Shares of Hellmann’s mayonnaise owner Unilever and Frank’s RedHot sauce maker McCormick fell on Tuesday following the announcement over concerns about the transaction’s structure, long path to closing and antitrust risks.

The top U.S. spice maker, home to more than 30 household brands, is playing the long game, some analysts said.

While many food companies are scrambling to reformulate products and resize portions as the surging popularity of GLP-1 weight-loss drugs reshapes eating habits, McCormick argues that flavor will remain essential even as calorie counts fall.

“We will continue to flavor calories while others compete for them,” McCormick CEO Brendan Foley, a packaged-food industry veteran, said on a call with investors on Tuesday.

“As consumers increasingly focus on cooking at home, adding more protein and produce, and pursuing healthier lifestyles, flavor plays a critical role in elevating those choices,” Foley said.

The GLP-1 bet

The surge in weight-loss drug use has consumers craving more flavor ‌in their food, leading to condiment and spice makers benefiting and attracting more interest in the M&A marketplace, dealmakers have said.

“Consumers shifting away from fatty, greasy, or overly sweet foods … creates a massive opportunity for flavor enhancers (spices and hot sauces) that provide sensory satisfaction without adding calories,” said Timothy Malefyt, professor of marketing at the Gabelli School of Business at Fordham University.

The deal will also help the U.S. company tap into Knorr stock cubes maker Unilever’s global scale and expertise, executives said on Tuesday’s investor call. Unilever executives highlighted its popular flavors such as Asian and Chinese.

“McCormick with this could be well-positioned to create the right nutritional functional benefit in food that is lacking in America right now,” said Mike Anstey, founder of Pilot Lite, a global CPG (consumer packaged goods) commercialization partner.

It would also open up key emerging markets such as Brazil, China and countries across Europe, the Middle East and Africa (EMEA).

“(The deal) represents a step-change in scale, broadening MKC’s exposure to faster-growing emerging markets and expanding opportunities for its foodservice platform,” Jefferies analyst Scott Marks said in a note.

Unkind market conditions

McCormick is seeking new markets and flavors against the backdrop of a tough U.S. market, where consumers are eating healthier and also looking for cheaper pantry alternatives and smaller pack sizes to stretch budgets hit by inflation.

“We’re certainly aware of the near-term pressures facing not just the food industry but broadly … the conflict in the Middle East and the broader CPG space. However, we continue to believe in just the long-term fundamentals that really underpin the confidence in this combination,” McCormick’s Foley said.

The company’s total volume growth has slowed over the last year, and was down 0.7 per cent in the most recently reported quarter, falling across both its consumer brands and flavor solutions segments.

“Despite the combination’s strategic merits, we think this may be a ploy to incite growth in an industry where gains have stagnated,” said Erin Lash, analyst at Morningstar Research.

Rival Kraft Heinz, which media reports said had explored a bid for Unilever’s food business, underscored the tougher U.S. market when it paused plans for a split.

“Investors should look at this transaction more optimistically than broken deals like Kraft Heinz because it creates value through greater depth in a single category, flavorings, rather than diversification,” said TD Cowen analyst Robert Moskow in a note.

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McCormick Canada, the Canadian arm of Baltimore-area condiment and spice maker McCormick and Co., on Monday announced it had completed a “multi-million dollar expansion” at its London, Ont. plant to blend, bottle and package French’s ketchup.

Bottling of French’s ketchup began at the London plant last month, the company said Monday, but added that “full production ramps up this week.” An exact dollar figure wasn’t given for the cost of the expansion.

McCormick said it would continue to source 100 per cent of its tomatoes for French’s ketchup in Canada from the Leamington, Ont. area and would continue to offer the product in four varieties: original, garlic, low-sodium, and no-sugar-added.

By bringing its ketchup line to London, McCormick said it would be “deepening its local roots” and transitioning away from a “third-party Canadian supplier.” The French’s line has been packed in Canada by Toronto-based Select Food Products since 2016.

McCormick has operated at London since 1959, when it bought the Club House brand of spices and extracts, a business founded there in 1883 by Gorman, Dyson and Co.

The French’s brand, along with Frank’s RedHot and others, came to McCormick in 2017 when it bought the food business of British consumer health and hygiene firm Reckitt Benckiser for US$4.2 billion.

