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Six months ago this column drew reader attention to a trio of food stocks that looked too expensive. One of them, snack specialist Snyder's-Lance (LNCE), has risen a bit since then, but the other two have plummeted.
Diamond Foods (DMND) has lost 62%. Questions have swirled around how it accounts for payments made to walnut growers. Last week, the company said the Securities & Exchange Commissions has launched a formal investigation.
Green Mountain Coffee Roasters (GMCR) has lost 43%. Early last month the company reported quarterly earnings that missed analyst forecasts for the first time in more than two years. Worse, the miss was owed to a big sales shortfall -- and inventories increased faster than sales. Some analysts have taken that to mean that demand for the company's K-cup brewing machines is slowing. Green Mountain management says it was owed merely to lumpiness in orders from retailers, and reiterated its forecast for sales growth of 60% to 65% next year.
Neither stock was helped by its valuation. Back in June, Diamond sold for 28 times earnings and Green Mountain, for 54 times earnings. Snyder's-Lance was a touch cheaper at 22 times earnings. The typical stock sells for closer to 14 times earnings.
Diamond and Green Mountain are hardly harbingers for the rest of the packaged food industry. The biggest financial uncertainty surrounding a giant, solid player like General Mills (GIS) is whether it will increase its dividend by double- or single-digit percentages in coming years. (It hasn't missed or cut a payment in more than a century.) But there are two things that should give investors pause about even the strongest names in food.
The first is that their shares have gotten expensive. Among 23 packaged food companies in the S&P Composite 1500 index, the median sells for a whopping 21 times earnings forecasts for its current fiscal year. Food is a slow growth business, with sales increases in developed markets linked mostly to population growth, inflation, new product launches and market share gains. Profit margins are vulnerable to volatile crop markets and price wars among competitors. Those aren't traditionally the attributes of companies whose shares fetch premium prices.
Blame fear. Investors are deeply worried about the threat of recession at the moment, and while food isn't the most profitable good around, future demand for the stuff isn't in doubt. Investors are paying richly for businesses that can survive a downturn. But chief among the things that predict tomorrow's stock performance is today's valuation, so expensive safe havens might not be as safe as investors are assuming.
The second problem is volatility. Food shares typically display less of it than the broad market. True to form, those 23 stocks have a median "beta" of 0.5, which suggests they've been about half as volatile as the S&P 500 in recent years. But a dissection of that number shows that the beta is 0.2 for periods when the market has broadly risen and 0.8 for periods when it has fallen. In other words, food stocks haven't been all that resistant to short-term market swoons.
All of this suggests investors should shop elsewhere for safety. For those who wish to stick with food, Campbell Soup (CPB), ConAgra Foods (CAG), Ralcorp (RAH) and Kellogg (K) are less expensive than the rest relative to earnings. They sell for around the broad market's average price, but not at a meaningful discount to it.
Those who are willing to pay full price should at least demand plump dividend yields. Lance's yield of nearly 3% has surely added to its appeal at a time when the 10-year Treasury pays about 2%. General Mills, Kellogg, ConAgra, Heinz and Kraft each pay more than 3%.
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