Small cap portfolio management in turbulent times

It is striking how quickly the world can change. A mere 12 months ago the food industry was optimistic about growth and the government was incentivising the building of new production facilities. Throw in a couple of black swan events like the war in Ukraine, fuel and supply shortages leading to price hikes and a massive cost of living crisis, and those forecasts look remarkably different.

Given the new realities of what could be two-to-three-year period of belt-tightening and inflationary pressures, how can food manufacturers pivot their capex portfolio management in response to potentially lower output requirements for an interim period while retaining the ability to scale back up when normality returns?

Businesses will need to re-analyse their strategic priorities which can can always be simply expressed as a percentage split between sales growth, new stuff and cost improvement. Adjustments can then be made to those ratios to ensure resources are being allocated correctly and strategically, or in other words doing the right things with the right products.

Table 1 Showing a pivot in Capex prioritisation focus towards cost reduction

An example at one end of the scale might be of a business that was considering investment in a new facility to create capacity at the start of 2022 and now as the market conditions start to drag down forecast future sales to a point where a new facility is no longer immediately required. Reviewing ways to de-bottleneck existing capacity through automation or restructuring processes may provide a more cost-effective way of bridging the capacity deficit until conditions improve.

All food businesses will have a long list of potential investment projects, generally many more than the available resources will cover. So how to decide where to focus limited resources in a recession?

Within a factory environment, projects can generally be split into three categories.

1. New stuff and growth
2. Cost reduction
3. Base spend including safety and regulatory compliance spend

Producing a prioritised list for each category is a good place to start. It allows the prioritisation to be agreed within the organisation and helps to establish how much the business is prepared to spend in each category and in each year over a limited time period; usually Current year + Next year + Year2 and beyond is a good place to start.

Each project list needs to be scored against a number of factors. Some will be specific to the category and deal with business or regulatory prioritisation. Additional factors will include – how quickly the project can be delivered, how easy it is to deliver, and what the rate of return is. Bear in mind that all returns are not equal – some savings are better (i.e more reliable) than others.

There are typically three classifications of benefit: direct cost reduction, material substitution, additional sales capacity. In general, direct cost reductions (including energy savings) are the most reliable and senior management will factor this in when reviewing an investment. Other savings such as the ability to use alternative materials provide greater flexibility but savings forecast at the outset of a project can disappear as commodity prices move around.

Providing increased capacity for additional sales generally creates the highest return but the sales need to happen for the benefit to crystallise and so it becomes important to understand the likelihood as well as including a range sensitivity. It is good practice to think of how a project can create value in these three areas. Even regulatory compliance projects must be viewed through a commercial lens and potential savings assessed.

Once these weighted rankings have been assigned and strategic priorities identified, it quickly becomes obvious which projects go to the top of the pile. Another portfolio assessment technique is to hypothetically reduce the amount of capex available – so if you had planned to allocate $100M to projects, what would happen if that was reduced to $80M? Which projects would you drop? This approach helps you to prioritise projects in the most appropriate order.

External factors will have an influence on these rankings and therefore the portfolio assessment exercise should be repeated quarterly. For example, a renewable energy installation project might have a simple 3-year return period on a fuel price calculation of $50 per barrel, but when the price of oil jumps to $100 per barrel, that return period becomes 18 months.

Secondly, applying a dynamic capital allocation approach enables the business to adjust its spending up or down depending on how well the business is performing. This will require detailed analysis of profitability and establishment of milestone tests that must be passed to release additional capital for investment.

Thirdly, where there is more than one site in the network, consider looking at each site as a separate investment portfolio and analyse the return on capital deployed just as a city trader would do – applying investment criteria and measuring performance. If each site is competing for access to investment cash, this enables you to identify which sites will generate the best returns on cash invested and generate free cash to support the business. Furthermore, this enables you to identify the characteristics of the best performing products and sites, in order to inform new product development.

To summarise, as the external pressures in the world create new challenges, they also create an opportunity to revisit how you manage your portfolio: look at each site individually rather than as a part of the whole, review capex portfolio management techniques to ensure you are spending correctly on strategic priorities, and drive projects according to anticipated return.

DDK is a leading project delivery company in the food and speciality manufacturing sector. Our expert team of food manufacturing specialists have over 100 years of combined project management experience in the food and speciality manufacturing industry, having delivered £5+ billion of capital projects ranging from £1m to £150m with multisite investment programmes from £200m to £500m.

Services offered by DDK range from feasibility studies and concept designs through to equipment and process specifications, tendering and construction management, transition planning and delivery of a fully operational facility.

DDK can bring world class portfolio management to your organisation with a full-service that can deliver projects in a smaller, more agile manner.