Much ado was made about Kraft Heinz Co.’s (KHC, Financial) recent dismal results that included a dividend cut as well as a massive and unprecedented writedown of its once inviolable Oscar Mayer and Kraft trademark brands to the tune of $15.4 billion dollars. The steep downward trajectory of the lines in the chart below paints a bleak picture. However, Kraft Heinz isn’t the only company in distress; the entire packaged food products sector has been experiencing turmoil.
Given the disappointing results of some stocks in the consumer staples sector, prices have dropped to the point where they could be considered attractive by enterprising investors.
The price of a basket of nine major U.S. food product companies tracked by FactSet has dropped 30% over the past two years. During the heady days of the bull market, zero-interest rate investment environment, this sector was selling at 20 times project earnings, which represented a hefty 30% premium to the broader market. These same nine companies today are trading at 14.8 times earnings — a 10% discount. An additional factor that makes this group attractive is that while the Federal Reserve has put rate increases on hold, dividend hunters will be coming out of their safe harbors. The FactSet food group pays out a handsome 4%.
The group’s current attractive valuations, however, must be assessed against the future environment in which today's food product companies will operate and the increasing fragmentation of brands and specialty items. Although the large food companies are not going to disappear by virtue of their enormous capacity and distribution capabilities, changing consumer habits will continue to erode these companies once impregnable market shares.
Consider the following foreboding statistic. The combined market share of the largest packaged food companies decreased to 42.4% in 2018 from 46.8% in 2011, according to Credit Suisse analyst Robert Moskow. Niche and private-label brands will continue to erode the larger companies dominant market share. Although many small startup companies may come and go, the preference trend of consumers for specialty packaged foods appears to be irreversible. The recent wild price swings in stocks that for years provided refuge in times of economic stress is testament to the transformation of the consumer food product market.
The single most telling indication of the change in status of stocks once considered “defensive” is the mind-numbing writedown of what was, for years, a staple, ubiquitous household brand, synonymous with quality and recognized as such by consumers.
It is no mystery the dissipation and devaluation of the intellectual property value of the trademark brand occurred in tandem with the rise and reach of social media and other nontraditional medium through which consumers are exposed to various food brands. Oscar Mayer soon will be residing in the same retirement home as Don Draper.
For decades, prior to visiting their local grocers, consumers had already been inundated and preprogrammed with the food product brand name by hearing it a million times during the week on television and once in the store, behaved liked automatons, unaware they were subconsciously heading, robotic-like right to the aisle where the Oscar Mayer wieners lay. Traditional advertising today, long the staple marketing medium for the large food companies, can no longer command the undivided attention of consumers.
Because today’s advertising environment is so fragmented and disjointed, due to the prevalence of social media, today’s consumers have multiple food choices available. Consumers can instantly read reviews of products online, bypassing or rendering television advertising irrelevant as reviews from fellow consumers are more credible and easily accessible, supplanting traditional Madison Avenue pitches.
Some analysts blame Kraft’s poor results on a cut in research and development spending. Aaron Back of the Wall Street Journal noted recently that the company spent $93 million on research and development in 2017, compared with a combined $242 million that Heinz and Kraft Foods spent in their last year as independent corporations.
However, reduction in R&D spending on new products is merely a symptom. The white coats in Kraft Heinz’s food laboratories can mix and match ketchup with mayo and other condiments for endless combinations to no avail. The real cause for the demise of some of theses companies is due to a profound disruption in the entire food product landscape that is shifting beneath their feet.
Defensive staple investors should heed the coming transformation and make appropriate adjustments to their portfolios accordingly.
Disclosure: I have no positions in any of the securities referenced in this article.
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