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Cage-free Craze! Companies Continue to Commit to Cage-Free Eggs

With more companies announcing cage-free commitments, will cage-free become the standard?

Over the last 6 months, there has been a growing number of companies committing to using only cage-free eggs in their businesses. From fast food restaurants to retailers, many are stating their intention to transition away from conventional cage farm production to cage-free. While most of these announcements occurred recently, the actual timeline to switch to cage-free eggs ranges from one to ten years, and some, such as Burger King, have made previous commitments to cage-free eggs they weren't able to meet.

In this quarter's Ascendant Insight we'll look at the companies making these commitments, their motivations, and the implications for producers. Listed below is the definition of cage-free eggs along with several other egg types:
  • Caged: eggs produced from hens raised in 67" cages.
  • Cage-Free: eggs produced from hens able to freely roam but not outside, typically space is 1-1.5 square feet, can vary depending on state or customer requirements.
  • Free Range: cage-free with access to the outdoors, amount of access is not defined.
  • Organic: eggs certified organic by the USDA, access to the outdoors, antibiotic free, fed with organic feed.
  • Pasture Raised: eggs from hens that have uninhibited access to outdoor pastures.
Ascendant Insight.

In the last several months numerous companies have announced intentions to source their eggs from cage-free operations. As the supply chain adapts, new producers are entering the arena as establish egg producers have already made significant capital investment inhibiting their ability to switch to cage-free production. These new producers and others in the supply chain, including equipment providers and feed suppliers, offer investment opportunities for debt and equity providers as the industry moves to meet demand.

According to the latest count, 70 restaurants and restaurant chains, retailers, grocers, and suppliers have committed to cage-free egg production. Many have pointed to McDonald's, who made their announcement in September of 2015, as the impetus for others to publicly announce their cage-free intentions. While several companies have laid out plains for 100% cage-free eggs by the end of 2016, many have indicated 2025 or 2026 as their target date for making the switch.

It is conservatively estimated that these commitments represent between 25 and 30 billion eggs annually or one third of estimated annual egg production based on the USDA's latest estimated layer flock size of 293 million birds. This represents a number that is almost 10 times higher than today's current cage-free flock population of 12.2 million layers or 3.3 billion eggs.

Producer Costs and Retail Pricing
While the industry has increased the cage-free flock from 4.5 million hens in 2007 to 11.4 million hens in September 2015, the investment required to convert to cage-free production remains a significant hurdle for many in the industry.

In addition to the upfront investment that is 2-2.5x that of conventional egg production, cage-free operating costs can be 23% to 27% higher than conventional eggs with as much as 10% lower egg production and higher mortality rates. Another hindrance to the pace of conversion is the amount of companies that can build cage-free facilities: United Egg Producers indicates there are only five or six companies who make cage-free equipment worldwide, and most are located in Europe. 

While the layer flocks will likely never be 100% cage-free, many new production facilities, driven by demand and returns relative to conventional eggs, are making the decision to build cage-free facilities. Currently, most producer pricing is done through long-term contracts with limited spot price transparency. The lack of a standard definition for cage-free eggs, which may vary from between contracts and customers, adds additional complexity to producer pricing. As shown above, a recent USDA report shows retail cage-free prices 1.5-2x higher than conventional eggs. 

Growth Drivers
There are several drivers influencing the growth of cage-free egg production including consumer demand, social impact, and legal requirements. 

Consumer demand is a large driver for the growth in cage-free eggs. Ultimately, consumers vote with their pocket book and thus far consumers have been willing to pay more for cage-free eggs. Their motivation for doing so stems from the underlying trend for more transparency and perceived higher-quality from products utilizing organic or natural ingredients or livestock. Cage-free eggs fall under this trend as consumers perceive cage-free to be a higher-quality product than conventional eggs. Interestingly, a recent University of Kentucky study found that in a blind taste test of 85 consumers, commercial cage-free eggs were preferred over locally-produced and conventional eggs, although the difference was statistically insignificant.

The Humane Society has been another factor driving the growth in cage-free eggs. It has been working for years to encourage producers and users of eggs to make the switch. Its campaigns have sought to raise awareness at the consumer level while pressuring companies to use cage-free eggs in their operations. The Humane Society has been the driving force behind commitments from brands such as Burger King, McDonald's, General Mills, and ConAgra.

Finally, several states have begun adopting laws that require cage-free eggs or prohibit new cage layer facilities. California and Michigan have passed legislation to phase out cage layer facilities and Ohio has placed a moratorium on new cage layer facilities. California has also passed a law requiring all eggs sold to be cage-free by 2015. Massachusetts has introduced a similar measure to California's cage-free egg requirement that will be voted on in November 2016.

These drivers and the growing number of commitments point to continued growth in cage-free production. However, while the timeline many of the commitments have laid out is necessary to allow the supply chain to make the required investments in production and equipment, it also allows them plenty of time to quietly move away from the commitments if consumer demand subsides in the coming years.

Transaction Profiles.

