THE humble sausage came in for a drubbing this year when Richard Hammond fronted a BBC1 programme called Should I Worry About Sausages? The programme found evidence to suggest that you should, especially if you have a taste for street catering or economy bangers.
Among other things, Hammond — one of Jeremy Clarkson’s two sidekicks in the BBC’s Top Gear — revealed that the average sausage served in schools and hospitals contains 25 per cent fat and a gram of salt. Sausages served in the BBC canteen were found to contain 52 per cent water.
Such media coverage leaves Graeme Alexander, chief executive of Moodiesburn-based sausage-skin makers Devro, unfazed. The company has carved out a dominant 55 per cent to 60 per cent share of the global market for edible collagen casings, whose main ingredient — collagen — is derived from the hides of cattle.
Alexander says: “These sorts of programmes have been coming out ever since I joined Devro back in 1977. There was a huge one in 1985. It’s sensational journalism but it never seems to make a significant impact on the market.
“The bulk of the sausages that I’ve had view of are well put together and bring good nutritional benefits when eaten as part of a balanced meal, and in appropriate quantities. I’m no nutritional expert but everybody needs some fat in their diet.”
“Sausages have been around since Adam was a boy and I don’t think they’re going to disappear tomorrow; in fact the growth is still there.”
But negative publicity over health concerns has impacted on Devro’s financial performance in the past year, after a BSE scare in Washington State increased the cost of sourcing cattle hides in the Americas.
On top of that, the company suffered from bad debts of £650,000 when two of its UK customers went bust.
These two one-offs have contributed to flat profits this year, with profits for the year to December 31, 2004 set to be in the region of £18m, mirroring the same period last year.
Overall, Devro itself has good reason to be optimistic.
The company, which had a turnover of £146m and made pre-tax profits of £18m in the year to December 31, 2003, has seen its shares rise from a low point of 38p in 2001 to 121p last week. Had it not been for the negative impact of the BSE scare and the bad debts, analysts believe 2004 profits would have been up 13 per cent this year.
Prospects look bright for 2005, with the worldwide market growing at 4 per cent to 5 per cent per annum. There is even faster growth in eastern Europe, where Devro has a factory in the Czech Republic, and in America. The consensus forecast for pre-tax profit in 2005 is £19.2m.
In broad terms the company is benefiting from a shift in the way sausages are made. Sausages were traditionally encased in animal gut, and indeed 70 per cent of the world’s sausages are still made like this.
But the growing requirement for more efficient manufacturing means that collagen casings are becoming more widely used by the industry, particularly in the developed world.
The biggest growth opportunities for Devro are in emerging markets, such as Eastern Europe, China, Russia and Latin America, where local food producers are coming round to the virtues of using collagen.
Being more malleable and smoother than traditional animal gut, the material is better suited to modern sausage-making machines, and can lead to dramatic cost efficiencies in production.
David Marshall, analyst at Bell Lawrie White, says: “Devro’s market dominance should permit it to extract higher prices from customers and increase its profitability in coming years.”
Today the company is seen by analysts as being well-placed to benefit from its focus on collagen sausage casing, particularly because it is able to offer a wider range of sizes and specifications than its rivals. And analysts predict further market growth as a result of the transition in the way sausages are manufactured.
Nicola Mallard at house brokers Investec Securities, says: “Devro stands apart from most of its food industry peers in that it is not encountering margin pressure from retailers, nor facing the threat of losing own label contracts.
“Fundamentally the business remains strong, Volume growth of 7 per cent stands comfortably above the group’s long-term average of 2.5 per cent-3 per cent. Pricing is also stable in most regions.”
The firm was bought out from J&J by private equity backers led by Royal Bank of Scotland subsidiary Charterhouse in 1991. It floated on the London Stock Exchange in 1993.
Devro already has plants in Scotland, the Czech Republic, Australia and USA, which together are capable of churning out two million kilometres of collagen sausage casings per year.
The firm has only three main rivals in what is a today a highly concentrated global market. Spain-based Viscofan has a 22 per cent global market share. Japanese-owned rivals Nippi and Nitta each have market shares of 11 per cent-12 per cent.
But surely Devro is vulnerable as a result of its dependence on a single global market?
Alexander denies this. “In reality there are a lot of local markets, which together make up the global market. There is not one global market. It’s not as if what you’re selling into the US you can also sell into Austria — they’re two different products. And you don’t get third party arbitrage across borders. Prices tend to be different.
“In reality there are a variety of markets with customers that are different the world over. The fragmented nature of the market gives you a lot of protection.”
But Alexander doubts whether competition authorities would allow Devro to expand its business any further by acquisition.
“We have somewhere between a 55 per cent and a 60 per cent market share. Our ability to make an acquisition would be severely restricted by the regulatory authorities. We might be able to think about one of the smaller more regional players. There’s not any need [for us] to make an acquisition.”
Instead the company is diversifying into markets such as skincare and healthcare. It is spending around £4m a year on research and development.
Alexander is keen not to over-hype such activities even though the company is showing early signs of aggressively exploiting such opportunities.
It is already supplying Boots and J Sainsbury with breath freshener products, and another large retailer is showing interest as well.
There is also the prospect that the delivery system developed by Devro for its breath fresheners could be employed to administer over-the-counter pharmaceuticals. However, these products are still at an early stage.
In June 2004 Devro entered a R&D arrangement with Irish pharmaceutical company Alltracel. This is introducing “stop bleeding blotters” designed primarily for shaving cuts which are already available in Boots under both the retailer’s own brand and under Alltracel’s Sealon brand.
Alexander explains: “We’re looking at this as a thin film delivery system. That’s one product that this film could carry, but there are all sorts of possibilities.”
A small pilot plant has already been set up for such diversification plans in Hamilton, Lanarkshire, and analysts expect these activities will reach break even in 2005, and make a more significant contribution in 2006.
Alexander says: “The focus is on keeping the core business cash generative and using that core business — while still moving forward profitably — to fund the development of biomedical and cosmetic and thin film technology.”
CATCH UP
DEVRO, formerly Johnson & Johnson’s development and research organisation, was floated on the London Stock Exchange in 1993. The business took a hit in 2000-01 when global overcapacity and plunging prices hit the cellulose market. The company disposed of its cellulose businesses and focused on edible collagen sausage skins. Today it has around 55% of the global market.
This article was published in the Sunday Herald on 12 December 2004