Not All Food Stocks Are Created Equal

by Will Ashworth | November 26, 2011 8:00 am

How do you fight food inflation? The traditional answer for many investors is to own defensive stocks like food companies, whose products will always be in demand no matter the economic cycle. That strategy used to be pretty solid.

The difficulty today is that these same companies face input costs that are rising faster than historical norms, in many instances forcing them to increase prices substantially. And not every company will successfully pass on these costs to their customers[1]. As a result, investors need to reevaluate the traditional strategies used to fight food inflation. Let’s explore the potential ways investors can profit from the inevitable.

It used to be that you couldn’t go wrong owning a cereal manufacturer like Kellogg (NYSE:K[2]) or General Mills (NYSE:GIS[3]). It’s not quite that simple these days. General Mills announced first-quarter results Sept. 21 that were anything but special. While sales grew 9% in the quarter, operating profit dropped by 3% year-over-year, thanks to significantly higher input costs — this after General Mills raised prices 7% in its largest segment, U.S. retail. As expected, higher prices resulted in lower volume.

Now, think back to 2008 when the recession hit. Many consumers switched to private-label grocery-store brands. Should cereal manufacturers continue to hike prices, watch for a return to private-label brands. The chief beneficiary would be Ralcorp Holdings (NYSE:RAH[4]), one of the largest producers of private-label food[5] in the country. Ralcorp also happens to own Post Holdings, the maker of Post-branded cereals that will be spun off later this year.

But forget cereal for a moment. Let’s think about other food- and beverage-related companies. Since J.M. Smucker (NYSE:SJM[6]) bought Folgers from Procter & Gamble (NYSE:PG[7]) in 2008, it’s become just as well-known for its coffee as its jellies and jams. How is it handling rising food prices? Immediately, it seems not so well.

Smucker’s second-quarter net income fell 15%[8] large part because of a 30% increase in commodity costs. To counter these increases, SJM too has raised prices, in some cases as high as 30%. Most of Smucker’s necessary price hikes already have been implemented, and it appears by the time they’re fully imposed by next April, commodity costs likely will have eased.

Still, Smucker’s price hikes resulted in an 18% increase in quarterly revenue, offset by a volume decrease of 1%. So in the long term, Smucker appears to be doing a reasonable job dealing with rising costs. Since acquiring Folgers, its stock has been on a tear, up 50% — better than any of the companies mentioned above. Who knew it was coffee — not cereal — we couldn’t live without?

By now, most investors are aware that Kraft (NYSE:KFT[9]) is splitting in two. Kraft feels shareholders will benefit from separating its U.S. grocery business from its international snack business, which includes Cadbury. In September, I chronicled the reasons KFT shareholders shouldn’t wait for the post-spinoff benefits[10] to kick in. Since then, Kraft has reported strong earnings despite $1.7 billion in commodity cost increases year-to-date.

Kraft’s customers aren’t balking at price increases that will continue through the first half of 2012. New products and more effective advertising are two reasons Kraft has been able to keep upping the ante. Of all the big food companies, Kraft is doing the best job dealing with volatile prices.

Possible Alternatives

Of course, you can find other ways besides traditional food businesses to take advantage of the food production pipeline. For instance, take a look at wheat. While gluten-free products are popping up in grocery stores — which is good for companies like Smart Balance (NASDAQ:SMBL[11]) — most diets still include wheat. As the global demand for wheat — and other agricultural foods — becomes increasingly greater, fertilizers are increasingly necessary to help speed the growing process. Two companies that stand to benefit from increasing crop demand are agricultural biotech company Monsanto (NYSE:MON[12]) and fertilizer specialist CF Industries (NYSE:CF[13]). Of the two, CF Industries is more likely to benefit[14] from the growing global requirement for food.

Of course, before wheat comes out of the field, it has to be harvested. That’s where John Deere & Co. (NYSE:DE[15]) comes into play. The maker of the iconic green-and-yellow farm machines also is facing higher input costs, but it’s having no problem increasing revenue.  Deere announced fourth-quarter earnings Wednesday, and they were good, rising 46% year-over-year. Its revenues increased 20% to $8.61 billion, the fifth consecutive quarter with double-digit growth. Earnings for all of 2011 came in at $6.63 a share, and the company expects earnings of $7.73 a share in October 2012. Deere and CF Industries are both strong food-related stocks. 

Last, in what might seem like an odd choice when faced with rising prices, is restaurant stocks. While prices of at-home food rose 6.2% in September from the previous year, food away from home rose a more modest 2.6%. Because grocery stores are raising their prices so quickly, restaurants are following suit. Panera Bread (NASDAQ:PNRA[16]) has increased its prices 2.5% year-to-date, and Chipotle Mexican Grill (NYSE:CMG[17]) raised prices 3.5% in the third quarter alone. Like Starbucks (NASDAQ:SBUX[18]), these are two companies that likely will get away with price hikes. If you plan on investing this way, limit your choices to the very best, whether it be quick service, fast casual or casual dining.

Bottom Line

Food inflation isn’t going away. Especially when you consider the demand pressures of a global population with seemingly out-of-control growth. While food companies are easy targets when seeking investments that take advantage of this reality, they’re not necessarily the best investments. Take your time and broaden your horizons, and you just might find something better than General Mills or Smucker.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned stocks.

  1. pass on these costs to their customers:
  2. K:
  3. GIS:
  4. RAH:
  5. one of the largest producers of private-label food:
  6. SJM:
  7. PG:
  8. fell 15%:
  9. KFT:
  10. shouldn’t wait for the post-spinoff benefits:
  11. SMBL:
  12. MON:
  13. CF:
  14. is more likely to benefit:
  15. DE:
  16. PNRA:
  17. CMG:
  18. SBUX:

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