This Food Stock Has Good Near-Term Upside Potential

Anjali is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Most of the food giants, including General Mills (NYSE: GIS), ConAgra Foods (NYSE: CAG) and Kellogg (NYSE: K), have suffered a great deal over the last year and their shares have significantly underperformed the broader markets. The following chart summarizes the stock price movement of these companies over the last 12 months.

 

We can see that while the S&P 500 has gained more than 17% over the last year, shares of General Mills and Kellogg have actually seen a decline. However, the earnings of food companies seem to be improving, as anticipated inflation relief in the near term is benefiting gross margins while lower pricing is driving volume gains. After struggling for most of the year, both General Mills and ConAgra Foods posted better than expected earnings last month; as a result, their shares are finally seeing some upward momentum.

While I expect grain, meat, and dairy inflation to be a headwind for 2013, I believe companies are well hedged through year end, with a benign inflation outlook for manufacturers. Overall I am positive on the food sector, given its relative valuation vs. other staples (valuation gap between packaged food and other staples sectors has widened to 15%) and a higher probability of consensus EPS beats. Kellogg would be my choice for a food company that has a good upside versus expectations.

Why Kellogg?

Kellogg is set to report its Q3 earnings on Nov. 1, and I expect good results as EPS beats by General Mills and ConAgra Foods depict strong earnings trends from packaged food companies; particularly for companies where inflation fears tied to this summer’s drought have caused recent underperformance.

Kellogg guided to a very high number (7%) for inflation this year, but the company’s commodity inflation might not be that bad considering ConAgra’s commodity inflation for the last quarter came in at 3% (significantly below the 4%-6% the company previous forecast for the year). General Mills is also expecting a modest cost inflation of 2%-3%. 

Kellogg is buying "food grade" grains that are grown in a wider swaths of the country that have been less impacted by the drought. Moreover, the spike in grain prices is likely to be short-lived, as the inflation is supply-related rather than demand-related. South American countries are increasing land area to compensate for the U.S. drought, and livestock producers are finding substitute sources of feed.

Kellogg also has a room to post better volume in its core category, as General Mills has backed off in Cereal promotion in US and Europe. Thus, I see a path for near-term outperformance at Kellogg as it should benefit from the market share losses that General Mills alluded to in both the U.S. and in Europe.

Another positive is the strong showing of Kellogg's newly acquired Pringles business. The company recently indicated that the strong performance from Pringles brand offset the anticipated costs a recent recall of Mini-Wheats cereal. Moreover, the acquisition of Pringles provides significant ongoing synergy opportunities, as the company expects $50-$75 million in cost savings exclusively from P&G overhead reduction.

To sum up, I think Kellogg offers a good near-term upside potential. We have already seen that other food companies have lowered their commodity inflation guidance, and thus I think Kellogg’s commodity inflation this year might not be as bad as feared. Moreover, the company should gain market share from General Mills in the cereal category. Kellogg’s recently-acquired Pringles is posting good results and offers a good long-term growth prospects.

Longer-term, the health of Kellogg appears to be solid and the company continues to leverage profits from the successful execution of its volume-to-value strategy against its brands. Thus, I recommend buying it.


AnjaliPaliwal has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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