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How to Invest in Food Stocks: The 'Middleman' Plays

" How to Invest in Food Stocks " focused on the front of the food (investment) chain: farm equipment, chemicals, farm products, biofuels and fresh produce. Now let's zero in on the middle part of the chain where food production, delivery and retail operators set their sights on you, the end user.



Food Processing and Packaging

By far the largest segment of the food chain is made up of the food processors and packagers. These are the companies which take the raw foodstuffs, grains, meats, vegetables and fruits and prepare them for general consumption at home or in restaurants. These companies tend to share many characteristics, such as:

  • The companies or their products are household names. In other words, you have grown up with them and they are integrated into your everyday life. You can see them on your shelves at home or in the supermarket.
  • These companies produce our consumer "staples" or necessities), such as bread, canned vegetables, cereal, pasta and soup.
  • Academia refers to these products as being "price inelastic." The elasticity of demand refers to the relative change in demand for a product relative to a change in price. Inelastic demand occurs when there is little change in demand associated with changes in price.
  • This segment is far less prone to shifts in economic conditions. As a result, these companies will be considered defensive in nature when money managers seek stable and less risky investments during economic downturns.
  • Please note: I'm being very liberal with my definitions above. The reason: what one person defines as a necessity may be another person's luxury. Take chocolate as an example. Some people might see chocolate as a consumer staple while others see chocolate as a luxury snack that can be easily substituted with a cheaper snack alternative.

    However, for the purposes of this discussion, to maintain brevity and simplicity, and to focus on investing rather than textbook economics, I am going to take liberty and lump all professed and packaged foods into the same consumer staple category. However, just as with clothing retailers, within this category there is a whole spectrum of brands that produce similar products at different price points -- from the very "basic" of brands (like National Beverage's soda Shasta) all the way up to high-end, luxury names (like niche soda-maker Jones Soda).

    So what are some of these household (investment) names? Here is a look at some of the bigger, more established stocks in this part of the investment food chain. (How many have you grown up with?)

    FOOD PROCESSING AND PACKAGING
    Company Ticker Symbol Closing Share Price
    on 2/22/2008
    2007
    EPS (Earnings Per Share)
    2008
    Estimated EPS
    Campbell Soup (CPB) 32.67 1.95 2.07
    ConAgra Foods (CAG) 22.13 1.43 1.62
    General Mills (GIS) 56.90 3.18 3.46
    Kellogg (K) 51.04 2.76 2.99
    McCormick (MKC) 35.61 1.92 2.11
    Ralcorp (RAH) 56.04 3.25 3.50
    Sara Lee (SLE) 13.13 0.83 0.99
    Unilever (UN) 30.88 2.04 2.20
    Hershey (HSY) 36.84 2.08 1.86
    HJ Heinz (HZN) 45.29 2.38 2.63
    Kraft (KFT) 31.37 1.82 1.90

    A final note on this all too important part of the food chain: while normally these companies are low-risk in nature and are viewed as economically stable, with the current demand for biofuels (see " How to Invest in Food Stocks "), the food processors are being challenged by price inflation stemming from raw input costs. This is forcing the food producers to absorb higher than usual costs or pass them on to the end consumer.

    To some extent, this state may change or even void the conventional investment themes of "safety" for the food processing and packaging companies. In the current financial environment, we are experiencing a reverse impact of a slowing economy and rising food prices, as we watch investment dollars flow away from this process/package segment toward the more risky agricultural and biofuel companies (see " How to Invest in Food Stocks ").

    However, be forewarned that while investment balances may shift in short periods of time (a few months to a few years), over the long-run we will have a return to normalcy, so be careful how much (and for how long) you are willing to bet on the shift from consumer staples to agricultural stocks.

    Beverages

    Whether you have dinner at home or go out to a restaurant, there is always room at the table for a beverage. Beverages run the gamut from bottled water to soft drinks to sports drinks to beer to hard liquor. No matter what the occasion, there is likely room for a liquid refreshment to wash down your meal or go with those nachos while watching the ball game.

    There is an interesting twist when it comes to the carbonated soft drinks part of the beverage market. It is split into two components: syrup manufactures and bottlers. The syrup manufactures, like Coca-Cola (KO) will hold the patents for the soda flavorings and manufactures the concentrates and syrups for their products. The concentrates and syrups are then sold to the bottling companies that manufacture, bottle and distribute the final products which you drink out of a can or bottle at home. For Coca-Cola, the bottling arm is Coca-Cola Enterprises (CCE).

