The coronavirus pandemic has changed much of American life, and that goes double for how we eat. With people social-distancing and dining in, even hoarding groceries, the rally in packaged-foods stocks that began at the end of March might just be getting started.
It was hard to imagine being bullish on food companies and their shares even a few months ago. The industry was plagued by stagnant sales growth, declining profit margins, and high levels of debt used to fund acquisitions. Large packaged-foods companies were routinely discounting their products to maintain retail shelf space and stanch market-share losses to private-label goods. Gone were the days when investors could consider food stocks safe, or defensive, although their dividend yields—which average about 3.3%—kept some buyers nibbling.
As a group, the food and beverage stocks in the S&P 500 (.SPX) are lower in the past three years, compared with a return of 26% in the broader index. Some stocks were truly dismal performers; Kraft Heinz (KHC) shares lost nearly 70% in that span.
Then Covid-19 upended everyday life, turning the tide for packaged-foods stalwarts, such as Campbell Soup (CPB), Conagra Brands (CAG), and General Mills (GIS). Suddenly, America can’t buy enough groceries, in particular name brands, making the industry’s pricey acquisitions now look like a smart strategy.
Packaged-foods stocks have rallied nearly 25% since the market’s March 23 lows, in line with the broader indexes, and more gains for the group could be in store. Food stocks are trading at a 13% discount to their historic price/earnings ratios, compared with the S&P 500, which fetches a 15% premium to its historic P/E.
If food stocks can regain a market valuation, investors will realize appetizing gains. And if the group can achieve its historic 10% to 20% premium to the market—not a farfetched possibility in a post-Covid-19 world—the shares could rise 30% from their recent levels.
Behind the sector’s latest gains is explosive volume growth: U.S. packaged-foods sales jumped 32%, year over year, for the week ended March 28, and 24% for the week ended April 4. While the initial Covid-19 bump has faded, the numbers still look strong.
A shift away from restaurant spending is largely responsible for this surge . Restaurant traffic has fallen about 60% since the coronavirus outbreak in the U.S., according to Jeff Farmer, an analyst at Gordon Haskett. Before the outbreak of Covid-19, the disease caused by the virus, Americans ate about five meals a week away from home. Assuming that they now have only two restaurant-prepared meals each week out of a total 21, the number of meals cooked at home has risen to 19 from 16, an increase around 20%.
Groceries have also gotten more expensive, as demand has risen and supply in some places has become constrained. “No one is promoting,” says Karen Short, an analyst at Barclays who covers big-box grocers, including Costco Wholesale (COST), Walmart (WMT), and Target (TGT). “Everything is full-price.”
And, in yet another surprising turn, large brands are elbowing out private-label, or store brands, which grew to nearly 25% of total U.S. unit sales in recent years. In part, that’s because big food companies have the resources to help supermarket chains stock their shelves as home deliveries of groceries soar.
“Retailers are relying on the large food companies,” says Alexia Howard, an analyst at Bernstein, who cites the sophisticated supply chains of producers such as Campbell Soup and Mondelez International (MDLZ).
Howard raised her investment ratings on March 18 to the equivalent of Hold from Sell on food stocks including Campbell, Conagra, General Mills, and J.M. Smucker (SJM), based on “a huge surge in [grocery] traffic,” she says.
But she has refrained from rerating any of the stocks to Buy, given questions about whether the industry’s sudden sales bounce will have a lasting impact.
Among the biggest U.S. packaged-foods companies, Campbell Soup, Conagra, Kraft Heinz, General Mills, and Kellogg (K) look like the best bets. That quintet has the right mix of valuation and growth potential stemming from changing consumer behavior. All sell products currently in high demand, from frozen vegetables to canned goods to baking supplies, and boast above-average product profiles, based on their ratings from Access to Nutrition, a nonprofit that ranks food companies, in part, on the healthfulness of what they sell. In other words, the product assortments of all five should enable them to capitalize on the trend toward healthy eating at home.
Industry earnings are expected to rise by a modest 3% annually, on average, for the next couple of years. That’s well below the 20% growth rate of S&P 500 earnings, but the comparison isn’t quite apt. For starters, 2020 estimates for the S&P 500 have been cut by about 15% in the past four weeks, whereas those for Barron’s five food picks have risen 12% in the same period. And 2021 and 2022 forecasts for packaged-foods companies don’t yet reflect any long-term benefits stemming from recent trends.
Campbell, Kraft, and Conagra trade for an average of about 15 times this year’s expected earnings, below the broader food group’s P/E multiple of 18 and the market’s 20. Wall Street expects Campbell to make $2.78 a share; Kraft Heinz, $2.34; and Conagra, $2.24. If the trend toward eating at home persists, as expected, estimates could jump about 10%.
Cereal giants Kellogg and General Mills fetch about 17 times this year’s consensus profit estimates of $3.86 and $3.47 a share, respectively. Dividend yields for the group range from 2.5% for Conagra to 5.6% for Kraft Heinz.
Campbell, Conagra, and Kraft all have relatively high debt levels. Campbell’s net debt—debt minus cash and equivalents—totals about $6 billion, or 50% of assets, versus a debt-to-asset ratio of roughly 10% for the S&P 500. The company purchased snacks maker Snyder’s-Lance in 2018 in a $6 billion debt-financed deal.
Conagra’s $10 billion of net debt owes largely to its 2018 purchase of Pinnacle Foods; its debt equals about 50% of assets. Kraft has $28 billion or so of net debt, equal to 25% of total assets, a legacy of the private-equity transaction that merged Heinz and Kraft Foods in 2015.
Perversely, debt can be a plus, as it focuses management and makes capital-allocation decisions—how to deploy cash flow—easier. Paying down debt is a good way to raise equity value by shifting overall corporate value back to stockholders from bond owners.
All five food companies are generating free cash flow well above their debt-service payments.
Covid-19 has hammered many sectors of the economy, and how Americans will travel, shop, and eat in a post-coronavirus world is unknown. The newfound popularity of packaged-foods companies might fade as social distancing ebbs and restaurants finally reopen, but there is plenty of time until then for the industry’s biggest players to cook up decent sales and profit growth, and stock-price gains.
|For more news you can use to help guide your financial life, visit our Insights page.|