Sunday, April 30

Week 304 - Bread and Milk

Situation: The top 3 grocery basket items are sugary soft drinks, milk, and bread (see Week 297). By USDA category, “sweetened beverages” represent 7.5% of grocery store sales, “milk” represents 3.7%, and “bread and crackers” represent 6.1%. Bread and milk are basic foodstuffs because of their nutritional value, meaning they are rich in energy (starches and sugars) and body-building proteins. Bread is made from high-gluten flour that comes from hard red or hard white wheat. Milk is perishable and has to be sourced from regional dairy herds. It has high protein content (both caseins and whey proteins). Milk proteins and gliadin (the gluten protein found in hard red and white wheat) contain all 9 of the “essential” amino acids that cannot be synthesized in the human body.

Mission: Find out which well-established companies in the Food & Beverage sub-industry process either dairy products or high-gluten flour to put milk or bread on your grocery store’s shelves. Focus on the companies that have over a billion dollars of stock market capital and own their own bakery or milk processing plant. 

Execution: There are 9 companies that meet our criteria (Table).

Administration: Three of those 9 companies derive the majority of their sales from groceries. Namely, Wal-Mart Stores (WMT), Costco Wholesale (COST) and Kroger (KR). Kroger has 17 milk processing plants and 9 bakeries. Wal-Mart’s first food production plant in the US will be a milk processing plant in Fort Wayne, Indiana, scheduled to open this fall. Otherwise, Wal-Mart sources milk from regional dairies. Many of Costco’s warehouse stores have a bakery nearby. Wal-Mart sources its bread from Grupo Bimbo USA. Grupo Bimbo is a Mexican company that sells more bread than any other company in the world.

The only bakery that delivers bread throughout the US is Flowers Foods (FLO). The only milk processor that has nationwide processing plants is Dean Foods (DF).

Both Bunge (BG) and Archer Daniels Midland (ADM) process wheat into high-gluten flour for wholesale delivery nationwide. General Mills (GIS) sells the leading brand of flour on grocery store shelves (Gold Label), particularly the high-gluten flour that is required for making bread. 

Coca-Cola (KO) co-produces a high-nutrition “ultra-filtered” milk called “Fairlife” for distribution nationwide. Fairlife costs approximately twice as much per ounce as standard milk. In return, you get twice as much protein and half as much sugar per ounce.

Bottom Line: Basic foodstuffs like bread and milk are typically produced locally, by limited liability companies (LLCs). Production processes are standardized and widespread, so local producers have the advantages of low shipping costs and guaranteed freshness. To compete, a for-profit national corporation would have to introduce special features in its milk or bread products, and achieve economies of scale. That would mean owning several large processing plants and a dedicated fleet of trucks. In return for marketing a product with razor-thin profit margins, the company is distributing an “essential good”, which means that price changes would have a minimal impact on per-unit sales. Such products are said to be inelastic. Kroger (KR) is the only company that produces both milk and bread for nationwide distribution.

We have calculated the Net Present Value (NPV) of owning a stock for the next 10 yrs then selling it (see Column Y in the Table). NPV aggregates the income streams from the current dividend (Column G), continuation of the dividend growth rate that has been established over the past 3 yrs (Column H), and continuation of the price growth rate that has been established over the past 20 yrs (Column K). A positive number suggests a total return of 9%/yr or more. Per NPV, your leading choices are Flowers Foods (FLO) and Costco Wholesale (COST). 

Risk Rating: 6 (where 10-Yr Treasuries = 1, S&P 500 Index = 5, gold bullion = 10)

Full Disclosure: I dollar-average into KO, and also own shares of COST and WMT.

NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 17 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K ( Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 29 in the Table. The ETF for that index is MDY at Line 16. For bonds, Discount Rate = Interest Rate.

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