Food Sector Gets Crushed But Opportunity May Lurk

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

We already know that there are certain segments within the market that have gloomy outlooks. For example, there are certain industries such as sliver, ethanol, and coal that are considered “weak”. But one space that many might not consider “weak” is food, because after all, we must eat to survive. Yet according to analysts, food companies are a “Sell”! Personally, I am not so sure.

Food Demand Grows, It Does Not Decline!

According to the U.S. Census Bureau, the population in the US was more than 311 million people to end 2011.  PBR Country profiles estimate that this number will grow by at least 80 million in the next 37 years, or nearly 30%. Therefore, with the food business being such a secular industry (an industry that grows regardless of the economy) that is dictated by population growth, how is it that firms have such a negative outlook for the companies within this space?

Goldman Pushes the Space Lower

In case you didn’t know, General Mills (NYSE: GIS), Campbell Soup (NYSE: CPB), and J.M. Smucker (NYSE: SJM) all received downgrades on Friday for the same reason: A weak outlook. Goldman Sachs downgraded all three. The firm removed Campbell Soup from its Conviction Buy list, downgraded J.M. Smucker to “Neutral,” and General Mills to “Sell.” As a result, all three of these stocks traded lower on Friday.

In the food industry downgrade, Goldman Sachs issued a note implying that fundamentals are expected to decline and high valuations make the space unattractive. Furthermore, General Mills, which received the most harsh downgrade, is rolling out a number of new cereals and has chosen to focus on this brand in 2013. Yet this is a space that declined 3% in 2012 and Goldman Sachs believes that this decision will be the beginning of its fall.

The downgrades to this sector caught much of Wall Street by surprise. However I think the real factor to determine whether or not downside exists is valuation. Because after all, it might not be fair to suggest that all stocks will trade lower, as each company is different. General Mills offers a number of products but sees a large portion of its earnings from cereal. Campbell’s main business is soup and J.M. Smuckers is primarily a sweets company. Therefore, to suggest that the outlook for all three is gloomy is to suggest that the outlook for food is dim, which is somewhat hard to believe.

Choosing an Investment

With these three companies operating in the same space, I took some time to look through and compare each from a valuation and fundamental point-of-view. The first thing I notice is that these are three companies that are valued almost identical in terms of price/sales, forward P/E ratio, cash flow (compared to market cap), margins, etc. However, like I said, no two companies are created equally, and in my opinion, there is one clear choice as the best.

General Mills does face some adversity with its cereal business, but overall is a very solid company. With a forward P/E ratio of 14.01 it’s hard for me to understand how the company’s valuation played a role in the “Sell” rating. This is a company that has increased its dividend by 65% over the last five years, has a forward yield of 3.20%, and has institutional ownership of 70%. Therefore, I am not certain of how much downside could exist.

In my opinion, Campbell’s is the worst of the bunch, yet has the highest rating. The company’s growth is equal to the other two yet has nearly 9% of its float being short. Furthermore, the company has institutional ownership of 43% and has only increased its yield by 32% over the last five years. Therefore, in a weak economy, I think Campbell’s presents the greatest likelihood for loss.

J.M. Smucker is my choice for the top pick of the three on this list. Once again, the metrics and the fundamentals are all comparative based on valuation; but the company does have slightly better growth. The stock has the highest institutional ownership, nearly 75%, and has increased its dividend by an incredible 90% over the last five years. Therefore, the company’s very shareholder friendly, along with having very attractive metrics.

Conclusion

After looking at each stock, I see no reason for so much pessimism. All three were pushed lower on Friday on fears of weakening demand. However, all three operate in industries that will remain strong due to an increase in population and all are attractively valued. Therefore, it might be wise to use the selling as an opportunity to buy one of three stocks that should remain strong, regardless of the market.


BrianNichols has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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