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Food Stocks For Profit-Starved Investors

Last update: 7/14/2008 6:58:04 AM

     By Anjali Cordeiro     Of DOW JONES NEWSWIRES   

Dairy prices are soaring and cereal boxes are shrinking. Even candy prices are heading higher. There are few bargains left in grocery aisles, but investors may still be able to spot some deals among food stocks.

Companies that make milk, cheese and cereal have been hurt by inflation because they are paying more for raw materials like grain and for fuel. But despite these pressures, some of these packaged-food makers have managed to keep growing their profits and sales.

Food makers aren't hit as badly as some industries by a slowing economy - people keep eating in good economies and bad. And some food companies are even helped by consumers' efforts to shun restaurants and eat at home more as the economy slows.

(This story and related background material is also available on The Wall Street Journal Web site, WSJ.com.)

The Dow Jones Wilshire U.S. Food Producers Index is down 8.9% for the year (and only slightly more from the Oct. 9 stock-market high). That is better than the Dow Jones Industrial Average's year-to-date drop of 16.3%, including a decline of 1.7% last week.

Wall Street analysts expect soaring commodity prices to continue to make life difficult for packaged-food manufacturers, but they say companies with strong brands and the ability to control costs internally will be able to weather the difficult combination of a slowing economy and rising inflation.

     Household Names   

One of food analysts' favorites picks is General Mills Inc. (GIS), maker of household names like Cheerios, Hamburger Helper and Haagen Dazs ice cream.

"I'm not sure there is a company in the food industry executing as well as General Mills," says Stifel Nicolaus analyst Chris Growe. In mid-June the Minneapolis food company hiked its earnings guidance for its fiscal year, as higher-than-expected sales helped offset higher costs.

Besides General Mills, Growe has buy ratings on Kellogg Co. (K), the maker of Apple Jacks and Pop Tarts, and ketchup producer H.J. Heinz Co. (HNZ).

These three stocks deserve to trade at higher prices relative to company earnings than the average food stock because of their strong performances, he says. Instead, Heinz is right at the food industry's average price-to-earnings multiple of about 16.8, Growe says, while Kellogg and General Mills are just below.

"They have been producing the strongest growth across the food industry," Growe says about the three companies. Because of their strong brands he believes they "have the best ability to raise prices."

Growe isn't as bullish on the rest of the food sector. He believes the sector as a whole is already pricing in much of the benefits these companies will see from consumers eating more of their meals at home. On a price-to-earnings basis food stocks have historically traded at a 3% discount to the broad consumer group that includes makers of tobacco, household products and beverages, but they are now trading at an 11% premium, he says.

Analysts have some concerns that branded food companies could lose market share to cheaper private-label or store brands in the weakening economy. Longbow Research analyst Alton Stump says food companies whose products are seen as far superior to private-label items are in the best position to raise prices to pass along higher commodity costs.

     Not Different Enough?   

Stump, for instance, has a sell rating on Del Monte Foods Co. (DLM), which sells canned food. Consumers don't appear to care very much if they buy private-label cans of corn or Del Monte branded ones, he says.

On the other hand, he sees buying opportunities in a number of smaller food companies that are dominating or gaining share in the categories they are focused on.

He has a "buy" recommendation on Green Mountain Coffee Roasters Inc. (GMCR), which makes both coffee packets for single-cup brewing machines and single-cup coffee machines. Single-cup brews are doing well and Green Mountain is gaining share in the coffee category, he says.

Other stocks he likes are Diamond Foods Inc. (DMND) and B&G Foods Inc. (BGF).

Diamond has an attractive nut business, which has been growing in volume and the company has been successful in passing on its costs to consumers, Stump says, while B&G Foods has attractive brands in areas like sauces and marinades and is buying new ones at low prices.

In a recent analysis of food-industry trends, Wachovia analysts found that wealthier families are still buying branded food products. But the research indicated that the lower 40% of earners are trading down to private-label brands in categories like dairy. That trend could translate into better results for some private-label food manufacturers.

     Private-Label Picks   

The private-label industry "is well positioned to take much-needed pricing increases and data suggests it is doing just that, which augurs well for margins," said Wachovia analyst Jonathan Feeney in a research brief to clients.

Among the private-label manufacturers that Feeney recommends are TreeHouse Foods Inc. (THS), a retail supplier of private-label pickles and soups, and Ralcorp Holdings Inc. (RAH), a maker of private-label cookies and crackers.

TreeHouse is a pricing leader in its sector, raising prices more than enough to offset dramatic commodity costs, the analyst says. Ralcorp, meanwhile, reported a strong quarter in May, the Wachovia analysts say.

Wachovia is also bullish on companies that sell chicken and meats. Many of these stocks have recently been hurt by concerns about rising prices of commodities, particularly corn, used as animal feed. But Wachovia analysts say that pork and turkey seller Smithfield Foods Inc. (SFD) and Tyson Foods Inc. (TSN), a processor of chicken, beef and pork, should both benefit from strong global food demand.

-By Anjali Cordeiro, Dow Jones Newswires; anjali.cordeiro@dowjones.com

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