For decades, the commodity food business has been a race to brand supremacy. For common items such as cereals, breads, canned goods, and the usual grocery store gamut, the winner is the most familiar name with a logo we know and love. In this mini-margin game, the stakes are high and the consequences can be devastating. For investors in this space, understanding brand power and product stickiness is crucial to avoiding a portfolio pitfall. With that in mind, let's take a look at the biggest brand emerging in food retailing today, and what will lead to profits tomorrow.
A horse with no name
If you were thinking I had stumbled across the best thing since Lucky Charms, I have. But it doesn't involve catchy names or flashy labeling, and you will rarely see advertisements on TV for these products. The next big brand is terribly anticlimactic -- it's the no-name brand, or as grocers like to call it, "private-label."
You might feel duped right now, having clicked on a headline you thought promised riches in the form of well-advertised mass-produced grub, but this really is the biggest brand shift to take place on grocery store shelves in a while. Though the economy has recovered from the depths of the crisis, the idea of value-oriented, no-name brands has seemed to stick for food shoppers. Nielsen data shows that private-label brands now make up 22% of the packaged food business, up from 18.4% in 2007, according to The Wall Street Journal. For a more real-world view of the private-label growth story, look at Trader Joe's. For those who may be unfamiliar with it, Trader Joe's is a grocery chain that exclusively sells in-house items, all with the Trader Joe's name or some variant (hand soap is sold as Trader Jacques).
While the business model is apparently a state secret, the method seems to be working. In 2010, the company opened 22 new stores. CEO Dan Bane plans to open 30 stores a year going forward as the concept has taken off, mainly by word-of-mouth marketing.
One of the big suppliers for Trader Joe's foods is Ralcorp (NYSE:RAH). While certainly not a household name, Ralcorp also supplies products to wholesale behemoth Costco (NASDAQ:COST)(NASDAQ:COST). The food supplier is making headlines today as it was just picked up by food giant ConAgra (NYSE:CAG) for nearly $5 billion. This represents around a 25% premium to Ralcorp's value yesterday. The move makes ConAgra the second-largest packaged food provider in the country, behind Kraft Foods Group (NASDAQ:KRFT). More important, the acquisition makes ConAgra the largest private-label food provider in town (the town here being the United States).
One argument against the strength of private-label brands would be that they have actually slowed down in growth over the last two years, as people have recovered from the financial crisis and shifted back to bigger brands. While it is true that store labels are not growing at the rate they were in 2008 to 2009, it only makes sense that this would happen. It does not indicate, however, that the private-label trend is dying. Some people invariably switched back to big brands as their personal finances improved. We did not have a secret consumer meeting to plan for a unanimous mass exodus from Cheerios (though I am still down for that if anyone is interested). Really, it seems logical that some of that growth would lessen. But if you look at the increasing popularity of the aforementioned Trader Joe's, or even the "365" store brand of premium grocer Whole Foods Market, it's easy to see the movement is far from sputtering out.
In addition to a recovering economy, national food brands also have made a push in recent times to fight back against the private label. The evidence was clear a few years ago that people were drifting from premium-priced goods, and national food brand management teams aren't (that) stupid.
The bottom line is, national food brands have owned the shelves for a long time, and the consumer was long too nervous to buy an off-label jar of peanuts. But then, with the financial crisis, we all seemed to get over ourselves a little bit and realize that once you get by the drab labeling and the lack of a cartoon spokesperson, the food itself is largely the same quality. Embarrassingly, a couple of years back when visiting my parents, I screamed in horror when I found a CVS version of Cheez-Its in the pantry. It seemed impossible that a drugstore brand could ever replicate the culinary prowess of the flavorists behind the delicious sweet and salty cheese cracker. But after the initial shock, and the fact that there weren't any Famous Amos to be had either, I ate a brandless cheesy cracker.
I'll be damned if it wasn't the same processed, delicious, saturated-fatty goodness found in the more expensive, more attractive Kraft product.
Invest in anonymity
If you want to hitch a ride onto the private label train, your best bet may be ConAgra. There are a few other companies, such as Dole (UNKNOWN:DOLE.DL), that are shifting their focus to providing grocers with in-house goods, but ConAgra looks to be a safer bet as Dole still struggles with the impossible banana business and other low-margin produce.
ConAgra sells for 13.44 times its projected one-year forward earnings. That's cheaper than Kraft Foods' 17, and well below grocers such as Whole Foods and Costco.
We may have grown up on a sugar-addicted vampire who slings chocolate to little kids, or a giant, muscular green man peddling vegetables, but that doesn't mean the future holds the same respect for premium priced, perfectly marketed foods on the shelves.
Fool contributor Michael B. Lewis has no positions in the stocks mentioned above. The Motley Fool owns shares of Costco Wholesale and Whole Foods Market. Motley Fool newsletter services recommend Costco Wholesale and Whole Foods Market. 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.