Sunday, April 19

Week 198 - Food Processors

Situation: Food and agriculture stocks should be good investments. Food is an “essential good” and its availability is tied as closely to weather trends as to macroeconomic trends. (Farmland is the most rewarding asset to own on a risk-adjusted basis.) But the companies that actually process grain and meat for sale in grocery stores don’t do so well. Why? Because food processing, to be efficient, has to be done at large regional plants. That means packaged food has to be transported over long distances, often in refrigerated vehicles, which is expensive. Locally-owned companies and farmer’s cooperatives have the competitive advantage (see Week 177 and Week 178). But some publicly-traded companies have been able to centralize food processing by purchasing raw food commodities in large volumes, then using refrigerated railcars and ships to distribute the packaged food over long distances. Another strategy has been to produce organic foods, coffee, chocolate, specialty beverages and other upscale food offerings that have high pricing power in combination with low price elasticity. People will pay top dollar for their favorite treat, even if it comes from a country they’ve never heard of and couldn’t find on a map. Ivory Coast for example, where cocoa for half the world’s chocolate is grown.

There are 17 Food Processors in the Barron’s 500 List but two are missing from the Table because their company’s bonds are “junk-rated” (S&P bond rating below BBB-). Six of the 15 are Dividend Achievers (see Column P in the Table), and 3 more Dividend Achievers have been added that don’t have revenues high enough to be included in the Barron’s 500 List. We’ve also included the biggest Food Processor on the planet: Nestle (NSRGY), based in Switzerland. We’ve also included two additional international companies: Unilever plc (UL) and Danone (DANOY). You’ll note that 9 of these 21 companies were highlighted in Week 191’s list of 14 “Key Food and Agriculture Companies.” That list focused on the most valued players along the entire food chain. This week’s list drills down on the food processing sector, i.e., companies take over after crops and meat animals leave the farm.    

To evaluate the risk of owning stocks in any of the 21 companies listed in the Table, look at 4 metrics: losses during the 18-month Lehman Panic (Column D in the Table); 5-yr Beta (Column I); S&P bond rating (Column N); and the S&P stock rating (Column O), where the lower letter indicates risk, and H is high, M is medium, L is low. Be aware that stocks of defensive companies like Food Processors are ~10% overpriced (see Column J in the Table). However, operating earnings relative to enterprise value (Column K in the Table) are still within the normal range. Valuation shouldn’t pose a problem for the long-term investor who picks stocks of quality companies and practices dollar-cost averaging

This week’s blog refreshes our previous blog on the same subject (see Week 161), removing two companies that carry a poor credit rating and one that was bought out by another company on the list. Those 3 losses have been replaced by 4 new companies to the list: Archer-Daniels-Midland (ADM), which is involved in food production and the distribution of food commodities but also does some food processing; Seaboard (SEB), which is involved in hog production and pork processing; Ingredion (INGR), formerly known as Corn Products International; and Unilever plc (UL).

Bottom Line: You need to pay attention to Food Processors when planning for retirement. Foods are “essential goods” that have inelastic prices. In other words, if raw commodities (wheat, rice, soybeans, corn, pork bellies, chicken wings, packaged beef, etc.) rise in cost, the company passes those costs on to the consumer without fear that sales will drop. The market for food is not saturated, as many investors think. Instead, it grows reliably: Every year, ~10 million people in East Asia move up from poverty and can finally afford an adequate protein intake (60+ grams a day). Another benefit is that the value chain for food depends on the weather cycle as much as the economic cycle. By owning stock in food companies, you are holding, in part, a non-correlated asset-, i.e., one that is not tied closely to the economic cycle. Such assets tend to be relatively unaffected by recessions. 

Risk Rating: 4

Full Disclosure: I own shares of HRL, GIS, MKC, PEP, and KO.

NOTE: red highlights in the Table denote underperformance relative to our key benchmark, the Vanguard Balanced Index Fund (VBINX); metrics in the Table are current as of the Sunday of publication.

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