Shortly before that sale, the French’s brand had made a splash in Canada by promoting its use of tomatoes grown in the Leamington area and by bringing the product’s bottling to Toronto.

Ketchup provenance by then had become a sore spot among some Canadian consumers, after Kraft Heinz shed its Leamington tomato processing plant in 2014 and began bottling its Heinz ketchup for the Canadian market at plants in the U.S.

Kraft Heinz sold the Leamington plant in 2015 to an Ontario consortium, Highbury Canco, and still sources some tomato products from the latter company. Kraft Heinz also announced last November it would resume packing Heinz ketchup in Canada for the Canadian market, this time at its plant in Montreal. –– Glacier FarmMedia Network

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Cultivated painstakingly over years from an orchid plant, vanilla is the second most expensive spice in the world, after saffron.

In less than five years, the wholesale price has risen nearly 500 per cent, partly because of growing global demand for healthy, natural ingredients. But supply is an issue too: Cyclones, drought and crop-theft have hit Madagascar in recent years, slashing into the tender crop’s quality and quantity. The African island nation produces about 80 per cent of the world’s vanilla.

For McCormick and Co., the world’s largest spice company, the scarcity of vanilla has become too big a risk to ignore, spurring it to begin cultivating an alternative source on the north coast of Papua, Indonesia. McCormick, which sells vanilla and its extract to retailers, restaurants and packaged food makers, said it has been passing the higher costs on to buyers.

The price of black whole-bean Madagascar vanilla, the benchmark product, costs $520 per kilo (all figures US$). While this isn’t quite the spice’s record-high of $635 per kilo — reached after a ruinous cyclone in 2017 — it is still nearly six times the price of $87.50 per kilo in early 2015.

Back-to-back typhoons in 2017 and 2018 “definitely put input pressure on costs,” Nestle U.S. CEO Steve Presley recently told Reuters.

The world’s No. 1 food company raised prices for U.S. ice cream products in 2017, partly due to mounting vanilla prices, he said. The Swiss food giant makes Haagen-Dazs, Edy’s and Skinny Cow ice creams, which tout natural vanilla flavouring or beans on their labels.

General Mills, which sells Haagen-Dazs outside the United States and in the brand’s international ice cream parlours, said higher vanilla costs were forcing prices upward.

Now, Donald Pratt, managing director of McCormick’s global procurement arm, said the company is looking to Indonesia as a possible solution to the industry’s supply problem.

But pulling this off may be an uphill task.

Indonesia produces only about 100 tonnes of whole vanilla beans a year, a far cry from Madagascar’s output of about 2,000 tonnes, Pratt said. And some others who have tried to cultivate a secondary source for vanilla have not been successful — Unilever’s Ben and Jerry’s, for instance, “invested heavily” in a similar project that backfired in Uganda.

‘The dark side of vanilla’

Vanilla — sometimes called green gold — is so coveted thieves will kill for it.

“This is the dark side of vanilla. You don’t realize because it’s such a sweet thing,” said Cheryl Pinto of Ben and Jerry’s, which uses vanilla in most of its ice creams, as well as in other items such as cookie-dough chunks. Pinto said she is in charge of managing the company’s supply chain with a “social mission” in mind.

To protect their crop in Uganda, “farmers were sleeping in these fields and there were murders and beatings,” she said. “It was awful.”

This month, when setting harvest dates, the Ugandan government called out “cases of theft and loss of lives” spurred by higher prices. The violence goes both ways: Last year, Reuters reported Malagasy growers defending their fields by beating apprehended suspects to death.

Vanilla is valuable largely because it is laborious to grow.

New vanilla vines take three to four years to produce orchids and can only be pollinated — by hand — a few days each year during a pre-dawn, four-hour window. From bloom to sale, the average production cycle is 16-18 months, and 600 hand-pollinated flowers yield only about one kilo of dried beans.

The vines can flourish only if intertwined with small trees that provide support and shade. And they must be grown close to the equator.

Bourbon vanilla, which McCormick sells, is by far the most popular variety in the world. Though it has historically been cultivated in Mexico, it mostly has been produced in Madagascar for the past century because many farmers elsewhere found it such a time-consuming, delicate crop, not worth the uncertainty and price fluctuations.

Pratt said he doesn’t yet know how much Indonesia would have to produce to calm market prices.

