Is There Grow Juice in These Small Food Producers?

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

Food production is naturally a critical part of keeping society going, and companies with smaller market caps are more likely to experience heavy growth than companies that are already extremely large. But these two components aren't necessarily enough to guarantee that a stock will grow. Let's look at a few of the smaller diversified food companies and see if they have what it takes to produce bumper crop share prices.

A bright little candle

Lancaster Colony (NASDAQ: LANC) has some solid reasons to be called a good company. For one, Lancaster has paid 200 quarterly cash dividends and has a yield as of this writing of 1.9%. For another, the company has gathered popular brands such as Simply Dressed salad dressing, New York Brand Texas toast and Sister Schubert's rolls. Beyond these reasons, Lancaster Colony is rocking a 9.4% dividend yield. Between decent brands, solid profit margins and a sweet little dividend, there's a lot to like about Lancaster's chances of strong growth.

Of course, nothing is perfect. For one thing, roughly 20% of Lancaster's sales depend on Wal-Mart. If Wal-Mart's sales suffer, so do Lancaster Colony's. If Wal-Mart ever decided to cancel its contract with the smaller company, that's an instant loss of 20% in sales that would need to be made up in a hurry.

Beyond this, Lancaster has some serious competition in narrowly niched companies and from major diversified food companies like Kraft, Blyth and Heinz and additional competition in the company's CandleLite business. Further, for a company with a $2.3 billion market cap, paying a dividend is a risky proposition because it has the potential to sap valuable cash that might be better reinvested into the company. Overall, if Lancaster's earnings multiple were to get down below the S&P 500's, I would rate it a solid buy.

Stunted growth power

Pinnacle Foods (NYSE: PF) has an interesting story. The company is fairly young, having only been started in 1995 and having only come back to being publicly traded in 2012.  Being built as a mini conglomerate of different brands that no longer fit with their original owners' core businesses and buying them at reasonable prices, Pinnacle has acquired the likes of Birds Eye, Van de Kamp, Swanson TV dinners and Vlasic Pickles. Delivering a 3% dividend yield and being a serious player in the frozen and shelf stable-foods segment, the company offers shareholders a nice incentive to hold on and enjoy the ride.

However, there are disadvantages to be found here. For one thing, Pinnacle's acquisition by Blackstone and relatively recent new IPO means that the company is still primarily held by the private equity group, which may weaken the average shareholder's say in company operations. Beyond that, Pinnacle is only pulling a 2.7% profit margin, which could limit the amount of cash the company has for expansion. Further, trading for an earnings multiple over 30 means that Pinnacle is not the sweetest deal around.

I would recommend avoiding Pinnacle if you're looking for growth. However, if the share price drops into an earnings multiple in the 10 to 15 range, I would suggest snapping up some shares as a nice income play.

Not quite flying the coop

Sanderson Farms (NASDAQ: SAFM) is the fourth-biggest chicken producer in the US, with 397 million chickens and 2 billion pounds of meat per year. Sanderson's big margins on prepared-chicken products come from a high consumer demand for convenience -- less preparation means things are easier on the consumer, and people will regularly pay for that even during bad economic times.

Sanderson also refuses to add things like salt or water to its chicken, making its birds more meat for the price than most of the company's competitors. So there are solid reasons to like the company. There is even a small 0.9% dividend to sweeten the pot somewhat.

Unfortunately, there are risks aplenty. For one, Sanderson's tiny $1.7 billion market cap means it may have more trouble than a larger company adjusting to commodity price fluctuations. With feed-commodity prices, foreign and domestic competition and demand for chicken being serious risks to the company's profit margins, and the margins themselves being 2.2% trailing, there is significant risk of Sanderson Farms stalling out and growing very little. The fact that the company is trading for nearly 30 times its earnings also doesn't say very positive things about its probable short-term share price prospects.

The Foolish bottom line

There is potential for small-cap companies, but this is easy to diffuse. Paying preemptive dividends, being highly sensitive to the sales of larger companies and having a strong sensitivity to commodity prices can hurt these companies a lot. Be wary of high current valuations and do your due diligence.

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Chris Hodge has no position in any stocks mentioned. The Motley Fool owns shares of Sanderson Farms. 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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