as inflation moderates and companies seek to stabilize and ultimately expand their volumes. Historically, the sector typically experiences volume increases during economic downcycles as consumers shift to at-home dining versus away-from-home purchases. However, the pandemic shifted consumers' priorities toward experiences. The extraordinary inflation and price increases have also pressured consumers's wallets, limiting their discretionary income.

We believe historical trends will rebase in 2024 as the industry cycles through high price increases and consumers remain stretched. Over the medium to long term, we expect the industry's annual volume growth will normalize to the low-single-digit percent area.

Chart 1

(1) Campbell Soup Co.'s fiscal year ends July 31. 2019 data is not shown due to the company's divestitures. The company reports price and mix together and volume separately. (2) Conagra Brands Inc.'s fiscal year ends May 31. The company reports price and mix together and volume separately. (3) Flowers Foods Inc.'s fiscal year ends December 31. The company reports price and mix together and volume separately. (4) General Mills Inc.'s fiscal year ends May 31. The company price and mix together and volume separately. (5) The Hershey Co.'s fiscal year ends December 31. The company reports price and mix together and volume separately. (6) The J.M. Smucker Co.'s fiscal year ends April 30. The company reports price and mix together and volume separately. (7) Kellanova's fiscal year ends December 31. The company reports price and mix together and volume separately. 2023 data reflects the spin-off of U.S. cereal. (8) The Kraft Heinz Co.'s fiscal year ends December 31st. The company reports price separately and volume and mix together. (9) McCormick & Co. Inc.'s fiscal year ends November 30. The company reports price separately and volume and mix together. (10) Mondelez International Inc.'s fiscal year ends December 31. The company reports price separately and volume and mix together.

Benefits from price increases will abate

As inflation moderates and companies lap their double-digit percent price increases in 2023, we expect price contribution to revenues will decrease to a few points at best. A favorable sales mix could partially offset this decline if companies ramp up their innovations and promote higher-margin items.

As shown in chart 2, prior to the most recent inflation cycle, packaged food companies increased their prices or price mix by nearly 2% in 2019. In 2022, this jumped to a median of about 8% and rose to nearly 13% by 2023 (based on our sample of the large packaged food names). This indicates that it took the companies two years to realize price increases when inflation took off in mid-2021.

Chart 2

Private-Label Goods Have Gained Market Share

While consumers have traded down to lower-cost products and private-label goods have gained market share following a few years of decline, we believe lower consumption is a greater risk to the industry. We believe private-label gains will moderate, especially with more stable economic growth. During the last economic downcycle in the U.S., private-label share gains peaked in the low-20% area before stalling thereafter.

The categories that remain the most vulnerable are those that already have a high degree of private-label penetration. These include commoditized categories such as cooking oils, frozen mixed vegetables, broth, herbs and spices, baking ingredients, and breads. The companies most exposed to private-label competition include Flowers Foods Inc., McCormick & Co. Inc., B&G Foods Inc., and Kraft Heinz Co. (The).

Resilient categories tend to have lower private-label penetration, such as salty snacks, ready-to-eat cereal, seasoning blends, health and nutrition, and chocolate. The companies least exposed to private-label competition include BellRing Brands Inc., Hershey Co. (The), Mondelez International Inc., Simply Good Foods Co. (The), and Utz Brands Inc.

Margins Still Lag 2019 Levels

For 2024, we expect stable margins relative to 2023 but still lower than a few years ago before the inflation cycle. This is due to lower inflation and higher productivity, which will be partially offset by higher advertising and promotional spending.

Before the pandemic in 2019, the median gross margin (S&P Global Ratings-adjusted, less depreciation and amortization) was about 39% for the sample group. It expanded to nearly 40% in 2020 and remained above 2019 levels in 2021 before falling over 250 basis points (bps) to 36.6% in 2022 from 2019 levels. It gradually recovered in 2022 and expanded over 45 bps in 2023, relative to 2022, due to aggressive price increases. Despite this improvement, the median gross margin in 2023 remains below 2019 levels. This demonstrates the lag before companies fully realize the benefits from their price increases, as well as the persistent inflation levels.

