Key takeaways
A surge in inflation following supply-side disruption has hit the food and drink sector in the UK.
Rising energy prices have eroded profitability at most manufacturers. It has also forced factories to cut down on production of liquid CO₂, which is used for fizzy drinks and packing perishable goods such as meat.
Heat waves and droughts in parts of Europe, and El Nino conditions in Asia, are expected to lead to further supply disruption and upward pressure on prices for some goods.
In May 2023, Russia and Ukraine agreed to extend their Black Sea grain deal for another two months, allowing Ukraine to export key food ingredients, including wheat and maize, from its three ports — Odesa, Chornomorsk, and Yuzhny. The extension eased some pressures in the food and drink sector across Europe, including in the UK. However, Russia pulled out of the Black Sea grain deal during July 2023. This, along with air strikes on Ukrainian grain depots has led to price increases and uncertainty over future pricing and availability of grain.
Inflation remains high in the UK, hovering around 40-year highs and contributing to a cost-of-living crisis for many households. According to the British Retail Consortium, food inflation was 13.6% in August 2023, down from 14.8% in July 2023. Alcohol and tobacco inflation rose from 9.4% to 10.5%, reflecting duty reforms effective from 1st August 2023. The continued increase in prices has hit food and drink businesses, squeezing margins, and putting pressure on cash flows. The underperformance of food and drink businesses is evident in our KPMG Financial Performance Index (FPI) score.
The index, which indicates scores out of 100, reflected that the food and beverages sector in the UK declined to a score of 94.9 in Q2 of 2023. The UK food and drink sector has the fourth lowest FPI score in the EU, beating only Sweden, Norway and Poland who are facing their own macroeconomic challenges.
Beverages, packaged foods and meats have been impacted by soaring natural gas prices, which have forced factories to cut down on the production of liquid CO₂. This is a key input for fizzy drinks and packing perishable goods, including meat.
Russia-Ukraine war disrupts supply chain, driving cost-push inflation in Europe
The Russia-Ukraine war has disrupted food and drink supply chains, pushing up prices for energy, transport, carbon dioxide, wheat and maize. The UK has been acutely impacted as it imports about 46% of the food it consumes, according to International Trade Administration US Department of Commerce.
Rising prices have driven a divergence in volume and value of food sales amid soaring prices and weakened purchasing power. This trend is evident from Summer 2021 and has accelerated since Russia’s invasion of Ukraine in February 2022. Rising value and falling volume indicates that whilst inflation is forcing consumers to pay more for products, they are purchasing less to limit spending. The July 2023 data shows that food volumes fell by 2.7% compare to June 2023, and are 5.1% below the February 2020 pre Covid-19 levels.
Rising interest rates squeeze margins and put further upward pressure on pricing
In an attempt to curb inflation, the Bank of England pushed up base rate to 5.25% in August 2023, the highest level since the 2008 crisis. On 21st September 2023, following an unexpected fall in inflation, the Bank of England held base rate at 5.25%, bringing an end to 14 consecutive rate rises. The Bank of England’s monetary policy is aiming to reduce consumer expenditure and lower inflationary pressure. However, for businesses with debt funding, if no action is taken, higher interest rates will erode cash flow and profitability. Many corporates are increasing prices to maintain margins, fueling further inflation.
Bleak outlook amid concerns of drought and wildfires in parts of Europe
The challenges for the sector are expected to continue through 2023, following a dry winter and threats of another year of drought in some parts of Europe. Europe was also affected by wildfires during the summer of 2023. This has raised concerns over agriculture production in the region. Spain and Portugal are facing major drought conditions, forcing farmers to switch to less-water intensive crops, such as maize. Heat waves and water scarcity are expected to push down the summer harvest in the western Mediterranean, notably in Spain, Morocco and Algeria.
The upcoming El Nino event is also expected to see increased global temperatures and more disruptive weather over the next year. Parts of south Asia, notably India and Thailand, are already experiencing unseasonably dry conditions which are expected to reduce sugar production in 2023/2024.
However, there are some positive signs such as moderating price levels and improved consumer sentiment, which if prolonged will improve the prospects for food and drink companies. UK natural gas futures have dropped by 90% from a peak of 640 pence in August 2022, while GfK’s index of consumer confidence in the UK stood at -25 in August 2023, marking an improvement from -30 in July 2023 and -44 in August 2022.
The FPI scores for 3Q23 will provide more insight into the outlook for the UK food and drink sector – watch this space!
