Minister Hikes Sugar Tax

Sugar Tax – known as the Health Promotion Levy (HPL) – came into effect on 1 April 2018. Finance Minister Tito Mboweni’s announced on Wednesday in his National Budget Speech that the tax will be hiked from 2,1 cents to 2,21 cents per gram of sugar per 100ml (with the first 4 grams of sugar still exempted from taxation) will be implemented on its first anniversary.

Evidenced by the implementation of the tax – and its increase one year on, we believe that sugar – globally – has become an increasingly important driver of the food and beverage industry and that there are key catalysts that could result in Big Food becoming the next Big Tobacco, potentially resulting in lower sales growth, higher costs and large scale litigation.

Sugar consumption and its contribution to a wide range of health problems, such as diabetes, high blood pressure and obesity (which collectively are known as metabolic syndrome), are central to this risk. Our research suggests that there are a number of similarities between major food and beverage companies (“Big Food”) and major tobacco companies (“Big Tobacco”).

Below we take a look at the risks, how the industry is responding and why investors and the investment industry should be incorporating this risk into investment processes.

PART1: Sugar is a key strategic issue for the sector.

Catalyst 1: Increasing awareness amongst consumers and public health bodies
Increasing awareness of the health effects of sugar is leading to volume and price growth declines across the consumer staples sector, partly as a result of tougher regulations. While soft drinks have shouldered the bulk of this burden, food producers are next in the firing line.

Catalyst 2: Rising healthcare costs
Sugar is adding to governments’ increasingly burdensome healthcare bills, thanks to the part it plays in the global prevalence of obesity, diabetes and non-communicable diseases. Governments around the world - now including South Africa - have reacted by introducing sugar taxes, raising revenue and making products more expensive for consumers. Those companies that have already reformulated their ranges or have less exposed portfolios should benefit relative to slower peers.

Catalyst 3: Increased possibility of large scale litigation
Litigation risk is material. Despite challenges quantifying and attributing the damages caused by sugar consumption, we estimate the impact could be over 1% of the consumer staples sector’s current earnings. Companies with portfolios which are structurally less exposed to sugar are in the strongest positions.

PART 2: The industry is responding

M&A, divestment and the threat from activist investors
Since 2015 we’ve seen the continued rise of smaller challenger brands creating a wide range of M&A opportunities for the food majors. We have also seen the food majors themselves become a target of activism regarding their commitment to R&D into healthier products.

Reformulation, reducing portion sizes and product innovation
Food and beverage majors are also reformulating existing product portfolios to respond to consumer demand and the threat of sugar taxes. But the results of their efforts have been mixed; reformulation can be costly and can damage the brand if it doesn’t meet consumer expectations.

Increase in advertising spend
Another response we’ve seen is an increase in advertising to help offset the move to healthier alternatives.

PART 3: Taking steps to mitigate sugar risk

Engaging for better disclosure
We have seen an improvement in corporate disclosure with greater coverage of the issues around sugar in the last four years.

Company research and stock recommendations
Our proprietary research platform at Schroders includes over 40 instances of analysts factoring sugar risk into their recommendations, research or company discussions. There are over 50 references to sugar taxes alone.

Portfolio construction
That analysis is feeding into portfolio decisions across Schroders with teams adjusting their sector exposure to mitigate potential balance sheet risk faced by the food and beverages sector.

Conclusion
Sugar risk are on the rise. We believe that trends such as the implementation of sugar taxes, regulations regarding advertising and selling practices, and ongoing changes in consumer tastes will continue to create headwinds for the food and beverages sector. Food companies now face greater pressure to reformulate and innovate to protect future earnings.

Elly Irving is a Sustainable Investment Analyst at Schroders.