    Something else that the beverage companies have done over the course of the last one to two decades is to diversify their core business model beyond their primary product lines. Both PepsiCo (PEP) and Coca-Cola have gone beyond traditional soda pop into water, juices and sports/energy drinks. In addition, these companies are also verticality integrating into the foods business through the purchase or development of snack food labels. For example, Pepsi owns Frito Lay while Cadbury Schweppes (CSG) is a conglomerate of confectionary and beverage businesses.

    To whet your investment whistle, here is a look at a few public companies in the beverage section of our food chain:

    BEVERAGES
    Company Ticker Symbol Price
    2/22/2008
    2007
    EPS
    2008
    Est. EPS
    Coca-Cola (KO) 58.26 2.70 3.02
    Coca-Cola Enterprises (CCE) 24.21 1.39 1.52
    Pepsico (PEP) 71.38 3.38 3.73
    Pespi Bottling Group (PBG) 47.81 2.20 2.37
    Anheiser Busch (BUD) 47.81 2.78 3.02
    AMBEV (AVB) 80.39 2.74 3.22
    Cadbury Schwepes (CSG) 45.81 2.04 2.10
    Molson Coors Brewing (TAP) 52.91 2.80 3.40

    Retailers

    We have to buy all of these delicious food and beverage items somewhere. Traditionally, we did so at the corner "mom and pop" grocer. But as our society expanded in terms of geography and population, "supermarket" chain stores began to develop. The last step in grocery retail sales was the development of the "supercenters" (picture Wal-Mart (WMT)) and wholesale "member clubs" (picture Costco (COST)) which now dot our landscapes.

    What distinguishes the retail grocers from other parts of the food chain is that these businesses represent the highest volume, lowest margin companies in this broad category of stocks. As such, they rely on the ability to pass on large economies of scale to the end consumer (you) and in doing so they attract the consumer with the benefits of convenience, low prices and quantity.

    Over the past decade, via consolidation, the number of different supermarket chains has declined -- a trend we can expect to continue in the future. That said, the following is a snapshot of food retailers you might want to check out.

    RETAILERS
    Company Ticker Symbol Price
    2/22/2008
    2007
    EPS
    2008
    Est. EPS
    Wal-Mart (WMT) 49.97 3.13 3.40
    Kroger (KR) 25.74 1.70 1.90
    Supervalu (SVU) 27.94 2.74 3.06
    Safeway (SWY) 29.75 1.99 2.29
    Whole Foods (WFMI) 36.76 1.29 1.31
    Costco (COST) 66.02 2.63 2.99

    There is a plethora of investment opportunities in this middle part of the food chain. I want to emphasize that we are now ensconced in a very unique economic environment where consumer staples may not necessarily be the most ideal investments for a slowing economy. Furthermore, because of the sheer size and diversity of the companies mentioned, before you commit any capital , you need to factor in global economic conditions and foreign exchange considerations when formulating an investment decision (see " A Guide to International Investing ").

    Finally, if you prefer to invest in sectors rather than specific stocks, a focused ETF called the Consumer Staples Select Sector SPDR (XLP) is worth researching. This ETF's top 10 holdings include many of the stocks mentioned in this lesson.

    At the time of publication, Rothbort was long PEP (via a small amount in a personal trust), although positions can change at any time.

    Scott Rothbort has over 20 years of experience in the financial services industry. In 2002, Rothbort founded LakeView Asset Management, LLC, a registered investment advisor based in Millburn, N.J., which offers customized individually managed separate accounts, including proprietary long/short strategies to its high net worth clientele.

    Immediately prior to that, Rothbort worked at Merrill Lynch for 10 years, where he was instrumental in building the global equity derivative business and managed the global equity swap business from its inception. Rothbort previously held international assignments in Tokyo, Hong Kong and London while working for Morgan Stanley and County NatWest Securities.

    Rothbort holds an MBA in finance and international business from the Stern School of Business of New York University and a BS in economics and accounting from the Wharton School of Business of the University of Pennsylvania. He is a Professor of Finance and the Chief Market Strategist for the Stillman School of Business of Seton Hall University.

    For more information about Scott Rothbort and LakeView Asset Management, LLC, visit the company's Web site at www.lakeviewasset.com. Scott appreciates your feedback; click here to send him an email.

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