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The Food Processing Industry Has Hidden Potential

By Michael Nielsen - Mar 4, 2014 at 12:02PM

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The food processing industry is not viewed as a growth industry, however, I have identified three significant factors that suggest the industry will outperform the overall market over the next ten years.

Most analysts will agree that the food processing industry as a whole is a safe investment for one very obvious reason: unlike iPads, plasma screen televisions, or streaming movies, people will always need food. This simple, yet powerful reality eliminates certain risks from this industry that other industries will always have. With the economy headed in the right direction, it may seem counter intuitive to invest in an industry as stable as food processing since high returns are usually derived from high-risk investments. However, I believe the food processing industry has hidden potential that could cause it to outperform other industries in the long-run.

Potential growth factors
As emerging markets mature, more and more people around the world will acquire the means and the preference to consume processed foods. There is already evidence to support this theory: cheese exports during October of 2013 increased by a year on year rate of 42 percent. The Chinese doubled their purchases of milk from the U.S. in 2013 relative the 2012. This data makes it seem safe to conclude demand for U.S. processed food products could continue increasing well into the future. 

As the pace of life continues accelerating, many people are scrambling to be as efficient as possible. Millions of people are turning to the extensive varieties of microwave-entrees, single-serve packages, and just-add-water meals that save precious time on preparing food. For many Americans, the opportunity cost of preparing meals is higher than the premium paid for prepackaged meals. This demand for processed food should result in significant earnings growth for food processing companies. 

As one-person homes become more common, I predict a growing number of people will turn to the single-serving, prepacked dining option. According to the U.S. Census Bureau, one-person homes have become five times more prevalent since the 1950's and now make up 27% of all households. It is no wonder that companies such as Green Mountain Coffee Roasters have experienced such tremendous growth recently -the vast majority of its revenue came from its single-serving coffee maker. In September, 2013, Campbell Soup Company announced an agreement that will combine the convenience of Green Mountain's Keurig system, with the snack ability of Campbell's soup. As the trends of saving time and cooking for one continue, food processing companies will continue innovating new products for the growing level of time- conscious consumers which will result in significant growth in sales and earnings for food processing companies.

Price to earnings valuation 
Before we get too excited about the food processing industry, we should take a look at the price of stocks in the industry relative to their earnings, then compare those prices to the companies in the S&P 500 to determine if we are too late to invest in this industry. 

The price-to-earnings ratio is a handy tool for quickly measuring a companies' price relative to its recent earnings. Let us look at the average trailing price to earnings multiple of the food processing companies in the S&P 500 and compare them to the P.E. of the S&P 500 as a whole:

Average P.E. of the twelve food processing companies in the S&P: 20.06 times earnings

P.E. of the S&P 500 as a whole: 19.55 times earnings 

So, the food processing companies have a price to earnings multiple that is minutely higher than that of the S&P 500. This is by no means a red light for investing. 

Let us take it one step further and find the 4 "cheapest" companies of the twelve food processing companies in the S&P 500. 

Kraft Foods Group, ( KRFT.DL ) 12.11 times earnings
Kellogg Company ( K -0.79% ) 12.19 times earnings
Tyson Foods, ( TSN 0.59% ) 15.43 times earnings
ConAgra Foods ( CAG 0.09% ) 17.61 times earnings

Kraft Foods has the lowest P.E. ratio of 12.11 times earnings, however this is partly due its outstanding earnings of $4.10, since 40% of those earnings were caused by market based impacts to post-employment benefit plans, it seems investors took note of this and did not bid the share price higher. 

Kellogg Company comes in at second cheapest with a P.E. of 12.19 times earnings. I believe the low P.E. is a result of investors fretting over the future demand of breakfast cereal, which I believe is solid reason to be leery of buying Kellogg stock.  

ConAgra Foods, has dropped 13% in the last month due to lowered company earnings guidance caused by lower sales volumes of private label brands. I believe there is still some room for the stock to fall and would be careful buying into this downtrend. 

Tyson Foods, with a relatively low P.E. of 15.43 is my pick out of the four companies listed above. With strong growth prospects, recent analyst upgrades, strong revenue growth, and lower input prices for 2014, the upward trend of TSN shares should continue through 2014.  

As confident as I am in this investment, there is still a good chance the food processing industry and the individual stocks I mentioned will not beat the market in the long-run. However, the best reason to buy stocks in the food processing industry is not necessarily to profit from their potential growth—which may turn out to be significant— it is to protect yourself from the risks inherent in other industries that the food processing industry is not exposed to. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Kellogg Company Stock Quote
Kellogg Company
$63.08 (-0.79%) $0.50
Kraft Foods Group, Inc. Stock Quote
Kraft Foods Group, Inc.
Keurig Green Mountain, Inc. Stock Quote
Keurig Green Mountain, Inc.
Tyson Foods, Inc. Stock Quote
Tyson Foods, Inc.
$83.97 (0.59%) $0.49
Conagra Brands, Inc. Stock Quote
Conagra Brands, Inc.
$31.80 (0.09%) $0.03
Dean Foods Company Stock Quote
Dean Foods Company
Campbell Soup Company Stock Quote
Campbell Soup Company
$41.12 (-0.44%) $0.18

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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