Week 161 - Food Processors That Stock Grocery Store Shelves

Situation: I think we’ve all become a little bit leery of the current stock market. Market analysts keep anticipating GDP growth of 3% but the International Monetary Fund projects that GDP growth in the US is only going to be 1.6% for 2014, and Janet Yellen (the new Chairperson of the Federal Reserve) says that our economy won’t return to 3% GDP growth until 2016 at the earliest. Investors have responded by again sheltering in safe harbors like companies in the 4 “defensive” S&P Industries. Those would be: Consumer Staples, Healthcare, Utilities, and Communication Services. That means those stocks are overpriced according to their Price/Earnings ratio--price divided by earnings over the past 4 quarters (P/E) has moved into the danger zone. P/E ratios higher than 20 are considered too high because returns to the investor drop below 5%/yr. When returns from “defensive” stocks fall that far, professional investors will start to cut their risk profile by moving money into corporate bonds, e.g. Vanguard’s Intermediate-Term Investment-Grade Bond Fund (VFICX, see Table). 

This week, our task is to look at the safest sub-industry (after regulated utilities) within the 4 defensive industries: Food Processors. To get a clear picture, we’ve included all 20 of the publicly-traded companies that stock your grocery store’s shelves to a material degree and have  long-term trading records (see Table). The first column of data (Col C) tells the story. All 20 have total returns that equal or exceed that of our benchmark, the Vanguard Balanced Index Fund (VBINX, see Table), which has returned a little over 5%/yr since the most recent inflation-corrected peak in the S&P 500 Index occurred on 9/1/00. Because it’s hedged, VBINX performed better than the lowest-cost S&P 500 Index fund (VFINX in Table). Risk for the 20 aggregated food processors (Line 22 in the Table), as measured by both total return over the 18-month Lehman Panic panic period and 5-yr Beta (Columns D & J), was less than for VBINX even though total returns after both 14 yrs and 5 years were much greater (Columns C & F).

Now that we’ve got your attention, let’s “muddy the waters.” Look at the Table and note that only PEP, GIS, and SJM provide the investor with what she wants, which is to be at least as good as VBINX in terms of performance (Columns C, F, G, H, I) as well as safety (Columns D, J, K, M, N, O). The aggregated data on Line 22 look great but you’ll need stock-picking skills to capture those high returns at low risk. Remember: data points that underperform VBINX are highlighted in red. Column K (P/E) has an abundance of those, indicating that the market is pricey.

Bottom Line: Food Processors are a mother lode of opportunity for investors but that sub-industry is highly fragmented. Out of the 20 companies in the Table, only 5 are sizable: Nestle (NSRGY), Danone (DANOY), Mondelez International (MDLZ), Coca-Cola (KO) and PepsiCo (PEP). But size (Col L) and bond ratings (Col O) don’t matter much when a company is selling an essential product. The exception occurs when government regulation imposes price controls, as is the case with milk, e.g. Dean Foods (DF at Line 17 in the Table), which is the largest milk producer in the US. 

How should you prioritize your research into the “story” that supports the market value for each of these stocks? We suggest that you assign the same priority as the PowerShares Dividend Achievers Portfolio (PFM, Line 36 in the Table), an exchange-traded fund or ETF. That priority is: KO, PEP, GIS, HRL, SJM, MKC, FLO, LANC.

Risk Rating: 4

Full Disclosure: I don’t plan to purchase any stock listed in the Table, but do own shares of MKC, KO, HRL, GIS, and PEP.

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