The year 2015 proved to be a big year for M&A with many large deals completed. The food and beverage industry was no exception with several large deals completed throughout the year. To close out 2015, Pinnacle Foods acquired Boulder Brands which had been struggling for most of 2015. In 2016, many signs point to a continuation of this trend with low borrowing rates, strong corporate balance sheets, and a tough market for growing organically. Another contributing factor is the increasing number of private equity funds providing growth capital or acquiring companies in the natural and organic space.

is Acquired by Pinnacle Foods - November 2015
Deal Terms: $967.5MM
              1.8x Sales
              17.8x EBITDA
                        40.5x EBIT

Boulder Brands has built a portfolio of brands targeted to the natural and organic food space. In 2015, Boulder Brands had fallen due to operational challenges and struggling sales of its legacy brand, Smart Balance, leading to the exit of its CEO and co-founder in June. Smart Balance has lost traction in the market place as consumers have shifted back to more natural spreads such as butter. The deal gives Pinnacle a foothold in the better-for-you food categories with brands such as Udi's and Evol, which it will be able to integrate into its distribution networks. Pinnacle is looking at a number of opportunities to reduce costs - one of which is bringing co-pack manufacturing in-house. Co-pack manufacturing is 40% of Boulder Brands' business.

  is Acquired by Bunge North America - October 2015

Deal Terms: $27MM

Whole Harvest Foods was acquired by Bunge North America for $27MM in October 2015. Whole Harvest Foods is a supplier of expeller-pressed oils for the food service industry with locations in North Carolina and Las Vegas, NV. Its products include canola, cottonseed and soy oils. Whole Harvest allows Bunge North America to add to its portfolio of trans-fat free products as it looks to meet consumer demand for health and functionality. 

 is Acquired by Atlantic Natural Foods - November 2015

Deal Terms: Not Disclosed
Neat foods is a producer of a pecan-based meat substitute and a meatless egg substitute made from garbanzo and chia seeds. Neat foods started four years ago and has an estimated revenue of $1MM after gaining national presence in 2014 with the retention of a sales force, brokers, and distributors. The company's products are currently found in Wegman's, Target, Whole Foods, Kroger, and Stauffers of Kissel Hill. Atlantic Natural Foods is a portfolio company of AFT Holdings, a private equity firm, and is a producer of plant-based meat substitute products. Adding neat foods to Atlantic's portfolio will allow them to offer a larger array of meatless products and provide a more consistent shelf placement in stores.

Earnings Spotlight.

The earnings spotlight highlights several companies in the natural food, commodity processing, and protein industries.

WhiteWave Foods (WWAV) - WhiteWave reported strong results with its portfolio of on-trend brands in the organic and better-for-you categories. WhiteWave's two acquisitions, Vega and Wallaby Yogurt, performed well but the company also reported 10% growth in brands owned a year or more. The company has recently introduced several new products including Sir Bananas, a milk and banana drink, and Nutchello, a nut-based beverage. Both of these new products are moving to expand usage into other categories and occasions. In 2016, WhiteWave estimates sales growth of 10-11%.
Boulder Brands (BDBD) - As highlighted above, the big news with Boulder Brands in 2015 was its sale to Pinnacle Foods. In the company's last earnings report it indicated sales of Smart Balance declined faster than its category and its margins were impacted by lower margins in its natural segment. *Note: Going forward, Hain Celestial will replace Boulder Brands in our Earnings Spotlight.  
Treehouse Foods (THS) - After several quarters of lower than expected results, Treehouse was able to post a solid 4th quarter driven by snacks and single-serve beverage categories. The company has also been closing the ConAgra private-label business which it agreed to acquire for $2.7 billion in November of 2015. Treehouse indicated the private-label business is seeing the same trends as branded companies of clean labels and natural products and that growth is prompting stores to seek to develop brands that will capitalize on those trends. Sales in 2016 are expected to be $6.3-6.5 billion with the addition of the ConAgra private-label business to the company's revenue.

ADM (ADM) - Earnings continued to fall in the second half of 2015 as global commodity prices continued their decline. ADM continues to emphasize its moves in the specialty commodity and ingredients space through its Wild Flavors and Specialty Commodities division. ADM has also indicated that it is working to understand the long-term fundamentals of the dry-mill ethanol industry.

Bunge (BG) - In the final months of 2015, Bunge purchased Whole Harvest Foods, a producer of refined expeller-pressed cooking oils. In 2016, Bunge expects a larger soy crop in Brazil to support crush and export margins and greater selling by Argentina farmers to increase capacity utilization.

The Andersons (ANDE) - The overall downturn in the commodity markets has affected The Andersons the most of our commodity processing stocks with a 52 week decline of 41%. Market conditions in the eastern corn belt and limited farmer selling resulted in lower than expected performance from the company' s agriculture business segment. In the fourth quarter, the company began construction to double the capacity of its Albion, MI ethanol facility.


Tyson Foods (TSN) - Tyson and the rest of the protein complex continue to enjoy strong results due to lower feed costs and robust consumer demand.  Tyson indicated it achieved over $300MM in synergies from the Hillshire acquisition in 2015 and estimates synergies of $500MM in 2016. Tyson is forecasting a 2-3% increase from 2015 in protein production which could could lower prices. 

Hormel (HRL) - Supply shortages in the Jennie-O turkey segment due to avian influenza were responsible for a 1% year-over-year decline in sales, however, earnings per share increased 18% over fiscal year 2014. Applegate continues to perform as Hormel initially expected but the company noted its performance has been constrained partially by pork and turkey raw material availability during the fourth quarter. Hormel is pursuing the sale of its Diamond Crystal Brands business, a business focused on customized food service solutions.

Sanderson Farms (SAFM) - Sanderson had a strong 2015 with a 13% volume increase from 2014 to 3.44 billions pounds. While overall poultry prices declined compared to 2014, grain prices were also significantly lower. The company also benefited from strong retail demand for chicken in 2015 while exports suffered from a strong US dollar, lower oil prices, and avian flu concerns. The big bird market, composed of product going into the food service sector, experienced excess supply due to domestic supply growth and lower exports; forcing more supply into the domestic market. Sanderson expects to grow processed volume 5% in 2016 to 3.6 billion pounds and anticipates capex for its new St. Pauls, NC facility of $140MM.

Thank you for allowing us a moment of your time this quarter. If you would like to discuss this or other topics or if you have suggestions for future issues, please don't hesitate to reach out to us. Our goal, as always, is to add value for you. Any replies will go directly to Ascendant.

- The Ascendant Partners Team