Moving Up The Food Chain
biz.yahoo.com
There's nothing sexy about a Slim Jim. And no one's lining up at midnight to buy the newest box of Wheaties.
But even in the current slowdown, Americans are still buying prepared-food products. That's helping food manufacturers bake in some modest revenue and earnings growth.
These food companies -- part of a broader consumer-staples sector -- are considered recession-resistant. They tend to deliver modest-to-decent results, and in tough times investors flock to them for their dividends and share buy-backs.
Steven Ralston, a senior analyst at Zacks Investment Research who covers consumer staples, calls food companies "moneymaking machines."
But those machines require constant tinkering to run smoothly.
Food companies face rising energy prices and a fiercely competitive environment. Worse still, the basic ingredients in their foods have become much more expensive in the last few years.
"Lots of turbulence," is how Nestle's (Other OTC:NSRGY.PK - News) incoming chief executive, Paul Bulcke, described the state of the industry at a recent investors conference.
But companies have successfully raised prices and cut costs, and Americans have kept eating.
Luckily for some of the global giants such as Nestle and PepsiCo (NYSE:PEP - News), consumers elsewhere are also eating more. Both companies posted stronger gains in developing markets.
IBD's miscellaneous food preparation group, which includes 47 stocks, ranked No. 26 out of 197 industry groups. Three weeks ago, it ranked No. 35; three weeks before that, it ranked No. 67.
1. Business
The food, beverage and consumer packaged goods industry brings in more than $2 trillion in sales globally each year, the Grocery Manufacturers Association says.
IBD's ranking system parses out the soft drink and alcoholic beverages companies, as well as the dairy firms, confectioners, and meat, flour and grain producers.
What's left is a hodgepodge of food manufacturers, additive makers and specialty suppliers. The group's collective market value is $278 billion.
It's a fiercely competitive market. Supermarkets operate on razor-thin margins and demand the same from the manufacturers whose products line their shelves.
Customers' brand loyalty runs only so deep. Price spikes can send shoppers elsewhere. So the trick has been to raise costs gradually, while keeping costs in line.
That's been no easy task. Corn, cocoa, milk and other commodity prices have been rising fast. But at least everyone is in the same oven, according to Nestle's Bulcke.
His company has delivered 5.9% growth over the past 12 years, regardless of economic cycles. Nestle is targeting 5% to 6% growth going forward.
Sales growth in developing markets helped. But Nestle is also tinkering with the mix.
It's been ditching brands and packaging configurations that haven't resonated with consumers. It will cut more this year. Nestle was due to report first-quarter sales Monday.
Name of the game: Increase prices to cover the rising costs for basic ingredients, but not enough for customers to notice much.
Companies also need to trim their own costs and keep their product lineup fresh -- in every sense of the word.
2. Markets
Who's buying? It's us, but not always directly.
Seneca Foods (NasdaqGM:SENEB - News) sells much of its canned vegetables and other foods to prisons and other institutions. Overhill Farms (AMEX:OFI - News) sells packaged meals to airlines and Jenny Craig diet programs.
Wal-Mart (NYSE:WMT - News), the nation's largest grocer, is the single biggest buyer for several of the companies.
But it's consumers around the world that ultimately choose PepsiCo's Doritos snacks, or General Mills' (NYSE:GIS - News) Hamburger Helper.
These companies say they haven't seen mass defections from their brands yet.
While established economies such as the U.S. and Europe represent the biggest markets, most new growth is coming from fast-growing economies in China, Russia, India and Brazil.
3. Climate
There's no easy way to put it. The pressure is on.
Growing crops, manufacturing food products and shipping those products to market is an energy-intensive process. Energy costs are way up, and so are prices for packaging and other raw materials.
Foul weather has disrupted crops in some regions. Globally, wheat demand is outpacing supply. A long drought in Australia is crimping dairy exports.
In the U.S., the Agriculture Department says farmers are planting 8% less corn this year.
The popularity and demand for ethanol, largely corn-based in the U.S., is diverting much of that remaining commodity out of America's pantries.
Since corn is a main ingredient in feed for chickens and cattle, less corn means higher dairy, beef and poultry costs.
Higher corn prices also encourage farmers to devote more acreage to corn, reducing the long-term supply of other crops.
"Commodities have been increasing at levels that we've never seen before," C.J. Fraleigh, chief operating officer for North America at Sara Lee (NYSE:SLE - News), told industry analysts during a recent conference.
Sara Lee, which makes a range of products from breakfast sausages to desert cakes, said its own commodity costs were up $100 million in 2007. The company expects those costs to rise another $200 million this year.
The main culprit: ethanol. The push for ethanol-based fuel is creating higher food prices -- with little environmental benefit, critics say.
"The federal government's food-to-fuel mandates are diverting one-fourth of America's corn supply from kitchen tables to fuel tanks," said Scott Faber, vice president of the Grocery Manufacturers Association, an industry trade group. "The result is corn selling for $6 a bushel, an all-time high."
Food producers are hoping they can pass off the additional costs.
Sara Lee's Fraleigh says that the company expects its price increases to fully offset $300 million in new costs by the end of the year.
Cincinnati-based Chiquita Brands (NYSE:CQB - News) managed a banana price hike of 10% in North America and 21% in Europe in the first two months of this year as droughts, bad weather and other production problems crimped supply.
Volume was flat in the U.S. and down in Europe.
Despite some gains in its bagged-salad business, the company just broke even in the fourth quarter, excluding special charges.
The banana company did get a boost earlier this month when the World Trade Organization ruled against some European Union tariffs on bananas. Chiquita and South American producers had argued that Europe unfairly favored imports from former colonies in Africa and the Caribbean.
Smaller players, including Omega Protein (NYSE:OME - News), even managed to pass a slight price increase for its fish oils used in dietary supplements and its animal feed products.
The Houston-based company posted $157 million in sales in 2007, up 12% from its 2006 showing. Analysts expect another double-digit gain this year.
Flavor and fragrance maker Sensient Technologies (NYSE:SXT - News) credited its 8% boost in sales last year to price and volume increases as well as favorable currency exchanges.
4. Technology
The diesel engine isn't glamorous. But it's still the industry's workhorse.
Diesel tractors and farm machinery harvest the crops. Diesel trucks transport those goods to the giant food-processing plants and factories.
It's the diesel engine that's likely to haul that finished Sara Lee snack cake, Del Monte can of pears or Slim Jim to the supermarket.
Diesel fuel is expensive these days, so some companies are turning to more efficient vehicles.
There's also a lot of chemistry involved in the process of finding flavors, extracting proteins and working with preservatives to increase shelf lives.
Advances in any of these areas can give a company that crucial edge in the cutthroat market.
5. Outlook
The consumer price index for all food climbed 4% in 2007. The government forecasts a rise anywhere from 3.5% to 4.5% for 2008. Consumers so far have accepted rising grocery prices, analysts say.
While some consumers have vowed to dine out less or buy more store brands and generics, big-name manufacturers say they're not seeing massive defections.
Meanwhile, the number of consumers continues to grow.
Demographers expect the mature markets of North America and Europe to add about 200 million or so people between 2000 and 2050.
The developing world -- particularly Asia and Latin America -- could add 3.3 billion people in the same span along with fast-growing economies that give its citizens more spending power.
Upside: Growing populations and increasing wealth in the developing world bode well for firms with the right products and reach. So far, consumers in the U.S. haven't balked at higher prices.
Risks: There's no getting around rising costs.
Crops and energy cost more, and there's only so many price increases that consumers will bear. |
