How to Feed a Dragon and Make Money

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In the past couple of weeks, two major transactions have highlighted the rising food demand in China.

Earlier this month, Smithfield Foods (NYSE: SFD), a producer and marketer of fresh meat and packaged meat products, agreed to be acquired by China’s Shuanghui International Holdings Limited. This week, Campbell Soup (NYSE: CPB) announced that it will acquire Denmark-based Kelsen Group to boost its presence in China.

The past decade of Chinese industrialization led to rising income levels, resulting in a change in dietary habits and raising food demand. In addition, China is now moving from an export and investment-led growth model to a consumer-led growth model. This should further increase demand for food products.

Ever rising food demand

If the past decade was all about China’s appetite for metals, the next decade is probably going to be all about the country’s rising food demand as its vast population gets richer.

China’s growing influence on global farm and livestock product markets was highlighted by the Food and Agriculture Organization (FAO) and the Organization for Economic Co-operation and Development (OECD) in their annual report on agricultural outlook.

According to the report, by 2022, China will overtake the European Union as the world’s leading consumer of pork on a per capita basis.

While changing dietary habits is a key driver for food demand in China, another major factor that will contribute to this trend is Chinese policymakers’ efforts to shift from an export and investment-led growth model to a consumption-led growth model. Several economists have already pointed out the urgent need for China to boost consumer spending as it transforms from a developing to a middle-income economy. Policymakers in China seem to have realized this. In the first quarter of 2013, domestic consumption was the biggest driver of growth.

How to benefit from all this?

While the FAO notes in its report that China’s food security has improved, the country will have to rely on global markets to feed its vast population. According to the FAO-OECD report, China’s consumption growth is expected to outpace its production growth by around 0.3% per year.

This explains the Smithfield-Shuanghui transaction. The acquisition will boost Smithfield’s pork exports to China. The transaction also addresses another major issue; food safety in China. Larry Pope, CEO of Smithfield, described the transaction as great for shareholders, as well as for American farmers and U.S. agriculture. Shuanghui Chairman Wan Long noted that the acquisition offers Smithfield the opportunity to expand its offerings to China through Shuanghui’s distribution network. Given the weak demand for meat products in the U.S., the transaction is a win-win for both companies.

However, it is not just meat and farm products that are seeing increasing demand in China, as highlighted by Campbell Soup’s acquisition of Kelsen this week. Kelsen is a market leader in the assortment segment of the sweet biscuits category in China, according to Campbell. Kelsen’s sales in China have grown at a compound rate of above 28% in the last three years. Denise Morrison, President and CEO of Campbell, noted that Kelsen will give the former a solid platform for growth in baked snacks in China.

Hormel Foods can also benefit from this opportunity

As more and more Western food companies build their presence in China to benefit from the country’s rising food demand, the question is how retail investors can benefit from this major trend. One of the stocks retail investors can look at is Hormel Foods (NYSE: HRL).

Based in Austin, Minnesota, Hormel is a producer and marketer of meat and food products. Hormel may come as a surprise to some, given that the company this week lowered its earnings forecast for fiscal year 2013. In fact, the downward revision led to a pullback in HRL shares, which have gained more than 27% this year. However, Hormel is a long-term play, and it presents long-term opportunities from in China.

Hormel lowered its outlook for fiscal 2013 earnings from $1.93-$2.03 per share to $1.88-$1.96 per share mainly due to lower-than-expected results in its pork operations, higher input costs and softer sales of its retail products in the refrigerated segment. However, CEO Jeffery M. Ettinger is bullish about the company’s future earnings potential.

Ettinger’s bullish outlook is being driven partly by a thriving international business. In the recently reported fiscal 2013 second-quarter results, Hormel posted a 21% sales growth and a 21% improvement in profit in its international & other segment. The improvement was partly driven by better results by the company’s operations in China. In a conference call following the quarterly earnings, Ettinger noted that the company expects continued sales growth and efficiency gains from its business in China.

In addition, Hormel is also expected to benefit from the acquisition of the Skippy® peanut butter business. Skippy peanut butter is a leading brand in China. Hormel has closed the acquisition of Skippy’s worldwide business, except in China. The company expects to close the acquisition of China business by the end of its fiscal year 2013.

HRL shares have seen a pullback in the last two days, however, this should be seen as a buying opportunity, given the company’s long-term outlook. The stock trades at a Price/Earnings (P/E) multiple of 20.99, which is higher than,Tyson Foods’s P/E ratio of 17.56. However, Hormel has a diversified business, and is seeing an improvement in its China operations.  Therefore the slight premium is justified.

Rising food demand in China offers an excellent long-term opportunity for food processing companies. Given their improving operations in China, Hormel is well-positioned to capitalize on this opportunity.

Varun Chandan Arora 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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