Markets & Finance

Any Treats in the Food-Stock Trash?


Investors haven't had much of a taste for food stocks lately. In the past 12 months through Feb. 3, the industry's stock prices have barely budged, rising a mere 1.3%, vs. an 8.2% gain for the Standard & Poor's 500-stock index.

And recent news out of the group hasn't made them any more appealing. On Jan. 30, industry behemoth Kraft Foods (KFT) reported that annual sales by volume were essentially flat with 2005. The Northfield (Ill.) maker of Oreo cookies and Cheez Whiz announced it would close up to 20 plants and lay off some 8,000 people through 2008. Share prices in the No. 1 U.S. food maker have dropped from a high of $34 to around $29 in the past year.

That story of woe echoes throughout much of the sector. At Chicago-based Sara Lee (SLE), maker of Jimmy Dean sausage and Hillshire Farm packaged meats, income from continuing operations fell 38%, to $193 million, in the most recent period. The stock is off more than 20% since last year. Earnings per share at Tyson Foods (TSN) dropped from 14 cents in the last quarter of 2004 to 11 cents in 2005, and the stock is hovering near a 52-week low.

CHALLENGING RECIPE. ConAgra Foods' (CAG) quarterly earnings, released in late December, dropped from 46 cents per share in 2004 to 31 cents in 2005. Like others in the group, including Kraft and Sara Lee, Omaha-based ConAgra is slimming down its portfolio. It announced plans in early February to sell off its refrigerated-meats businesses, including Armour and Butterball. Shares of ConAgra now trade hands for roughly $21, off 23% from a year ago.

Clearly, the news hasn't been uplifting for these outfits. Any good value investor would argue, though, that it's also worth rooting around in the garbage bin. But are there any treats in this trash?

On the whole, being a packaged-food maker is pretty tough these days. Rising commodity prices continue to depress earnings. Energy, a major component in packaging, remains an especially big problem since the costs can't be passed on to consumers in the form of higher prices.

"LACK OF INNOVATION." Making matters worse, competition is fierce. The industry continues to struggle in the face of hard-line discounters in Europe and generic labels in the U.S. In this new retail environment where category killers -- that is, the No. 1 and No. 2 brands in a category -- are king, innovation in product development and marketing are key. And few companies have shown they have the right stuff to lure consumers to pay up for their brand.

"There is a lack of innovation, lack of reinvestment, and lack of news in the category," says analyst Timothy Ramey with the research firm D.A. Davidson. "We're not recommending any large-cap food names."

A couple may be opportunities, though. One bright spot in the group: Battle Creek (Mich.)-based Kellogg (K). The cerealmaker has bucked the industry trend, expanding earnings by an annualized rate of 23% over the past three years, in part through acquisitions like cookie company Keebler. Management has also focused on cost cutting and using those savings to reinvest in marketing.

MODEL APPROACH? David Palmer, an analyst with UBS, figures Kellogg can increase profits by 9% a year over the next three to five years. Currently, it trades at roughly 17 times 2006 earnings, in line with Campbell Soup (CPB) and General Mills (GIS). But he says it deserves to trade at a premium.

"Other companies in the food space must be looking at Kellogg's and asking themselves, 'How do we establish a virtuous cycle of cost savings, innovation, and reasonable growth goals?'" says Palmer.

Ultra-contrarians also like the look of Sara Lee. At $17.55 as of the close on Feb. 3, the stock is trading at the low end of its five-year range.

AWAITING GOOD NEWS. There's little wonder why investors don't like Sara Lee. Last year, new CEO Brenda Barnes unveiled a massive restructuring plan that includes selling or spinning off some 40% of the revenue base. At the same time, Sara Lee has invested heavily in marketing and innovation -- the lifeblood of any packaged-food maker. It's a grand plan. But some worry that management has bitten off more than it can chew. And so far, the numbers have been terrible.

Sara Lee supporters argue that much of the bad news is already baked into the stock price. So just one piece of good news could perk up Wall Street. "Once it gets through the restructuring, the company should start to resume a decent growth track of 8% to 9%," says John Buckingham, manager of the Al Frank Fund (VALUX). "I think the market will pay up for that."

In the meantime, with Sara Lee shares sporting a dividend yield of 4.5%, value guys like Buckingham figure they can be patient for the turnaround. That's certainly something to chew on.


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