It can be easy to take for granted the sprawling industry that creates much of what we eat and transports it to grocery store shelves in neatly wrapped pouches and colorful boxes. The packaged foods industry obviously enjoys some staying power -- after all, the world has to be fed -- and exhibits some attractive investment characteristics as well.
What is the packaged foods industry?
The packaged foods industry consists of companies that enclose food in a variety of materials, including plastic, glass, paperboard, and aluminum canning, for retail sale. Packaged foods include savory snacks, confections such as chocolate and candy, staples including cereals and oatmeal, packaged meat and seafood, fruits, cheeses, vegetables, and condiments such as ketchup. The category also includes ready-to-eat packaged meals.
How big is the packaged foods industry?
The global packaged foods industry is a massive $4.4 trillion market. According to industry advisory RTS Resources, the market will expand to $5.0 trillion by 2017. The 50 largest global packaged foods companies, public and private, accounted for $558.9 billion in revenue alone in 2013, according to the website of Food & Beverage Packaging magazine.
How does the packaged foods industry work?
Easily recognized names such as Nestle, Tyson Foods, PepsiCo (which owns the Frito-Lay snacking business), Mondelez, Hershey, Kraft, and Unilever dominate the packaged food business. These companies have billions invested in manufacturing operations and enjoy worldwide distribution of their products.
Multinationals rely on intricate supply chains to convert farmed food to the packaged products bought in retail establishments. Common foods purchased at grocery stores often have extremely complicated distribution logistics. For example, ice cream is a product that requires refrigeration from point of manufacture all the way to store cooler, necessitating delivery via a "cold chain," or a refrigerated supply chain.
Snacks such as potato chips also demonstrate the challenges inherent in this industry. As chips are a light and fragile product, manufacturers must bear the expense of shipping chips from production plants to stores in a manner that protects the product. No one likes to open a bag of broken chips; thus, the packaging can't be simply compressed tightly together to optimize shipping costs. Some packaged-food companies take the costly step of owning their own transportation assets to protect their products in transit.
Through distribution, packaged foods find their way into a number of different retail outlets. Most prominent in developed countries are grocery stores, although in the past few years, pharmacy chains, dollar stores, and mass-merchandisers such as Costco have all increased packaged foods offerings.
In the developing world, while the grocery store concept is gaining traction, a good portion of packaged-goods items are sold in neighborhood stores and kiosks. This can create an interesting competitive dynamic, as local products compete shoulder to shoulder with multinational brands in the humblest of retail spaces.
What are the drivers of the packaged foods industry?
The success of packaged goods companies is very closely tied to economic growth and consumer discretionary income. Rising incomes can boost the prospects of industry leaders such as Mondelez, especially within developing markets. In developed markets, however, rising incomes have the potential to hurt corporations like Mondelez's grocery spinoff, Kraft, since consumers who feel more comfortable about the economy tend to increase visits to restaurants, thereby purchasing fewer prepackaged meals (e.g., Kraft macaroni and cheese).
Emerging markets also drive the industry. This is true particularly in Asia, where migration from rural to urban areas continues unabated, especially in China and India. As traditional diets are abandoned, consumption is becoming more "Westernized," with an emphasis on processed and packaged food. By 2015, China is expected to overtake the U.S. as the world's largest packaged foods market by volume. China's hunger for packaged food can be seen in the fact that pasta and soy products are one of the fastest-growing segments of the industry. India's packaged foods market is similarly expanding rapidly, and at a compounded annual growth rate of 20% per year, it's projected to reach a size of over $30 billion by 2015.
Mergers and acquisitions are a third driver of this industry. Mexican bakery giant Grupo Bimbo is one of the largest suppliers of baked goods in the world, with over $13.8 billion of sales in 2013. The company has generated its growth in part by acquiring leading brands in Latin America, North America, Europe, and Asia. In the U.S., Grupo Bimbo owns popular baked-goods brands Entenmann's and Sara Lee.
For the investor, most of the potential in the packaged foods industry lies in its modest but stable annual growth rate of around 3%. Corporate profit margins tend to be healthy: The Yahoo! Processed and Packaged Goods sector, an index of packaged foods companies, shows an average net profit margin of 8.3%, and an average return on equity of 23.5%. The stocks of these companies, many of them long-standing and well-regarded names such as General Mills, tend to be popular with those seeking a defensive investment, perhaps to balance out more aggressive positions in a stock portfolio. Finally, prominent corporations in this industry, such as Campbell Soup and Kellogg, pay out handsome dividends. With a broad base of both growing and mature corporations, the massive packaged-food industry presents diverse opportunities for long-term investors.
Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Costco Wholesale and PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.