Food Companies May Be a Healthy Repast for the Prudent Investor

What went up today? Or, to put it another way, into which sector of the market did money flow on a lousy day for most stocks? Consumer products and, more specifically, food companies.

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Speculation of Sweeter Offer Drives Up Bestfoods

This is getting to be something of a pattern. We've seen it for the last two months: When tech stocks fall with gut-wrenching speed, the unloved and often overlooked foodies rally. The rotation is continuing, and it may for some time to come.

Soup and snack foods may never be sexy, but the companies that make them are real businesses. Any way you slice 'em, their shares are cheap. Earnings expectations are so low that the chance of investors being disappointed and crushing these stocks is remote. And Abby Joseph Cohen, Goldman Sachs' market strategist, recently suggested a "market weighting" for consumer stocks rather than her previously recommended underweighting.

The yeast in today's rally was Unilever's (UN Quote - Cramer on UN - Stock Picks) unsolicited $18.4 billion cash offer for Bestfoods (BFO Quote - Cramer on BFO - Stock Picks). The bid values the maker of Skippy peanut butter and Hellmann's mayonnaise at $66 a share, a 30% premium to last Tuesday's stock price. Why a cash offer instead of stock? The Anglo-Dutch food and consumer goods company has enormous cash flow, and its stock trades about 50% below the all-time high. Bestfoods has so far spurned Unilever's offer. Wall Street analysts said today that they expect Unilever to sweeten its enticement.

Now is probably not the ideal time to charge into Bestfoods. Investors might do better to ignore several rather late buy recommendations from a few Wall Street analysts this morning. (One has to wonder at the usefulness of promoting Bestfoods with a price target of 75 a share when the stock is already trading at 62, up from Tuesday's 51 9/16 close.) Shares of Bestfoods would undoubtedly fall somewhat if it fends off Unilever's unwanted embrace.

Unlike technology companies, "food manufacturing companies" (isn't that an appetizing phrase?) are quite susceptible to fundamental research. In that light, a few cautionary words are in order:

• First, sales are not growing very fast, roughly in line with overall economic growth.
• Second, the winners will be those with the brands and scale that command respect -- i.e., increasing shelf space -- at the Wal-Marts (WMT Quote - Cramer on WMT - Stock Picks) and Costcos (COST Quote - Cramer on COST - Stock Picks) of the world.
• Third, competition is fierce and therefore management matters.
• Fourth, costs -- raw materials, packaging, distribution, labor and advertising -- are going up while prices may not.
• Fifth, what growth there is will likely go to the companies that can expand best overseas.
• And finally, the Unilever bid for Bestfoods is a sign that consolidation is the wave of the future.

It is not too late to do your homework. As of mid-April, the average large food company's P/E was 16 times this year's net income and about half the P/E of the S&P 500, reports Goldman Sachs' top food analyst, Nomi Ghez. Few food stocks have been bid up to outlandish prices. Yes, many big-cap companies have risen 25% from their 52-week lows, but those lows were in mid-March and followed a 22% decline since the end of 1999, according to Ghez.

Companies on many recommended lists include:

• Conagra (CAG Quote - Cramer on CAG - Stock Picks)


• Diageo (DEO Quote - Cramer on DEO - Stock Picks)


• General Mills (GIS Quote - Cramer on GIS - Stock Picks)


• Hershey Foods (HSY Quote - Cramer on HSY - Stock Picks)


• Hormel (HRL Quote - Cramer on HRL - Stock Picks)


• Kellogg (K Quote - Cramer on K - Stock Picks)
• Nestle (NSRGY Quote - Cramer on NSRGY - Stock Picks)


• Quaker Oats (OAT Quote - Cramer on OAT - Stock Picks)


• Sara Lee (SLE Quote - Cramer on SLE - Stock Picks)



• Smucker (SJM.A Quote - Cramer on SJM.A - Stock Picks)

Smaller-cap companies that have attracted a bit of investor attention are International Home Foods (IHF Quote - Cramer on IHF - Stock Picks), Suiza Foods (SZA Quote - Cramer on SZA - Stock Picks) and Del Monte Foods (DLM Quote - Cramer on DLM - Stock Picks).

A Food Watcher's Insights

One of the top food company investors is Thomas A. Russo, a partner at the investment management firm Gardner Russo & Gardner. Russo owns large slugs of Nestle and Diageo for his firm's clients. He recently met with senior management of Sara Lee and Quaker Oats, and he came away impressed.

"Sara Lee trades at about 16 times earnings if you annualize its first-quarter earnings," said Russo. "It sells at about 5 times EBITDA , a reasonable multiple of cash flow. The difficulty is that it has five different business units with several, like its food service business, lacking critical mass. On the other hand, the Hanes apparel business truly dominates the mass market and gives them a strong ongoing relationship with Wal-Mart and other mass retailers that helps the company get good placement for its food products. Sara Lee has been well-run for a long time and they are in the process of trying to become even better organized.

Somebody Doesn't Like Sara Lee, So Far Sara Lee vs. the S&P 500, one year

"Quaker Oats is somewhat more richly valued by the market, with a P/E of about 20," Russo went on. "But it has a magnificent business in Gatorade, which is supplanting soft drinks among many younger drinkers, and has shown superior revenue growth. It now has good management. The CEO is the former head of Kraft Foods [a unit of Philip Morris (MO Quote - Cramer on MO - Stock Picks)] and he is looking to streamline the company and optimize the scale of its various businesses. He has made good progress and I am watching to see how the rationalization of the company, especially in the breakfast foods business, behaves a year from now."

A Mover and a Quaker Quaker Oats vs. the S&P 500, one year

Russo hopes to earn a 15%-to-20% average annual compound rate of return on food companies. But he warns other investors that while there is still value in the sector, your return will in large part be determined by good analysis of the companies and by not paying too much.