4 Factors To Consider Before Buying 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.
There are several variables that you should consider before buying food marketers: (1) geographical exposure, (2) growth trajectory, (3) competition, and (4) return on invested capital. Competition is generally rising in the industry, so the best strategy is to buy companies that are penetrating high-growth emerging markets and possibly locking in a sustainable stream of free cash flow. Below, I review 3 food markets with this in mind.
The Good & Bad About Kraft Foods Group (NASDAQ: KRFT)
After spinning off its more popular snack business, Kraft is now left with just the domestic grocery business. It trades at only 13.6x forward earnings, but is forecasted for just 6.3% annual EPS growth over the next 5 years. This limited growth is largely the result of greater competition, as seen by (1) ConAgra's interest in dominating the private label food market with buying out Ralcorp Holdings and (2) McDonald's entry into bagged coffee. Perhaps equally as important, growth is likely to be much larger at the spun off company, Mondelez, both organically and inorganically (company is pursuing acquisitions in emerging markets). This will draw away investors who seek to capitalize on an improving macroeconomy.
However, there are several reasons to be optimistic. First, the 4.6% dividend yield target and absence of FX headwinds effectively place a basement on the downside. Free from "empire building,"the company is now focused on generating free cash flow that appropriately covers the cost of capital and thereby creates value. Right now, the free cash flow yield is at a reasonably 8.6% yield, which is fairly strong in light of the limited volatility. The price-to-book ratio of 1.5x is also well below the 6.8x industry average.
Even still, Kraft generates a return on invested capital of only 10.9%, which is around 320 bps below the industry average. Furthermore, I am not sure how much this figure can be improved from cost cutting in light of how operating margins are 400 bps above the industry average at 15.5%. Though no analysts rates the stock a "sell, 7 of 18 are still saying "hold," which is more or less tough love on the Street.
General Mills trades at a respective 16x and 14.2x past and forward earnings versus corresponding figures of 17x and 15.4x for Kellogg. General Mills is also forecasted for a 5-year annual EPS growth rate that is 130 bps higher at 7.9%. Assuming expectations are met, 2016 EPS will come out to $3.63. At a multiple of 15x, this translates to a future stock value of $54.45. This represents around a 9.5% annual return when you factor in dividend yields. For a company that is 83% less volatile than the broader market, this is an excellent return.
While General Mills is on track to meeting its EPS guidance of $2.65 and picked up momentum from Greek yogurt, its share in the cereal market has fallen to 31%. And even in the yogurt market, competition is rising and has caused some analysts to speculate the pressure on prices will by rise as much as 30% next year. PepsiCo's decision to distribute Muller Quaker yogurt in domestic markets, for example, will cut substantially into margins.
Kellogg's management also reaffirmed guidance. Going forward, the company's strategy includes innovating the North American business through product releases and reaching out to more consumers, particularly Hispanics, through TV advertising. I am also optimistic about the company's international strategy. In late September, the company entered a JV agreement with a Singaporean company to market cereal and snack products in the high-growth economy. Even though the company generates an incredible 17.6% return on invested capital, it has a high amount of debt (current ratio: 0.9x) and is very expensive at 8.9x book value. Accordingly, 17 out of 20 reporting analysts rate the stock only a "hold".
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