Food Companies Stuff Cash Flow With Artificial Fillers

(Bloomberg Opinion) -- Beware food companies relying on their bookkeeping rather than their cooking to keep investors satisfied.

A number of food companies have recently been selling their IOUs to deal with the fact that their customers, namely giant retailers like Walmart Inc., are taking longer to pay. The sales bolster cash flows, but critics contend they can make the giant food companies’ finances look better than they truly are as they face increased business pressures. The financing charges can also make those sales less profitable.

Treehouse Foods Inc., which two years ago bought the private-label business of ConAgra Brands Inc., in December became the latest food company to turn to its unpaid billings as a source of immediate cash. Treehouse sold $183 million of its accounts receivables to an unidentified financial institution in the first three months of the year, according to its first-quarter financial filing. Cereal maker Kellogg Co., which began selling its receivables two years ago, recently expanded its IOU financing arrangements. The company says it may borrow as much as $1 billion against its receivables, up from $350 million two years ago. Mondelez International and Kraft Heinz Co., which have both used similar financing arrangements for years, have also recently increased their sales of IOUs. Mondelez had borrowed $804 million against its unpaid receivables at the end of last year, up from $211 million at the end of 2014.

Changing consumer tastes — including a preference for healthier foods and organic household products — and internet commerce have been denting the brands of Big Food. Warren Buffett, whose Berkshire Hathaway owns slightly more than a quarter of the shares of Kraft Heinz, said recently that as brands weaken, retailers were gaining the upper hand in negotiations with food companies. That could be leading to the longer payment times and the need for the financing.

But more liberal use of receivable financing has also opened food companies up to criticism. Money manager Prescience Point Capital released a report on Kellogg in late April that accused the cereal maker of using “accounting gimmicks” to mask its growing problems. Prescience, which is short Kellogg and says its shares can fall by more than a third, cited receivable sales as one of those gimmicks. Prescience says Kellogg has tapped the financing deals to a greater extent than its rivals.

Kellogg’s operations, for instance, generated $228 million in cash flow in the first quarter, compared with a negative $34 million in the quarter a year earlier. But the improvement seems to come entirely from the receivable sales. What’s more, without the sales, Kellogg’s accounts receivables would have risen about 60 percent in the past two years. Its sales, on the other hand, were basically flat in the same period. Analysts typically view a rise in accounts receivables that outpaces sales as a red flag. Prescience says Kellogg has used longer payment schedules to entice customers to buy more upfront, potentially setting the company up for a sales shortfall down the road. In all, Kellogg has cashed in more than a third of its receivables, up from 3 percent two years ago. Kellogg did not return a call for comment.

Accounting expert Robert Willens cautions that a large jump in receivables is not necessarily a sign of trouble. He says that retailers taking longer to pay could be a greater reflection of their problems and not those of Kellogg or the other food companies. Either way, food companies may soon reach the limit of how much they can feast on IOUs, before their actual operations become malnourished.

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

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