Loading...
 

The Food Processing Industry is a mature sector that loosely tracks underlying demographic trends, such as population and income growth. Companies generate revenue from the sale of food and ingredients to a whole host of customers, ranging from supermarket chains and local bodegas to restaurants and other players further down the processing chain.

This sector is praised for its ability to deliver consistently positive investment returns. Indeed, over the past 20 years, Food Processing stocks have, on average, delivered high single-digit annual total returns (share-price appreciation and dividends), with much less volatility than the broader market indexes.

It is, therefore, of little surprise that food stocks are well suited to fairly conservative investors with low tolerances for share-price volatility. Defensive characteristics, including stable growth, ample interest coverage, and solid balance sheets, also establish these companies as "safe harbor" selections during major economic and stock market downturns.

Top-Line Drivers

Food, of course, is one of life's basic necessities. As such, underlying demand tends to be steady through prosperous and difficult economic times. That said, food companies benefit from population growth. Also, higher aggregate personal income affords people "richer" diets and those on the margin may rely less on homegrown staples.

Proactive efforts are arguably most critical for top-line growth. Companies endeavor to capture a greater share of household budgets through strong branding and the strategic positioning of their offerings. Trend-right products and re-formulations that are easy to prepare, portable, and healthful usually gain good traction. Expansion into new geographic markets is also a key growth driver. Cross-cultural expansion can prove difficult, though, given entrenched regional cuisine and tastes.

Cross Currents

Though food demand is reasonably predictable, there are certain cyclical undercurrents that present nimble investors the opportunity to strategically position their food industry exposure for above-average investment returns. In challenging economic times, for example, people tend to forego vacations and restaurant outings. Consequently, food companies with significant hospitality-sector exposure often experience a falloff in end-market demand and lagging share-price performance. Budget-constrained consumers might trade down within the food sector, be it from expensive national brands to cheaper private-labels or from pricey proteins, like steak and ground sirloin, to chicken and eggs.

Sub-Segments

Food companies fall into various sub-segments, and painting them all with one broad stroke can lead to surprising deviations from expected performance. Investors should be cognizant of where a producer resides within the commodity- "value added" spectrum. Poultry and other commodity-type producers have little individual influence over product pricing, and are susceptible to such vagaries as weather-related crop damage and cross-border trade sanctions. Commodity-like producers are also constrained by long harvest (in the case of grains) and life (livestock) cycles. Therefore, those companies tend to have difficulty quickly adjusting "production" capacity. These factors result in relatively high earnings and share-price volatility, as compared with the rest of the Food Processing Industry. Through innovation and branding, successful marketers of value-added goods face less direct competition and have more control over pricing. Accordingly, they enjoy stable returns.

Cost Considerations

Success also depends on the ability to control costs and leverage fixed/near-fixed expenses. Over its history, the industry has, at times, suffered margin pressure due to severe input cost inflation in the form of higher prices for ingredients and fuel (used to power processing plants and distribute goods to the retail trade). In periods of commodity-price deflation, however, the "stickiness" of retail price hikes supports profitability. When input costs spike, value-added producers, with their strong brands, are better positioned, and can pass along much of the higher expense to customers. Makers of private label brands have good cost leeway, given the absence of big marketing outlays.

Size matters for many of these companies. Distribution costs are often nearly fixed. As such, a larger portion of each incremental sales dollar tends to flow down to the bottom line. Processors with an expanding brand portfolio can quickly realize significant economies of scale. A wide portfolio of popularly selling brands also puts these companies in a stronger bargaining position, vis-a-vis major customers in the retail trade, which has increasingly invaded the grocery space. Small food processors, however, as potential takeover targets, may be the direct beneficiaries of industry consolidation.

Food Processing stocks are typically in vogue during recessions, when investors shun more-economically sensitive issues. That said, they are susceptible to sector rotation, when investors look to time the market bottom of cyclical issues. On balance, food industry exposure does serve most investors well, regardless of the economic backdrop. These generally stable franchises produce fairly consistent, if unspectacular, investment returns throughout the business cycle. Processors, the large names with strong brand portfolios, in particular, are suitable for somewhat conservative investors. But numerous sub-segments do enable more venturesome investors to strategically position their portfolios for outperformance. Commodity-type producers, for example, may appeal to savvy market timers. All in all, the Food Processing Industry has something to offer to nearly everybody.