Food safety concerns have been on the rise since the horsemeat scandal earlier this year showed how little control many food companies really have over their supply chain. When something goes wrong and food is recalled, the loss of product is really the least of a company’s concerns, as damage to the brand and subsequent lawsuits quickly outpace the cost of the recall itself. Looking at recalls and other food safety incidents, Societe Generale SA (OTCMKTS:SCGLY) (EPA:GLE) analysts Carole Crozat, Yannick Ouaknine, and Niamh Whooley have found that the most exposed companies will see their margins fall as they struggle to get food safety under control.
Food safety alerts have been on the rise
“Food safety alerts have been on the rise, especially in 2011 and 2012,” they write. “With a clear trend for food retailers with an increase in foodborne illnesses (including bacterial contamination) and more generally mislabeling of potential allergens.”
In the past, name brand food companies have relied on third-party audits to make sure their suppliers and food processors were delivering a high quality product, but these audits were often announced well ahead of time and were paid for by the suppliers and processors. Internal auditing has become more common, but it’s expensive. Auditing and quality control account for 3.5 percent of food manufacturers’ EBIT, but the cost is largely invisible to consumers, who may opt for cheaper products that carry a higher risk but have not yet had their images tarnished with a food safety incident. European consumers are particularly adamant about food quality and safety, but are equally unable to pay higher prices while wages continue to be depressed, putting pressure on manufacturers.
Growing concern among consumers about GMO
Additionally, there is growing concern among consumers about genetically modified foods (GMO), animal living conditions and feed, cloning, and other issues that are easy to sensationalize.
But the results on not taking action are high. The Societe Generale SA (OTCMKTS:SCGLY) (EPA:GLE) report estimates that the largest losses from a food recall are really marketing expenses as the company tries to win people back, followed by legal fees and settlements.
Britvic stocks fell hard
Britvic Plc (LON:BVIC) Soft Drinks provides a good example of what happens when a single company (as opposed to a segment of the food industry) is hit by scandal. After a child choked on a new type of bottle cap in 2012, Britvic Plc (LON:BVIC) had a ‘preventative recall’. No one died (including the child who first choked on the cap), but Britvic stocks fell hard. The share price has since recovered, but food companies cannot afford to have a reputation as being unsafe.
“Our analysis of more than 200 product recalls and safety incidents in the food, beverage, food retail and services industry shows that prepared foods and snacks, followed by meat and dairy products are the most exposed areas,” says the Societe Generale report. Labeling issues account for 37 percent of recalls, driven by undeclared ingredients such as nuts or milks that some people are allergic to, and foreign materials including everything from metal to wood chips is another 18 percent. Pathogens are less common, though they are higher profile and potentially more lethal.
Now that the public and governments are more aware of these issues, regulation is tightening and the cost of quality control, compliance, and heavier marketing will reduce margins in the food industry for the foreseeable future.