GIS General Mills Inc

By Leslie Josephs 

Investors are starting to lose their appetite for food stocks.

Last week's strong jobs report bolstered the case for a December interest-rate rise in the U.S., prompting investors to move money out of companies that have offered steady returns amid ultralow interest rates and market swings, such as large packaged-food companies. The shift comes as food stocks face other threats, such as slowing sales as consumers shift toward less-processed options.

The S&P 500's Food Products Index, which tracks companies including Hershey Co., General Mills Inc. and Kraft Heinz Co., fell 3.1% last week, while the S&P 500 rose 1%.

"I think that ship has already sailed for now," said Tommy Lackey, a portfolio manager at Barber Lackey Financial Group LLC in Greensboro, Ga., which manages about $20 million of assets.

He said he sold part of a high-dividend mutual fund last month that had a high concentration in consumer staples, including food stocks. "The consumer is still strong, so this area will still perform OK but not excel like others," he said.

The food-products index is up 5.7% so far this year, while the S&P 500 is up 1%.

Analysts and investors noted that cost-cutting as well as mergers and acquisitions have made the stocks attractive even though some of the companies' sales have slipped.

Quarterly revenues for companies in the food-products index have dropped 10.5% from a year earlier, with 57% of the companies having reported, according to FactSet. Revenues of S&P 500 companies have dropped 4.6%, with 85% of companies having reported.

Some food-company executives acknowledged changing consumer tastes.

The carbonated soft-drink market "continues to be under pressure from a volume perspective," said PepsiCo Inc. Chief Executive Indra Nooyi in a call with investors on Oct. 6. She added that noncarbonated drinks, such as water, "are really what's driving all of the growth in the whole industry."

The revenue generated by soda and cereal in the U.S. has contracted about 2% a year for the last two years, according to market-research firm Euromonitor International.

"Without seeing topline growth, there's really only one way you can grow, which is through cost-cutting," said Brett Hundley, a food-stocks analyst at BB&T. "They've kind of run out of road to cut cost."

Kraft Heinz, the combined Kraft Foods Group Inc. and H.J. Heinz Co., plans to close seven plants and cut 2,600 jobs. In its first report as a single company earlier this month, it said profit and revenue shrank and it raised its quarterly dividend 4.5% to 57.5 cents a share. Kraft Heinz shares are down more than 4% over the last month and down 2.4% since the combined company first traded in July.

Shares of Mondelez International, the maker of Oreo cookies, lost 1.4% over the past month but are up 22% this year. Revenue fell 18% in the third quarter. Mondelez said profit jumped more than 700% from a year earlier, to $7.27 billion, after it combined its coffee business with D.E. Master Blenders 1753 B.V.

"Even though earnings haven't been growing considerably for food in general, there's been a lot of consolidation," Mr. Hundley said. "When a big deal gets done, that lifts all stock prices, because people think 'who's. next?'"

But deals have slowed. There were 178 food-sector deals announced in 2015 as of Nov. 4, down from 236 in 2014 and 265 at their peak in 2012, according to Dealogic. And higher interest rates down the road could mean higher borrowing costs for companies looking to finance acquisitions.

Investors also say food stocks were becoming expensive compared with the broader market. The S&P 500's Food Product Index trades at 22.6 times its companies' past 12 months of earnings, versus the S&P 500's 18.5 price/earnings ratio, according to FactSet as of Friday.

Valuations are even more stretched in emerging markets, which are vulnerable if the U.S. raises rates. "If another significant emerging-markets downturn causes investors to abandon the asset class en masse, these defensives stocks with stretched valuations have the greatest distance to fall before putting in a floor," said Joe Gubler, portfolio manager at Causeway Emerging Markets Fund, with $2 billion in assets.

In addition, a five-year decline in commodity prices--particularly for the cornerstone ingredients for many of these companies' signature products--is starting to stabilize.

Some investors aren't deterred. These companies are still strong, predictive cash-flow companies," said Peter Santoro, a portfolio manager of Columbia Threadneedle's $7.9 billion Columbia Dividend Income Fund.

He said he increased the fund's holdings of General Mills and PepsiCo this year, drawn to the companies' cost-cutting strategies and efforts to make products fit in with consumer trends, such as offering gluten-free Cheerios or lower-fat potato chips.

"People have got to eat," said Hank Madden, co-founder of Madden Advisory Services Inc. in Jacksonville Fla., who holds the PowerShares Dynamic Food & Beverage ETF. "I don't care if it's a good time or a bad time."

Julie Wernau contributed to this article.

Write to Leslie Josephs at leslie.josephs@wsj.com

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(END) Dow Jones Newswires

November 09, 2015 20:54 ET (01:54 GMT)

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