Talk about the fruit of your labors. Consider a company that provides products to eight out of every ten American households. A company with an exceptional supply chain and industry-leading market share in three of its core products. No, it’s not Apple. But close, in a strange way. It’s Del Monte Foods (DLM), a company that sells premium brand fruits and vegetables as well as pet food and treats under the brands Kibbles ‘n Bits and Milk-bone. 

Think back to all the fruit you have enjoyed in your home this winter. You can be pretty sure that most of it traveled first by truck in South America, then by boat, then by truck, and was stored in a warehouse before it finally arrived on your local grocer’s shelves. Del Monte’s special expertise is in managing this complex supply chain, using economics of scale to cheaply move fruit thousands of miles while keeping it fresh. Key imports include bananas from Costa Rica, avocadoes from Chile, and cantaloupe from Brazil. 

Times of global turmoil a great time to focus on Del Monte as 94% of its sales come in the United States. The company’s portfolio of products is sufficiently diversified between food and pet products, with 55% of revenues from consumer foods and 45% from pet products.
importantly, who should pay for them.

Moreover, Del Monte is able to use its dominant market power to outperform generics. The company boasts the largest market share in the American fruit, vegetables, and pet snacks market. It’s second in tomatoes, broth, and pet foods. 

Ever known someone who bought clothes for her dog? Well, Del Monte food is taking advantage of this extravagance. Morningstar reported that, ”because of the growing trend to treat pets like humans, DLM can successfully market gourmet pet snacks and food products, which carry higher profit margins than basic offerings.” 

Del Monte is benefitting from a trend towards healthier foods. The company has developed specialized low-salt and organic products that are low in calories. Their pre-packaged fruits and vegetables are low in fat and contain vitamins, antioxidants, and essential nutrients. Company policy prohibits the use of preservatives and artificial additives. 

DLM has produced earnings surprises over the past four quarters as consumers have shown a tendency to move towards high quality brand names from generics, even during a recession. A key reason: concern over dangerous ingredients, diseases and lower quality products drive people toward better known brands.. DLM said recently it believes that it can continue to increase profits and raised its end of year guidance by 4% earlier this year. 

Del Monte strong earnings performance has led to similar returns for shareholders. Despite a sharp rise in commodity prices in 2008, management was able to cut costs and maintain margins. From June 2009, the stock is up 85% relative to 20% for the S&P. Technically, the stock looks bullish as DLM retook 20-day moving average on Thursday. 

Management has also demonstrated the ability to grow in the mature food distribution industry. In 2002, CEO Richard Wolford acquired a tuna canner, a pet food manufacturer, and other food producing assets from Heinz (HNZ). This doubled Del Monte’s sales and tripled its operating profit. Wolford continues to purchase higher-margin brands like Meow-Mix and Milk-Bone while selling low-margin ones like StarKist tuna. 

Related Article: Heinz (HNZ) raises its dividend yield

On May 27, Fitch upgraded Del Monte’s debt to BB+ from BB. The agency noted that ”Del Monte has shown improved its margins during the current fiscal year. Del Monte’s recent focus on debt reduction rather than share repurchases and large dividend increases has further strengthened its credit profile.” This improvement will allow the company to finance further growth at lower interest rates. 

Figure that DLM can grow at sales at 5% per annum as its healthy products and gourmet pet snacks attract more customers, while growing earnings at a faster pace due to cost cutting and other margin improvements. My model suggests that DLM will justify a 15 PE multiple over the coming year, putting the price north of $19 over the next year, about 35% higher. Next earnings report is June 10. 

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