SECTOR SCOPE by James A. Anderson March 15, 1999

What's Cookin' among the Foodmakers?
Lately, Wall Street has grown cautious, but good values are lurking in the traditionally defensive sector

Lately, food stocks have been about as popular as Aunt Wilmas beet and broccoli casserole at the Fourth of July picnic. At a time when investors claw to get hold of every technology stock they can, a Standard & Poors index of 33 foodmakers is turning stomachs on the Street. The group eked out a 5% gain for all of 1998, only to slip 4% in the first month of 1999. Yes, food producers trounced the broad market as recently as 1997, with a 38% gain vs. 31% for the S&P 500. But with some ominous changes afflicting the industry, analysts aren't expecting a repeat of that performance anytime soon.

Here's Wall Street's big concern: A spate of mergers over the past year has thinned the ranks of big supermarket chains, the food industrys primary outlet. An estimated 53% of all groceries will be sold through the top-10 chains this year, compared with 40% in 1990. Having snapped up smaller competitors, survivors such as Kroger, Safeway, and Albertsons will now wield more leverage on food prices. To make matters worse, discount juggernaut Wal-Mart is charging into food retailing. That means more haggling over prices and shelf space. "Big retailers are going to be looking to squeeze bigger discounts from suppliers," says S&P analyst Richard Joy. That will lower the industry's earnings growth to 7% to 9% a year, down from the reliable 10% or more the industry has generated historically, says Merrill Lynch analyst Eric R. Katzman.

So have food stocks passed their expiration date? Not entirely. While the recent sell-off hasnt made the overall sector a coupon-clippers dream, a number of foodmakers still look attractive relative to the market. H.J. Heinz (HNZ) currently trades at 22 times its consensus projected fiscal 1999 earnings, as compiled by Zacks Investment Research, a 20% discount to the S&P 500s p-e of 28. And at 20 and 21 times projected 1999 profits, Bestfoods (BFO) and Ralston Purina (RAL) are cheaper still. Thats a noticeable markdown when you consider that food stocks as a group have historically traded in line with the markets multiple.

CHEAPER INGREDIENTS. Theres also some good news for the industry this year. First, profit margins could hold up. For starters, companies such as Heinz and Campbell Soup have begun restructuring campaigns that should fatten their bottom lines. Perhaps more important is that some of the industrys key raw materials -- corn, wheat, and soybeans -- are cheaper than they've been in a long time. In 1998, large harvests for all three teamed with slumping demand in Asia to slash prices between 20% and 30% for ingredients that can account for 25% of a food producers costs. What more, commodity prices don't seem likely to rise soon. "Theres nothing to really boost demand," says Michael Singer an economist who follows agricultural production for the Federal Reserve in Chicago. "The only thing that will turn this around is a big drop in supply, which might not happen."

You might want to partake of the food group for another reason. Food is a consumer staple if ever there was one, and the group's stocks don't become too ruffled by economic ups and downs. In good times and bad, consumers still get hungry. So, when a market slowdown finally occurs, food manufacturers are likely to again enjoy their day in the sun.

For the time being, the sector looks ripe for some value plays -- either companies beaten down by earnings disappointments or overlooked despite being stocked with good brands. Take Ralston Purina (RAL), a mix of two disparate product lines. Its pet-food business is a winner with a market-leading 30% share and annual sales growth in the mid-teens. But Ralstons other half includes battery lines such as Eveready and Energizer, which have been a drag on earnings. Prudential Securities analyst Jeffrey G. Kanter estimates that in 1998's December quarter, when Ralston reported an earnings decline of 7.5%, its pet-food earnings rose 15%, while its battery profits fell 26%.

Kanter expects management to take drastic measures to improve the battery business. And word on the Street is that Ralston may figure some way to separate its two halves, perhaps going so far as to spin off or sell the battery division. Thanks to Fido and Flicka, though, analysts think Ralston still is likely to produce 12% annual earnings growth for the next five years, according to a Zacks Investment survey.

TAKING WING. Kanter also likes poultry power Tyson Foods (TSN), which processes one-third of all chickens in the U.S. With feed accounting for 55% of the cost of raising birds, Tyson, which buys 315 million bushels of corn and 120 million bushels of soybeans annually, has seen its margins take wing as grain prices have remained depressed. It doesnt hurt that poultry consumption should rise 8% this year according to the Agriculture Dept., more than pork or beef. Wall Street expects Tyson's earnings to grow at a 14.8% average annual clip over the next five years. Tyson is also realtively cheap: The stock currently trades at a p-e of 16 times projected 1999 earnings, as calculated by Zacks.

Bestfoods (BFO) could be another sleeper. Brazils currency crisis couldnt have come at a worse time for the maker of such brands as Hellmanns, Skippy, and Knorr: Bestfoods counts on Latin America for 21% of its earnings, and Brazil accounted for around half of that 21% in 1998. That said, a 13% drop so far this year in Bestfoods shares may be an overreaction. For one, the Knorr brand of bouillon cubes might be the kind of purchase consumers worldwide opt for when their economies go through difficult times. And to counter its problems south of the Carribbean, Bestfoods can look to Europe, where it generates some 42% of its earnings and where Knorr is a top brand. S&Ps Joy says, long-term, that kind of international exposure will pay off big -- in the form of 12% average annual earnings growth over the next five years.

If youre ready to try a food fund, perhaps the purest play available is the Fidelity Select Food & Agriculture fund (FDFAX). It's down 4.27% so far this year. But last year, the fund had a total return of 15.62%, and over the past five years has averaged 18.50% annually.

James Anderson, who teaches journalism for the City University of New York, writes Sector Scope every other week for Business Week Online _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _


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