Most Americans take for granted how easy it is to get food. Grocery stores are always fully stocked with everything from basic necessities to luxury items, and a wide variety of restaurants make it possible to go out to eat at a moment's notice. But behind all of that readily available food is an impressive distribution network that has to move millions of tons of fresh and processed foods every day. The food distributors that maintain those networks do an invaluable service to the population at large, but they also give investors opportunities to profit from their efforts. Let's take a closer look at food distributors.
What are food distributors?
Food distribution companies bridge the gap between the farmers, ranchers, and food processing companies that produce the food we eat and the grocery stores, restaurants, and other food retailers that sell that food to us. Some of the largest food distributors have nationwide distribution networks that include tens or even hundreds of thousands of different customers, while smaller local food distributors specialize in connecting a more select group of suppliers and retailers.
Regardless of the scope of any food distributor's business, the essential business model is the same. Food distributors build relationships with suppliers in order to make sure they can meet the demand they see from their end customers. At the other end of the supply chain, food distributors also keep in close contact with their grocery, restaurant, and food-service customers, ensuring they can meet and even anticipate changing needs, and make deliveries in an efficient and timely manner. Given the global scope of the food industry, the most successful food distributors have the capacity to deliver everyday staples as well as exotic products to cover nearly every situation.
How big is the food distribution industry?
With everyone needing food, the size of the food distribution industry is obviously large. According to the International Foodservice Distributors Association, total industry sales will come to $235 billion in 2014, and that only considers the portion of the industry that deals with prepared foods for restaurants, hotels, entertainment venues, and educational and health-care food services.
Add in the distribution networks that bring food products to grocery stores, and the size of the industry balloons even further. Figures from IBISWorld put the size of the grocery wholesale market at $137 billion. The actual level of activity is even higher, as many food retailers have started establishing and expanding their own distribution networks in order to boost overall margins.
For investors, the big publicly traded player in the business is Sysco, which has brought in more than $45 billion in revenue over the past year. Niche players like United Natural Foods serve smaller markets but have carved out profitable segments for themselves. To a large extent, though, much of the food distribution business is composed of local private companies, although part of Sysco's overall corporate strategy has been to seek smart acquisitions to add to organic growth. Sysco's $3.5 billion buyout of privately held U.S. Foods late last year is just one of the many consolidation opportunities in the business recently.
How do food distributors work?
Different food distributors have different business models. Some food distribution companies balance the needs of suppliers and customers, aiming to create their own lines of all-purpose products with an aim toward maximizing their profit from both ends of the spectrum. Other food distributors specialize in certain product niches, with a greater emphasis on the supplier side of the distribution chain by tapping into popular products and aiming to benefit from marketing efforts of the food producers that supply those products.
For instance, Sysco constantly builds partnerships with suppliers to ensure it has the raw materials it needs to deliver necessary products to its customers. At the same time, Sysco offers its own proprietary branded products to restaurants and other food-service providers, and although it also can deliver goods from well-regarded third-party brands, Sysco can maximize its margins when it keeps as much of its sales as possible coming from its own private-label products.
By contrast, United Natural Foods has aimed to cash in on the trend toward natural and organic foods. The company distributes more than 65,000 products from 4,000 suppliers, and it actually goes beyond food to include personal care and wellness products as well. United Natural has a close relationship with natural-foods retail giant Whole Foods Market, but it also supplies a host of smaller natural-foods stores, cooperatives, and other niche retailers with the products they increasingly want over conventional food products. United Natural relies on the rising popularity of natural foods to help drive demand for its products, and thus far, that's been a smart business model to follow.
No matter how efficient food distributors get, the business carries relatively small profit margins. In order to prevent food producers and retailers from cutting out intermediaries, food distributors have to provide good value for their services, and that keeps prices down even in segments where competition isn't as strong.
What drives the food distribution industry?
As with any intermediary business, the success of food distributors depends on being able to maintain profitability even as industry conditions change. Specifically, food production is largely a commodity business, so the costs food distributors have to pay in order to obtain the products they need can fluctuate wildly depending on supply and demand fundamentals in the underlying agricultural markets. Food distributors can use hedging strategies to reduce price volatility, but they still have to manage their supplier and customer relationships well in order to ensure they can pass through any price variations and maintain their profit margins.
At the same time, food distributors rely on consistent demand from their customers. Grocery-store demand is relatively stable, but the restaurant industry goes through definite business cycles, with tough economic times leading to fewer people eating out. That, in turn, can lead to dips in the amount of business food distributors do with ailing restaurant and food-service clients, leaving them vulnerable to the economic trends that affect dining behavior.
In addition, the costs of actually transporting food from place to place has a big impact on profitability. Large industry players like Sysco have their own fleet of trucks as well as taking advantage of third-party rail and intermodal logistics providers to improve efficiency and minimize fuel costs and other expenses. Efforts to incorporate hybrid/electric and natural gas-powered transportation options have also reduced exposure to energy markets, but food distributors still have to handle the inevitable fluctuations in those costs.
Food distributors have exposure to the agricultural markets as well as the restaurant and food-retail industries. Overall, though, with so many businesses not wanting to take on the challenge of figuring out how to obtain the food they need, food distributors play a vital role in taking that burden off the shoulders of food providers across the nation.
John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Sysco and Whole Foods Market. The Motley Fool owns shares of 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.