Wesley Moultrie: Industry challenges spur acquisitions and increase the consumer defensive sector M&A risk. Firms within the sector are facing a myriad of challenges: shifting consumer preference toward organic and natural foods and beverages that contain fewer additives and less sugar; evolving retail channels; expansion of discounters; and a new threat--online shopping.
Recently, Brandless, a new online retailer, started selling generic, health oriented and environmentally friendly consumer staples products. Although in its infancy, they pose a threat to the growth and profitability of the sector. These elements and lackluster global economic growth have driven many firms to seek strategic acquisitions, which tend to weaken their credit profiles, as many of these transactions are completed with substantial amounts of debt.
Although several acquisitions were completed this year, the number and the pace of large transactions have slowed compared to prior years. However, MCR Morningstar Credit Ratings) believes that the risk remains high, as several acquirers' advances were rejected and may be resurrected. Recently, Constellation Brands' overtures to takeover Brown-Forman were rejected, as the Brown family is not quite ready to relinquish ownership of the company and its iconic Jack Daniel's whiskey brand. Brown-Forman's market cap is just under $20 billion. Earlier this year, Kraft Heinz withdrew its $143 billion proposal to acquire Unilever, due to what was characterized as cultural incompatibly. However, it is well known that Kraft Heinz is still in the hunt for an acquisition with strong brands and exposure to faster growing international markets. Hershey's rejection of Mondelez's $26 billion bid last year is another example of pent-up demand, as we believe Mondelez is still seeking a strategic acquisition.
Many consumer defensive firms have wide economic moats, strong business risk scores, and generate sizable and stable cash flows, which makes them highly attractive targets. Acquirers that have the ability and the commitment to de-lever quickly or fund the acquisition with a meaningful amount of equity are likely to maintain their credit ratings; others will likely face negative rating actions.