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Food Stocks Spit Out By Investors

By Linda McDonough on March 29, 2017

Food stocks used to be a staple in every portfolio. While not very exciting, they offered stable growth, robust cash flow and typically, reliable dividends. The plan was that revenue would perpetually grow mid-single digits and costs would fluctuate based on commodity trends but always revert to the mean.

As the thinking went, everyone has to eat, so the reasoning followed that revenue growth would mirror population growth. But that investment arithmetic is changing.

In the past two weeks, many of the supersized food companies released their February quarters. General Mills (NYSE: GIS), Conagra Brands (NYSE: CAG) and McCormick and Co.(NYSE: MKC) each reported earnings that on the surface looked passable.

Yet analysts are throwing rotten tomatoes at them. Reported revenue for each of them missed conservative estimates, and each one warned of lower than hoped for revenue in 2017. Softness at grocery stores and heightened levels of promotion are the culprits.

It seems the long slow migration of consumers to healthier choices is continuing to pressure sales on what analysts call “the center of the store”. Anyone who’s ventured into a grocery store in the past 30 years is familiar with the racetrack layout of any grocery store. Produce, dairy and perishables are stored on the edge and processed foods in the center.

The reasoning behind this format was to force customers to trek down the aisles holding their highest margin inventory to get to the less profitable products. For you to grab that low margin gallon of milk from the dairy cooler, your local grocer would like to tempt you with a box of super profitable packaged cereal.

But consumers have become uber-aware of making healthy food choices. Fears over genetically modified meats or steroid boosted milk have led many consumers to pay up for significantly higher priced organic foods. These shoppers are sidestepping the center of the store where General Mills’, Conagra’s and McCormick’s products are shelved.

According to Natural Foods Merchandiser, dollars spent on “natural” foods are growing at four times the rate as traditional packaged foods. General Mills, for example, called out soup, refrigerated dough and yogurt as the most challenged food categories for them. Even in a food category like yogurt, which is considered a healthier food, General Mills is toughing it out with small, scrappy players producing what consumers believe to be a healthier product.

Giant food companies have been trying to join the Au natural crowd by buying up smaller organic players as quickly as possible. Last summer Danone S.A. spent $10 billion to buy White Wave, the manufacturer of Horizon and Silk soy and almond milk.

That deal followed Hormel’s $775 million bid for organic meat maker Applegate Farms and General Mill’s $820 million deal for Annie’s, maker of healthy macaroni and cheese.

The problem is that these deals, while very expensive, are not big enough to make a difference for these gigantic food companies. Besides, competition within the organic space has heated up with couponing and promotion becoming more common.

Consumer food stocks, bloated with debt and deprived of revenue growth, have a belly ache. I think the painful trend is here to stay. Younger generations are increasingly more careful about the foods they feed their families. These consumers are just beginning to fill their shopping carts to the brim and will weigh on processed food sales for some time.

At Profit Catalyst Alert we just closed out a put position in a food company for a 64% gain and still hold a few more that I think will be just as profitable. Staying on top of these trends and continuing to add more bearish food positions will hopefully keep subscribers rolling in the dough.

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