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When Earning Profit Becomes a Challenge, Brand Value Means a Lot to Food Companies

November 07, 2013 | About:
Victor Selva

Victor Selva

9 followers
The U.S. food markets sector is mature and competitive. The processed food industry is facing low growth rates and high energy costs (electricity and fuel), but there are opportunities still left for companies that make acquisitions, cost reduction programs or differentiation strategies. We expect volumes in the next year to look better than they have in the past year due to the modest signals of recovery in the U.S. economy.

Two Reasons to Be Long

Kraft Foods Group Inc. (KRFT) is one of the largest consumer packaged food and beverage companies in North America, based on 2012 net revenues of $18.3 billion.

Solid Brand Portfolio

The company´s business includes two brands with annual net revenues exceeding $1 billion each (Kraft cheeses, dinners and dressings and Oscar Mayer meats) plus 25 brands with annual net revenues of between $100 million and $1 billion each. The only risk that I can see here is that demand for some products (e.g. packaged meats and cheese) is elastic, which means that quantity demanded reacts more than proportionally to changes in prices.

Restructuring Efforts

The company approved a $650M restructuring plan related to its spin-off from Kraft Foods Inc. The plan is expected to include severance, asset disposals, other manufacturing-related one-time costs, and professional service fees. This plans aims to aggressively reduce costs and improve efficiencies in order to reach productivity gains. We think that cost reductions will be a profit key driver for the next years in the industry.

Valuation

In terms of valuation, the stock sells at a current P/E of x17.4, trading at a discount compared to an average of x19.7 for the industry. Analysts’ expectations imply a forward P/E of 17, trading at a discount to peers. To use another metric, its price-to-book ratio of 6.7 indicates a premium versus the industry average of 1.49x and the price-to-sales ratio of 1.8x is above the industry average of 0.85x.

A Leading Food Company

ConAgra Foods Inc. (CAG) is one of the largest U.S. food companies and operates through four segments: Consumer Foods, Commercial Foods, Ralcorp Food Group, and Ralcorp Frozen Bakery Products.

$5 Billion Bid

The company acquired Ralcorp Holdings, Inc. a leading producer of private-brand foods and food service products that are sold under individual labels. Private label cereal, pasta, crackers, jams and jellies, syrups and frozen waffles, are all products that ConAgra did not have an important presence. So with the acquisition, ConAgra will be the largest private label packaged food company in North America. We expect in the future the acquisition will generate cost synergies and boost sales because products in general are less expensive than substitute’s goods.

Strategic Ideas

The firm is looking to bolster a number of its brands with increased marketing support. Also, emerging markets are fast growing regions that enable the company to quickly expand. With products often less expensive than competing goods, ConAgra can increase their appeal to cost-conscious consumers.

Its P/E multiple on a trailing-12 month basis is 20.4 and the forward P/E multiple is 12.7. The current dividend yield is 3.07%, which is quite good to protect the purchasing power.

Finally, I always like to see of one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity.

Company ROE Compared to Industry Mean (=7.1)
Kraft 46 Above
ConAgra 14.7 Above


It is very important to understand this metric before investing in a high-growth company.

Final Comment

Due to changes in the lifestyle of North American countries and the interest in healthier eating, packed and processed foods experience an increasing demand. We expect the industry to boost its profit in the current year, especially those companies that could adapt to continuously changing consumer preferences. Executives in the food industry continue to focus on cost reduction and value differentiation. I believe that companies that will be successful in the long term will be those that follow those strategies.

In my point of view, the restructuring efforts make Kraft the most attractive choice. Also, Zacks downgraded the recommendation on ConAgra to Underperform from Neutral. Hedge fund gurus like Joel Greenblatt, Murray Stahl and John Keeley added Kraft stock to their portfolios and I would advise fundamental investors to consider adding this stock to theirs´ as well.

Disclosure: Victor Selva holds no position in any stocks mentioned.


Rating: 4.8/5 (8 votes)

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