Inequality Scrambles the Snack Foods Market
Demitri is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There's a mini class war raging on aisle three. According to a recent New York Times article, PepsiCo's (NYSE: PEP) Frito-Lay has taken to pursuing both the high and low ends of the U.S. snack foods market, leaving the middle to drift along its salty path of no growth.
The article quotes Ann Mukherjee, an executive at Frito-Lay's North American branch, pointing out that "the rich are getting richer and the poor are getting poorer,” causing a split in the $20 billion snack market. High end treats like energy bars are attracting customers that have disposable income to burn, while value snacks like bulk tortilla chips are increasingly feeding those looking to trade down from fast-casual or fast food meals. The middle of the market, packed with traditional staples like Doritos and Tostitos, just isn't seeing growth.
Besides what it might say about American society right now, the fragmenting of the snack market promises to complicate the strategies of consumer food companies like General Mills (NYSE: GIS), Kellogg (NYSE: K), and Kraft (NASDAQ: KRFT) as they struggle to extract growth in the face of consumer dynamics that are breaking the market apart.
To set the stage, let's first take a look at how these food titans size up:
|EPS Growth (5 year)||3.83%||13.25%||6.13%||1.5%|
What stands out in this list is that, factoring in growth estimates, none of these companies are cheap. That's surely a reflection of their blue-chip status and the stellar brand portfolio that each of them has built over the decades.
Still, that doesn't mean there aren't bargains in this sector. All of these companies' stocks have lagged the broader market this year as investors continue to flee consumer-facing stocks on recession fears. And thanks to inflationary pressures coupled with a rough income environment for consumers, we have a unique chance to judge these companies' performance through the toughest of times. How well did they manage?
Pass (on) the Inflation
The consumer food staples industry saw massive inflation in raw material costs last year. Worse yet, this spike in costs came at a time when U.S. incomes have stubbornly failed to rebound. It's one thing to pass along higher costs to your customers but quite another to be able to raise prices while your customers' incomes are flat or declining.
Reflecting that balancing act, last quarter General Mills saw net snack sales rise in the U.S. by 3 percentage points, but that was only thanks to 9 points of increased pricing more than offsetting the 6 point drop in volume. Likewise, rising costs led Kellogg to book a drop in profit contribution from its snack business despite an increase in revenue from the group. The story was the same for PepsiCo's Frito-Lay: higher prices made up for a small drop in volumes.
Kraft alone was able to book minor increases in both revenue and operating profit from its U.S. snack business last quarter. The maker of Oreo, Fig Newton, and dozens of other leading brands is particularly worth watching. It is preparing to spin off its snack business later this year in what could unlock significant value for shareholders.
Overall, though, the story of the last year has been rough, with consumers reluctantly swallowing big price increases that only just kept corporate profits in line from the year before.
New, and Improved
But there was one area of organic revenue growth, and it was driven by innovation. Frito-Lay introduced new products including Doritos JACKED, to commercial success, and Kellogg also saw solid growth from its Special K Cracker Chips and Cheez-it brand innovations. Consumers were pressured by the weak economic environment, but they were still willing to give new products a try.
The real standout on the innovation front is General Mills which has seen strong growth in its Fiber One and Nature Valley brands. To its credit, the company maintained investments in advertising and R&D and has even bucked the industry trend by investing - instead of cutting - in the U.S. market.
General Mills caught flack in its latest conference call from analysts demanding to know why the company refused to "slow down" its investments like the rest of the industry. CEO Kendall Powell rejected the premise, responding "we get great new product innovation out of that investment." Cutting costs while investing in future growth is a tough balance to strike, but I think General Mills has been following the right long-term strategy.
The U.S snack industry, the highest margin business for many consumer staples companies, is reflecting serious pain from the American middle, shaking up what used to be a steady industry. But the toughest adjustments have already been made, and there is a lot of value in the sector. I think investors would be smart to nibble on two names in particular: Kraft as it prepares for its spin-off, and General Mills, as it looks to cash in on its long-term investments.
SigmaSwan has no positions in the stocks mentioned above. The Motley Fool owns shares of PepsiCo. Motley Fool newsletter services recommend PepsiCo. 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.