Slow Growth, FX Headwinds Overshadow Food Marketers

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

From inflationary cost pressures to FX headwinds, international food marketers have single-digit growth trajectories ahead. How do you succeed in this market? While I see few opportunities for outperformance, I think the industry offers a few stocks that are incredibly safe, even if they are also slightly overvalued. To be clear, none of the stocks highlighted below are poor investments; rather, they just have constrained momentum that precludes entry of high-growth investors. Accordingly, I recommend reviewing these stocks to determine which ones are ideal for a defensive portfolio.

Mondelez International : Poor Returns Ahead

Early last month, Mondelez (NASDAQ: MDLZ) split off from Kraft Food Groups. Mondelez retains the more popular core snack business, which includes favorite brands like Wheat Thins, Newtons, Cadbury, and Trident, among others. At 16.4x forward earnings, however, the stock is fairly expensive, especially when you consider, it has a yield of just 2.7%. But volatility is still less than half that of the broader market, and 11.8% annual EPS growth is forecasted over the next 5 years. Clearly, there is some value to be had. So, how is the business doing fundamentally?

In the third quarter, performance was in-line with expectations while Kraft Foods was ahead of consensus by 16.2%. The greatest potential comes in emerging markets, but profit realization thus far is being held back by FX headwinds. Operating income still gained over 9%, and revenue in the biscuit and chocolate categories remain strong in the mid- to high-single digits. Gum, on the other hand, has been challenging. Though revenue, overall, in 3Q12 was disappointing, 4Q12 is set for a rebound, according to management. However, management has guided for 2013 organic net top-line growth at the low end of its long-term 5-7% target. Even developing markets are only forecasted for just high-single digit growth.

All in all I recommend, avoiding the stock. Margins have expanded 90 bps during the last 9 months, but there are tremendous risks going into 2013. Inflationary inputs and FX headwinds are more of a long-term problem than a seasonal weakness. Brazil and Russia have also seen operational missteps, including lower pricing and contribution. A dislocation between consumption and distributor inventories have depressed momentum in those regions. And while this dislocation will be corrected, it's the slowdown in growth that is problematic.

General Mills Preferable Over Kellogg Company

Unfortunately, there are a lack of good alternatives. General Mills (NYSE: GIS) and Kellogg (NYSE: K) have <4% free cash flow yields and are rated around a "hold" or worse on the Street. Kellogg, for example, is rated a "sell" and has weak earnings momentum to drive returns. Over the past 5 years, it grew EPS by 6.2% annually-- a rate of 6.6% is forecasted over the next 5 years. Assuming expectations are met, 2016 EPS will come out to $4.40. At a multiple of 15x, this translates to a future stock value of $66. That is an average return of just 4% and does not warrant an investment. When you discount the future stock price by 10%, you find that the current price is around 25% overvalued.

General Mills has been a solid winner over the years. It has gone up and up and now is priced at its record high of $25.1 billion. What makes the stock so attractive to many is that it performs well in good times and bad. During the past 5 years, GIS went up around 41% while the S&P 500 slid 4.9%. Combined with the 3.3% dividend yield (a distribution has been in existence of 113 years), investors have been very fortunate with returns. However, the past is not an indicator of future performance. Management says that it is on track to hit its issued guidance call for earnings of $2.65 per share.

Yet ROA has climbed from around 5% in 2003 to 7.9% today. Gross margins have held relatively steady over the last decade, but competition is rising. So, all things considered, while the stock may not be undervalued, it is not risk-free.


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