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In the U.S., several major consumer staples companies are implementing a strategy called zero-based budgeting to cut costs and increase margins.

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This all started with Warren Buffett’s 2013 purchase of Heinz alongside Brazilian company 3G, says Marc Scott, portfolio manager at American Century Investments in Kansas City, Missouri. “The strategy behind choosing Heinz was to cut costs, spend less on advertising [and] hold the line a little bit more on pricing given most people recognize the Heinz Ketchup brand.”

Scott, who co-manages the Renaissance U.S. Equity Growth Fund, adds Buffett and 3G were able to increase Heinz’ margins from 18% to 26% in two years by implementing zero-based budgeting.

Read: Why the Heinz-Kraft deal is good for investors

Scott explains that rather than budgeting for the year ahead by adjusting and adding onto costs from the year prior, this new strategy involves “justify[ing] every single expense and every single line item on the income statement. Maybe your company spent $10 million on travel last year. You’re not going to automatically say $10 million plus 5%; you’re going to plug in ‘zero’ and you have to justify the entire $10 million spend.”

After seeing margins increase 8% with the new strategy, Heinz and Kraft merged in 2015 and took the same approach, says Scott. “They’re cutting costs, cutting advertising, holding the line on price [and] improving their manufacturing footprint; things of that nature.”

Read: Why to watch a company’s adjusted earnings

And now, other companies in the food industry are following suit. This includes Mondelez International, which owns brands such as Cadbury, Oreo and Trident, notes Scott. “Their target is to take their margins from 12% to 15% or 16% in a couple of years. So not the same degree of improvement we saw at Kraft-Heinz, but [I think] they’re being conservative on that improvement. And they’re doing the same thing: zero-based budgeting.”

Read: Expect more M&A in Canadian market, says EY

Mondelez also plans to cut costs by upgrading plants. “They have some plants in the U.S. that were built in the 1970s” that are inefficient. So, “they’re taking some of that manufacturing capacity down to places like Mexico where they’re seeing upwards of 10% improvement in margins.”

And, those savings are being reinvested into the company, says Scott. “[Mondelez] is spending a little bit more on advertising and [is] also rolling out their brands in emerging markets where they have no presence.” For example, in the last couple years, Oreos were introduced in China and Russia. “[Mondelez International is] rolling [its] brands out across the globe and that should drive some nice top-line growth.”

Read: A four-factor strategy for stable returns

Kellogg’s is another name Scott says is joining the zero-based budgeting bandwagon this year. “They’re developing the same strategy of cutting costs, and they’re taking their cost savings and reinvesting to improve the quality of their brands. They’re putting better ingredients in their products to drive some premium-ization.”

A look at U.S. wage growth

“We’re seeing early indications of wage growth in the U.S.,” says Scott. If you look at companies such as Walmart, Target and McDonald’s, “they’re all talking about increasing their minimum wage.”

Scott adds Walmart plans to increase its minimum wage to $10 an hour.

But even in combination with lower gas prices, a potential wage increase isn’t spurring U.S. consumer spending. “Early indications appear to be that the consumer is saving a little bit more money and paying a little bit more debt. We’ve seen small indications of a little bit of growth out of the consumer, but definitely not across the board.”

Read:

U.S. consumers craving luxury products

Would wage hike bolster U.S. consumers?

This year, choose equities over fixed income: report

Originally published on Advisor.ca

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