Navigating the Food Crisis: Go Generic

In an earlier dissection of rapidly rising food prices, we clarified what sorts of food companies were poised to feel the pinch, and which ones weren’t.

See, contrary to popular belief, not every food-based commodity is soaring. Corn and wheat are certainly through the roof right now, causing investors to make across-the-board generalizations about food prices. But, not all of those generalizations are accurate — cocoa, sugar, and coffee are still relatively cheap.

On the flip side, even if only a certain kind of food is more expensive than usual right now, higher fuel prices are forcing most food producers to pass along those elevated shipping costs to customers, and broad protectionist measures are crimping the overall supply of food stocks … whether those measures are necessary or not.

Point being, trips to the grocery store are generally costing more than they were a couple of months ago, and consumers are going to have to figure out a way to offset bigger grocery bills.

There’s opportunity in that undertow.

Numbers Don’t Lie

In the not-so-distant past, store-branded goods and generic foods only made up about 15.2% of a grocery store’s sales. Now that figure is a surprisingly strong 17.4%, and rising. In terms of volumes or servings, 30% of the food the average American puts in his or her mouth is a store-brand good, versus only 20% in 2003.

The grocers love selling them, too. Though these generic products don’t command the same kind of premium pricing that name brands do, higher margins on store brands more than make up for the typically 27% lower selling prices. Broadly speaking, margins on name-brand foods and good average around 30%, versus 40% on white-label items.

The key to their increase in popularity has a lot to do with the fact that those so-called white-label products no longer come in those oddly institutional black and white packages, and they’re no longer treated like second-rate products. Their packaging looks — and this is no accident — like the packaging of the name-brand items those goods are competing with, and in many cases the quality of store-brand goods is quite high.

How adept have food retailers gotten at selling these in-house brands? So good, you might be using them and not even noticing it.

Take Archer Farms, for instance. Ever noticed you don’t see that brand of oats, nuts and other food items anywhere else but Target (NYSE:TGT)? That’s because it’s a Target brand. Great Value? That’s a Wal-Mart (NYSE:WMT) line of products. Fans of Kirkland Signature might want to know that’s a Costco (NASDAQ:COST) product in a relatively fancy package.

It all begs the question: If generics are ousting the name brands as the product of choice, who’s making the store brands?

Picks of the Litter

Which generic food companies are best positioned to take advantage of the continued migration to store brands? There is a handful to choose from, but three stick out as clear winners of this mega-trend:

If you’ve eaten Kroger (NYSE:KR) raisin bran, you’ve actually eaten a Ralcorp Holdings (NYSE:RAH) product. In fact, if you’ve eaten any store-brand cereal, odds are Ralcorp made it. The company is possibly the biggest name in white-label food products, and is the parent company of subsidiaries Ralston, American Italian Pasta, Bremner Food Group (cookies and crackers), and Carriage House Companies (condiments).

While the company spun off its Post (NYSE:POST) cereal division last quarter, it has been acquiring smaller companies in the meantime in an effort to beef up its core private-label business. Smart move. In the generic food game, economic efficiency is better achieved through size and the elimination of redundancy, as is evidenced by last quarter’s per-share income growing from 51 cents to 60 cents.

While Ralcorp might be the big dog on the white-label block, TreeHouse Foods (NYSE:THS) is a compelling possibility, too. The company’s sales as well as profits have been up every year since 2007.

On the flip side, the stock has been clobbered during the past six weeks, and last week in particular after waning soup sales led the company to cut its 2012 earnings outlook, and even close a couple of its soup plants. The drubbing appears to be winding down now, though, and what’s left behind is a company that’s stronger than the recent pullback would imply now that synergies from the Naturally Fresh acquisition are being achieved. Selling, shipping and general administration expenses fell 15% last quarter.

Last but not least, Cott Corporation (NYSE:COT) is a frequently forgotten generic food name, most likely because it’s not a food producer. Rather, it makes white-label drinks and sodas, not to mention it’s the owner of some name-brand beverages like RC Cola. All told, the company supplies more than 200 different retailer-brand beverages, offering everything from carbonated sodas to sports/energy drinks to juice to pre-mixed teas.

More important, though revenue tumbled in Q2 and the bottom line contracted by 5%, Cott has posted more earnings beats than misses over the past three-and-a-half years, and the 2013 EPS estimates of 80 cents are more than achievable given that the company’s on pace for a per-share profit of 66 cents for 2012. That translates into a forward-looking P/E of 10.5, which is more that a palatable price given the ongoing broad migration toward lower-cost groceries.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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