We see similar margin trends with respect to EBITDA. The median S&P Global Ratings-adjusted EBITDA margin in 2019 was about 21.0%. This expanded to 21.6% and 21.7% in 2022 and 2021, respectively. In 2022, EBITDA margin declined over 200 bps to about 18.9%. By 2023, margins nearly recovered to 20.5% but remained slightly below 2019 levels as companies pulled back on advertising and promotions and cut costs to preserve their profitability.

Chart 3

Chart 4

Cash Flow And Capital Allocation

We forecast favorable cash flow trends for larger or investment-grade issuers as they reduce their inventory levels and improve their working capital amid improved supply chains. Free operating cash flow (FOCF) generation and overall cash flow conversion declined for many companies during 2022 and 2023 due to lower profits and increased working capital investments, and cash flow conversion levels have not fully recovered to 2019 levels. This is because many companies paid for higher-cost inventory and held more of it due to supply chain disruptions. Still, companies continued to pay their dividends and conducted manageable discretionary share repurchases.

Chart 5

Chart 6

Companies Have Lower Leverage

We expect leverage to remain near 2023 levels, absent large acquisitions. In 2019, the median leverage for the group was 4.0x after large acquisitions conducted in 2017 and 2018. By 2020, the median leverage dropped to 3.5x, then to about 3.0x in 2021-2023. We rate many of these issuers in the 'BBB' category, where the 3x leverage level supports the rating while providing a cushion to absorb acquisitions and additional shareholder returns.

Chart 7

M&A And Valuations

We expect ongoing portfolio reshaping but anticipate companies will be opportunistic. More companies have leverage headroom; however, they will need to balance that with higher borrowing costs and a challenged volume environment. The packaged food industry went through a heavy M&A cycle between 2014-2018, during which leverage increased to about 4x or more for some issuers. Since then, many companies have deleveraged and reshaped their portfolios.

At the time, multiples were high, with higher-growth assets commanding EBITDA multiples of more than 20x enterprise value. In 2023, we saw a few large transactions after a lull during the pandemic and inflation cycles. Notably, Smucker's acquired Hostess Brands for about $5.6 billion, which increased its leverage to over 4x. The deal commanded a 17x multiple. Campbell's pending acquisition of Sovos for $2.7 billion is valued at about a 21x multiple. Despite the higher-rate environment, we do not expect valuations to decrease materially. Attractive assets with strong brands and high growth potential will command premium multiples. Companies with room on their balance sheets to make larger acquisitions include Hershey, General Mills, Kraft Heinz, Mondelez, and McCormick.

Conagra Brands' leverage is higher than that of its peers who have not engaged in acquisitions, and the company is working toward reducing its leverage to 3x by 2026. Flowers Foods has less headroom given its recent litigation settlement. Smucker is digesting Hostess and will need to reduce its leverage below 4x by fiscal year 2025 to maintain the current rating. We expect Campbell Soup will soon close on the Sovos transaction and we believe it will take the company over two years to restore its credit measures.

Table 2

Upcoming Debt Maturities And Cost Of Debt

Investment-grade issuers have manageable debt maturities over the next year. Currently the average cost of debt for investment-grade issuers is about 3.5%. In comparison, the average cost of debt for speculative-grade issuers is closer to 9.0%.

Speculative-grade issuers with sizable upcoming maturities in the next 12-24 months include H-Food Holdings, 8th Avenue Food, and B&G Foods. Notably, H-Food has about $2 billion of debt due in 2025, and its $202.5 million revolver is due in November 2024. 8th Avenue has a revolver due in March 2025 and $650 million of first-lien term loans due October 2025. B&G Foods has about $265 million in notes due in April 2025, and its $800 million revolver is due in December 2025.

Table 3