Pet Food Company Fighting to Survive

Pet Food Company Fighting to Survive

Menu Foods Income Fund's unfolding troubles over the tainted pet food scandal have begun to resemble a car crash in slow motion. The initial impact last March, with the recall of 60 million cans and pouches of pet food, was explosive. The company instantly became the focus of worldwide attention and pet owners' wrath after using tainted wheat gluten from China in its pet food. But the real damage has come over the past several months, with the slow crumpling of a once finely tuned machine that dominated the pet food industry. What remains to be seen is whether the accident will be fatal, or if something can be salvaged out of the wreckage.

Mississauga, Ont.'s Menu Foods is now facing big losses, potential lawsuits, and worst of all, lost clients, including its largest. Procter & Gamble, which accounted for over 20 per cent of Menu's business, said last week that it would no longer buy canned food from Menu Foods. The company, which sells under the brands Iams and Eukanuba, had already said in June that it would stop buying wet food sold in pouches from the company. The announcement came on the heels of news that Mars Inc., which sells pet food under brands like Nutro and Royal Canin, also plans to sever ties with Menu and will buy the company's production facility in South Dakota.

For Menu Foods, it all adds up to some bleak numbers. Its share price has taken three distinct hits since the recall - once in March, once in June, and another this month. Its shares, which once topped $7, are now trading at just over $2. Earlier this month, the company said its second quarter sales were down to $47.2 million, compared to $84.3 million in the same period last year - a 44 per cent plunge.

But worse than the cringe-inducing financial statements has been the blow to Menu Foods' all-important reputation. "What is most damaging to the company is its ability to do business in the future, not necessarily the cost of the recall itself," says Niraj Dawar, a marketing professor and brand management expert at the Richard Ivey School of Business. Massive recalls, when handled badly, have been known to ruin companies. In 1990, Perrier was dealt a major blow when it recalled over 200 million bottles of water after a lab found traces of benzene in the product. In the wake of the recall, the door was opened to competitor San Pellegrino and a weakened Perrier was eventually bought out by Nestle, says Dawar. "Menu Foods is in a critical situation," he says. In June, it went so far as to put in place a shareholders' rights plan to ward off the threat of a hostile takeover.

Announcing the end of the P&G agreement, Menu Foods CEO Paul Henderson called the tainting "a fraudulent act that victimized many pet food manufacturers, customers and consumers." But it appears many of Menu's clients are not willing to simply forgive and forget. Both P&G and Mars have used the recall as an opportunity to rein in an outsourcing problem, and shift some blame to Menu Foods in the process. Some other smaller companies that contract their production to Menu Foods could yet follow suit, says Aleem Israel, an analyst with Cormark Securities.

That is something Menu Foods can ill afford. The company has already lost an estimated 80 per cent of its contract business, in which it supplied other brand-name pet food makers, which represented about 45 per cent of its total volume.

But there is some good news. So far, Menu Foods' troubles haven't spread to the lucrative private label market (where stores like Wal-Mart and Loblaws sell Menu Foods' products under their in-house brands). Loblaws, for one, remains committed to Menu Foods. "We're still doing business with them and we're feeling confident and comfortable," says spokesperson Elizabeth Margles. "The private label customers and retailers realize that Menu wasn't at fault," says Israel. But the real ace up Menu Foods' sleeve may be the fact that even if such customers wanted to go someplace else, they wouldn't find a whole lot of options. Prior to the recall, Menu Foods controlled over 75 per cent of that market in Canada, and 50 per cent in the U.S.

In a conference call this month, the company said most private labels have cautiously resumed business with them. "We're not going to get into specific numbers, but it's the vast majority," said Henderson. Still, what happens longer term is a question mark.

It could be many more months before a clearer picture emerges, but analysts aren't counting out Menu Foods yet. The company survived financial troubles in 2005, and they could do the same this time around. But given the severity of the pet food crash, it seems the best Menu Foods can hope for is to emerge as a shadow of its former self.

Maclean's September 3, 2007