Tam Hun Man Tombo, a vanilla exporter in Madagascar, is skeptical farmers elsewhere are up to the task.

“I’ve been in the vanilla business for more than 30 years, and every time I hear the same refrain: Buyers are looking for other origins, buyers will be working with farmers in other countries,” he said.

“It is a threat to which we are accustomed. But we do not fear that too much. Indonesia cannot produce vanilla as good as Madagascar.”

To boost production quickly, McCormick is scaling up training programs in Papuan farming communities. To produce beans of Madagascar’s quality — to which consumers are accustomed — McCormick has been changing some practices related to soil and water management.

McCormick is in discussions with CARE, a non-governmental organization that helped re-establish the market in Madagascar after the 2017 cyclone destroyed about 30 per cent of the island’s vanilla crops. The agency has founded co-operatives in Indonesia as well as Madagascar that provide training for growers — often women — on crop production and management, as well as aspects of financial literacy.

CARE has suggested other geographic alternatives, as well, including Uganda and Tanzania, said Elly Kaganzi, deputy director of CARE’s agriculture and market systems.

Pinto told Reuters Ben and Jerry’s efforts in Uganda foundered, however, because eastern buyers — mainly from China — swooped in and “showed up to the village with a boatload of cash” ahead of the government-sanctioned harvest date.

“We have not been able to get any vanilla out of Uganda,” Pinto said.

Ben and Jerry’s says it hasn’t raised prices due to vanilla costs, choosing to absorb them and stay competitive. But retail prices for other companies’ vanilla-containing products, from coffee sweeteners to yogurt to extract, continue marching upward.

As of May 30, a two-fluid ounce bottle of McCormick’s Vanilla Extract from Walmart.com cost $8.12, up from $5.94 in May 2015, according to the retail consulting firm GlobalData.

“Vanilla has always been a store-cupboard staple, a common product,” said Neil Saunders, who heads the firm. “Consumers might be surprised at the high cost, but what can they do if everyone from Amazon to Walmart is raising prices?”

— Reporting for Reuters by Richa Naidu in Chicago and Lovasoa Rabary in Antananarivo.

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Sales of California-grown garlic are now increasing after decades of losing ground to cheaper Chinese imports. Sales are poised to get even better as Chinese garlic faces even higher tariffs, with no end to the trade war in sight.

“In a perfect world, we’d love to see the tariffs stay on forever,” said Ken Christopher, executive vice-president of family owned Christopher Ranch, the largest of three remaining commercial garlic producers in the United States.

While many farmers are suffering through the trade war because they relied heavily on imports to China, U.S. garlic growers benefit because they rely overwhelmingly on domestic sales.

Tariffs on Chinese garlic increased from 10 to 25 per cent on May 9, when the U.S. hiked tariffs on $200 billion of Chinese goods and dashed hopes that a U.S.-China trade deal could come soon (all figures US$).

While soybean farmers in the U.S. Midwest watched silos fill with unsold crops as top buyer China all but stopped purchases, Christopher Ranch saw domestic garlic sales rise 15 per cent in the last quarter of 2018 after the U.S. applied a 10 per cent tariff on imports of Chinese garlic in September.

Then Trump ordered even higher tariffs this month after trade talks broke down when China backtracked on a host of issues crucial to U.S. officials.

The escalation came just a few weeks before the U.S. garlic harvest.

“The timing couldn’t be better for us,” Christopher said. “We anticipate a surge in demand for California garlic in the coming weeks.”

Christopher, 33, whose farm has 5,900 acres of grass-like garlic fields at Gilroy, traveled to Washington, D.C. in July to urge the Trump administration to include garlic in the list of imports that would face tariffs.

In lobbying for tariffs, Christopher follows in the footsteps of his grandfather, who fought to implement an anti-dumping duty of up to 400 per cent on Chinese garlic in the 1990s.

“We understand in a broader economic sense that a trade war is not in the U.S. best interest,” he said, “But since the tariffs were happening anyway, we needed to be sure that garlic was part of the equation.”

Not everyone is a fan of the garlic tariff. While Christopher was testifying in favour of tariffs to the U.S. International Trade Commission, executives from one of the world’s top seasoning companies, McCormick and Co., were arguing against them.

McCormick says its recipes mostly rely on Chinese garlic, calling it a different product from what is grown in the U.S.

