What's Cooking in the Organic Aisle?

Competition in the natural, organic, and gluten-free aisle is about to get a little more intense after Kraft Foods Group (NASDAQ: KRFT  ) announced that it wants to make its macaroni & cheese a little more organic. This move is directed at the leading organic macaroni & cheese brand Annie's (NYSE: BNNY  ) . Kraft also sells a gluten-free macaroni & cheese to compete Boulder Brands (NASDAQ: BDBD  ) . With all this action going on, it pays take a look at how all three companies compare and figure out which is the best investment for your portfolio.

Strictly all natural and organic
Annie's prides itself on being an all natural and organic food company. Its products are made without the artificial flavors, synthetic colors, and preservatives usually found in conventional packaged foods. Annie's makes over 135 products that are sold in over 26,500 retail locations in the U.S. and Canada.

One thing that I really like about Annie's is that the company does a great job in innovation and introducing new products. Just recently, the company introduced Rising Crust Macaroni & Cheese Pizza. I think this is a great idea, as it marries two of kids' favorite food items: macaroni & cheese and pizza. The product is made with organic flour, whole grains, and 100% real rBST-free+ cheese. I also think the product has a great price point of only $7.99, which should help spur sales of this new product.

One item that has me concerned about Annie's is that the company just updated its financial outlook last month. While the company expects sales to come in at the top of its guidance, earnings are likely to come in at the lower end of the spectrum. To me, this is a sign that margins are being pressured and that costs have gone up for the company along with its rising sales.

Annie's is also in transition, as its current CFO is resigning to spend more time with her family. The new CFO comes over from Molson Coors Brewing, but it will take some time for him to get familiar with all of the facets of Annie's business.

Everything gluten-free
Boulder Brands  sells its gluten-free products under the names Glutino and Udi's. Boulder's other brands include Earth Balance, Smart Balance and Level Life.

The biggest concern that I have about Boulder Brands is whether or not gluten-free is more than just a fad. A gluten-free diet is geared toward those individuals who have celiac disease, a condition where one has to avoid foods with gluten. While the market is there, only an estimated three million people have celiac disease. Those who do have it can opt to not buy pre-packaged gluten-free products and adopt more natural diets.

However, the gluten-free product market is still a $4 billion market, which is nearly triple what it was in 2008. Boulder Brands is set to benefit because the FDA has announced a new standard for gluten-free labels. The FDA set a minimum gluten limit of 20 parts per million in products labeled gluten-free. Boulder Brands has advocated this position with the FDA for years, and it is set to be a prime beneficiary of the new labeling rules because all of its products meet the minimum criteria.

The food giant
Kraft Foods getting into Annie's and Boulder Brands' markets is not good news for either company. Even though Annie's and Boulder Brands are ahead of Kraft in their respective markets, Kraft has the financial strength, distribution, and marketing to enter a market and quickly gain market share. Kraft's products include Maxwell House, Oscar Mayer, Philadelphia, Planters, Velveeta, Capri Sun, Lunchables, and JELL-O.

In terms of macaroni & cheese, Kraft is going to remove artificial dyes in favor of natural spices for next year's version of Kraft Macaroni & Cheese. This follows the company's lead in Europe, where it replaced Yellow No. 5 with paprika and beta-carotene. Kraft realizes that consumers, particularly parents, are becoming more health conscious and concerned about what goes on the dinner plate. Kraft will also introduce the same in its gluten-free version.

In the third quarter, while net revenues declined 4.2%, operating income rose 14.9%. The strongest operating segments were cheese and refrigerated meals, but beverages were weak because of higher commodity costs. Desserts, particularly the JELL-O line, also remained weak for the company.

Going forward, Kraft expects revenue to be in line or slightly lower than the overall North American food and beverage market. The good news is that the company expects to post earnings per share of $3.58, which is an improvement over the $3.10 per share it earned last year.

Foolish assessment
I think the best bet in the space for investors is to go with Kraft. The company offers a 3.8% dividend yield and has a lower P/E multiple than Annie's or Boulder Brands. Kraft, more impressively, has the highest operating margin of the three companies at 19%.

While Annie's and Boulder Brands might have more growth potential because of their smaller sizes, I think the entrance of bigger players like Kraft is a long-term negative. I think it's best to veer on the side of caution in this space and go with a more diversified food company for the long haul.

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