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Supply, Demand, and Organic Industry Risk

By Alyce Lomax - Jul 14, 2014 at 5:40PM

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In investing, do you “buy organic”? Consider this growing risk.

The number of consumers shopping for organic foods is burgeoning. This is a tremendous opportunity for some of the companies that have a competitive edge in this market, but it's also a double-edged sword. It's clear that a slew of companies want in on the game, but pursuing growth in the organic space is far more complex than it seems. These companies are poised to harvest the growth in the sector; the problem is, our food supply remains mostly conventional. 

I feel positive about the business missions and investment opportunities inherent in the following stocks. Still, it's unwise to ignore some risky ingredients when it comes to growth.

A cartful of questions investors should ask
The good news? The changing consumer attitude is ringing up more transactions at the register. The difficult part: Organic food supply is big on avoidance of agricultural practices like genetic modification. GMOs are incredibly prevalent in the American food supply as it stands now.

This issue is relayed in many risk factors in such companies' SEC filings.

Chipotle Mexican Grill ( CMG 2.02% ): The fast-draw burrito slinger is shifting toward more ingredients-related food philosophies such as local produce and naturally grown meat. Food With Integrity rocks. On the other hand, it represents risk to the growth area. According to the company's most recent 10-K:

Crops grown organically or using other responsible practices can take longer to grow and crop yields can be lower. It can take longer to identify and secure relationships with suppliers that are able to meet our criteria for meat, dairy and produce ingredients. Given the costs associated with what we believe are more responsible farming practices, and in some years due to decreased demand as a result of the weak economic environment, many large suppliers have not found it economical to pursue business in this area.

Annie's (NYSE: BNNY): The kid-centric packaged food company with the cute bunny brand has quite a few challenges right now, which makes it the riskiest stock on this list, but one particular challenge has been dogging it in fiscal 2014: supply. From its most recent 10-K:

...in fiscal 2014, organic wheat prices did not moderate as we anticipated, due to increased demand and limited supply... Cost increases for organic and non-GMO raw materials that exceed cost increases for their conventional counterparts may exacerbate these risks... We compete with other food producers in the procurement of organic ingredients, which are often less plentiful in the open market than conventional ingredients. This competition may increase in the future if consumer demand for organic or non-GMO products increases, if the number of producers of organic or non-GMO products increases or if existing producers expand competition for organic and non-GMO ingredients.

Hain Celestial ( HAIN -0.86% ): Everybody knows Celestial Seasonings' array of venerated tea, but the parent company owns a slew of organic and natural products, too. From its 10-K:

Our ability to ensure a continuing supply of organic ingredients at competitive prices depends on many factors beyond our control, such as the number and size of farms that grow organic crops ... [and] forecasting adequate need of seasonal ingredients. ... We also compete with other manufacturers in the procurement of organic product ingredients, which may be less plentiful in the open market than conventional product ingredients. This competition may increase in the future if consumer demand for organic products increases. This could cause our expenses to increase or could limit the amount of product that we can manufacture and sell.

Whole Foods Market ( WFM ): Much has been made of Whole Foods' goal to drop prices. The bright spot is a strategy that will grow mainstream demand for organic and natural foods even more. However, given supply issues, translation to higher costs could give Whole Foods a much more serious hurdle in this strategy. However, many investors perceive last quarter as a disastrous sign, and management's comments in the conference call underlined the climate:

We source our products from a variety of local, regional, national and international suppliers, and we rely on them to meet our quality standards and supply products in a timely and efficient manner. There is, however, no assurance that quality natural and organic products will be available to meet our needs. If other competitors significantly increase their natural and organic product offerings, if new laws require the reformulation of certain products to meet tougher standards, or if natural disasters or other catastrophic events occur, the supply of these products may be constrained..

Defined dichotomy
Supply and demand is a common risk in many companies. However, this particular factor is a truly mixed bag. Risk/opportunity is fraught with challenges in evolving markets.

Supply growing with demand is a simple economic concept, though, and we can't discount it knowing the changes in consumer tastes. As long as consumers keep showing an appetite for organics, more agricultural companies and food suppliers will provide the goods.There's absolutely no reason to believe these companies are guaranteed to underperform as the area evolves.

For example, Annie's 10-K disclosed an interesting caveat within the organic risk disclosure: Wal-Mart's increased demand for such products could be one of the drivers of increased production, and Wal-Mart's scale drives significant change in the marketplace.

Investors have currently lost their appetite for these heavily organic plays, with the exception of Chipotle. Still, in keeping with buying when the herd's fleeing, I see more opportunity than doom in these stocks. When it comes to the social responsibility factors I try to insert in the DNA of my portfolio, I believe these companies are blazing the path to a better, more positive world in many of their business practices.

That said, this area requires a watchful eye and a long-term view. Positive change is afoot; still, many companies could stand or fall.

Check back at Fool.com for more of Alyce Lomax's columns on environmental, social, and governance issues.

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

Chipotle Mexican Grill, Inc. Stock Quote
Chipotle Mexican Grill, Inc.
CMG
$1,676.67 (2.02%) $33.26
Whole Foods Market, Inc. Stock Quote
Whole Foods Market, Inc.
WFM
The Hain Celestial Group, Inc. Stock Quote
The Hain Celestial Group, Inc.
HAIN
$39.09 (-0.86%) $0.34

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

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