“They’re not substitutable,” CEO Lawrence Kurzius told Reuters in an interview. “Just like wine, origin matters and terroir matter.”

Taste differences aside, California garlic has traditionally sold at far higher prices than Chinese garlic. It now sells for about $60 per 30-lb. box on the wholesale market, according to Christopher. Until recently, Chinese garlic sold for $20 per box, but that has risen to $40 with tariffs and will likely soon rise further, he said.

The new profits U.S. garlic farmers have enjoyed from tariffs are an exception in the U.S. farm sector.

China last year retaliated to Trump’s tariffs with duties on U.S. goods including soybeans, corn and pork. Farm incomes in U.S. Midwest and mid-southern states continued to decline in the first quarter of 2019, according to banker surveys released this month by regional federal reserve banks.

Trump has pledged up to an additional $20 billion in aid to help U.S. farmers hurt by the prolonged dispute after groups such as the American Soybean Association criticized the failure to reach a deal. That’s on top of $12 billion the administration promised last year to compensate farmers for trade-war losses.

The trade war has also left many West Coast specialty crop farmers, like nut and cherry growers, scrambling to find alternative markets after China imposed steep duties on imports that made their products too expensive to sell there.

Jamie Johansson, an olive farmer and president of the California farm bureau — which represents 400 crops and 36,000 members — said the Trump administration had put California farmers in the middle of tariff wars with four of the state’s five top markets, including China.

“Among our members, I have not heard of anyone benefiting from the current trade war and tariffs,” Johansson said.

— Reporting for Reuters by Lucy Nicholson and Richa Naidu; additional reporting and writing by Caroline Stauffer.

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London-listed Reckitt said in April it was reviewing options for the unit, which includes French’s mustard and Frank’s RedHot sauce, to cut its debt following the $16.6 billion purchase of baby formula maker Mead Johnson (all figures US$).

The sale, announced late on Tuesday, will reduce Reckitt’s net debt to EBITDA ratio to 3.3 times from 4.1 times. It will also enable it to focus more closely on its consumer health and home brands, which include Durex condoms and Mucinex cold medicine.

It gives McCormick, the maker of Lawry’s and Old Bay seasonaings and Billy Bee honey, a leading position in the U.S. condiments category.

At $4.2 billion, the price represents a multiple of more than seven times the annual sales from the business and 20 times its earnings before interest, tax, depreciation and amortisation.

That is much higher than the long-term average of major deals in the sector, which Bernstein analysts say is 3.3 times sales and 16.2 times EBITDA.

Sources had previously estimated that the business, which attracted interest from several strategic U.S. players, would fetch more than $3 billion. They also noted that private equity funds were not invited to the process as they would have had trouble competing on price with industry players.

In the final stages of the auction, McCormick competed with Unilever and Hormel Foods, one source said on Wednesday. That source also said that PE funds would have slowed the process due to more lengthy due diligence requirements.

Unilever declined to comment, while Hormel could not immediately be reached.

RBC Capital Markets analysts said it “feels to us like a very high price for a U.S.-oriented ambient food business.”

Morgan Stanley analysts said the high price tag confirmed the value placed on unique assets like French’s, which is the world’s leading mustard brand.

Rating agency Moody’s said that the sale was credit positive for Reckitt as “the proceeds will be used to pay down some of the existing debt which will help faster deleverage.”

Maryland-based McCormick, which expects the hot sauce category to continue seeing robust growth, has been trying to expand through acquisition.

Last year it approached Premier Foods, the owner of British food brands including Mr. Kipling cakes and Oxo stock cubes, but was rebuffed.

With this deal, McCormick expects to achieve “meaningful accretion” to margins and adjusted earnings per share, excluding transaction and integration costs. It expects cost synergies of about $50 million, most of which by 2020.

McCormick said it had obtained bridge financing and expects to permanently finance the deal through a combination of debt and equity.

The combined entity’s 2017 pro forma net sales are expected to be about $5 billion, McCormick said.

Credit Suisse advised McCormick on the deal, while Morgan Stanley and Robey Warshaw advised Reckitt.

— Martinne Geller is a consumer goods correspondent for Reuters based in London, England. Additional reporting for Reuters by Sangameswaran S in Bangalore and Clara Denina in London.

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