By Matt Andrejczak
At what point will grocery shoppers gag on higher prices?
The answer to that question will go a long way toward
determining food companies' share prices this year. So far,
investors are taking a wait-and-see approach to the sector, but
there's a sense a showdown is coming soon.
Agricultural commodity costs continue to surge and brand-name
food makers still must vie with cheaper store brands that gained
popularity during the recession.
During this four-month rally for the U.S. stock market, Kraft
Foods Inc. (KFT), Campbell Soup Co. (CPB), General Mills Inc. (GIS)
and other packaged food makers have not kept pace.
Compared with the 20% gain for the S&P 500 since Sept. 1,
the S&P Food Products Index is up 3%. Campbell shares are down
6%, General Mills is off 2% and Kraft is flat.
Food companies became less appetizing as 2010 wore on.
Ineffective price wars and sluggish volume growth disappointed
investors as did less sanguine outlooks from food makers. Analysts
responded by reining in their profit projections, moves that
constrained share prices.
Now, surging prices for corn, wheat, coffee and dairy products
are of concern. Brand-name food companies are implementing modest
price increases to protect their margins. But the move might keep a
lid on the amount of food sold if shoppers opt for cheaper store
brands.
Unless food companies successfully pass along price increases
and volumes improve, "I believe the pressures could worsen," said
Rob Dickerson, analyst at Consumer Edge Research, who last year
made timely stock calls on Kellogg (K) and Sara Lee (SLE).
Looking ahead, can Kraft make the Cadbury deal pay off for
investors? Will new items help Kellogg jump start cereal sales
after twice cutting its forecast in 2010? Can Campbell convince
consumers to buy more soup?
The wave of food company earnings starts Feb. 2 with Hershey,
followed by Kellogg on Feb. 3. Sara Lee reports Feb. 8 and Kraft
issues earnings Feb. 10. Analysts at Janney Capital and Wells Fargo
Securities recently upgraded Hershey (HSY) to a buy, predicting its
growth will outpace others in the food sector.
Matt Kaufler, portfolio manager for the Federated Clover Value
Fund (VFCIX) , is one investor who isn't counting on the food group
to outperform the broader stock market this year.
If the economy and consumer confidence continues to improve, he
thinks investors will put money into faster-growing sectors. "Share
prices will be somewhat stagnant," said Kaufler, whose fund owns
Kraft and H.J. Heinz (HNZ).
Barclays Capital analyst Andrew Lazar believes fundamentals at
food companies will recover with companies cutting back on heavy
promotions.
Still, "it will be a slow grind at best," said Lazar, who
estimates Wall Street's earnings expectations for the major food
companies are too high for 2010's fourth quarter and the first
quarter of 2011.
Large food makers are planning to unleash new products, which
often carry higher price tags and can help improve volumes as
shoppers are lured to try something new. Most food companies backed
off innovation during the economic downturn, instead focusing on
ditching marginal products, closing manufacturing plants and
slashing supply-chain costs.
If new products fall flat and consumers shun higher prices,
profit estimates for food companies will be scrutinized come this
summer, said Deutsche Bank analyst Eric Katzman.
"Should the consumer stay in hibernation, this will present
meaningful challenges to growth and meeting stated financial
targets," Katzman said in his Jan. 5 outlook report.
Supermarket chains, whose margins suffered last year when food
prices dropped in value and consumers stocked up less, are passing
along price increases from food companies.
Supervalu Chief Executive Craig Herkert forecast Jan. 11 prices
for items sold in center-aisles of grocery stores would go up
between 3% and 14%, based on dealings with vendors. He said
Supervalu (SVU) would try to keep prices down.
While investors wait to see how the scenario of price increases
and higher commodity bills plays out, there should be some support
for shares of food companies in the form of healthy dividends and
potential industry consolidation.
Food makers generate steady cash flows and have long grown their
dividends, making them a relatively safe place for more
conservative investors seeking steady income even if share prices
stay subdued.
Acquisitions remain a wild card. Low interest rates will keep
this a possibility as private equity buyers like to use debt to
finance deals.
Del Monte Foods (DLM) is being acquired for $4 billion by a
consortium of private equity shops, while suitors have been
circling Sara Lee, whose shares have spiked the last few months.
Sara Lee said Friday it plans to split its company into two
publicly traded companies.
-By Matt Andrejczak, 415-439-6400; AskNewswires@dowjones.com