The size of the global food industry boggles the mind. Since there's no way to live without food, demand will always exist. Traditionally, that's made investing in food stocks a safe endeavor, serving up delicious returns to patient investors.
Consider that American households spend on average about $7,700 on food every year -- both at home and eating out, according to the Bureau of Labor Statistics. Multiply that figure by 128 million households for annual spending of nearly $1 trillion in the U.S. And this doesn't even touch the global food market -- which feeds a population over 20 times the size of the United States
The food business is huge and reliable. Any company that can harness efficiencies could reap enormous rewards, and many companies have capitalized on this simple truth.
These are the 10 largest food-related companies that trade on American stock exchanges:
|Company||Market Capitalization||It's a Food Stock Because It Is...|
|Amazon.com (NASDAQ:AMZN)||$990 billion||The owner of Whole Foods and a growing e-commerce grocery business.|
|Walmart (NYSE:WMT)||$327 billion||Reliant on grocery sales for over half of its revenue.|
|McDonald's (NYSE:MCD)||$162 billion||The world's most popular fast-food chain.|
|Costco (NASDAQ:COST)||$123 billion||A massive wholesaler of food and other products.|
|Starbucks (NASDAQ:SBUX)||$110 billion||One of the world's largest chains that sells food.|
|Mondelez (NASDAQ:MDLZ)||$78 billion||The owner of popular snack brands Nabisco, Oreo, and Ritz.|
|Target (NYSE:TGT)||$45 billion||A major retailer with strong grocery presence.|
|Kraft Heinz (NASDAQ:KHC)||$37 billion||The owner of popular brands like Kraft, Maxwell House, Oscar Mayer, and Heinz.|
|Sysco (NYSE:SYY)||$37 billion||A major food distributor.|
|YUM! Brands (NYSE:YUM)||$34 billion||The parent company of KFC, Taco Bell, and Pizza Hut.|
These businesses run the gamut in terms of industry. Most people wouldn't think of Amazon as a food stock, but it owns Whole Foods -- the grocery chain it bought in 2017 for $13.7 billion. And while we might think of Walmart as the place to buy just about anything, groceries accounted for 55% of the company's sales last year.
Even Sysco -- which doesn't grow or serve food on its own -- is intimately involved in the food value chain as the largest distributor of food in the country. Without Sysco, your grocery store or restaurant would have a tough time getting things from the farm to your kitchen table.
There are several industries touched by food: agricultural chemicals, farm machinery, diversified and specialized food products, wholesalers, grocery stores, distributors, and restaurants. In general, farms aren't included in the list because they aren't part of publicly traded companies.
How to evaluate food stocks
Because the food industry is so vast -- and there are so many niches, each with its own dynamics -- it's tough to cast a wide net and say, "This is how you should evaluate all food stocks."
That said, there are some common themes worth evaluating for each company:
- Sustainable competitive advantages, or moat: Something the company provides that no one else can -- which keeps the competition at bay.
- The strength of the company's balance sheet, including:
- cash -- including long and short-term investments.
- long-term debt.
- the dividend -- or quarterly payment you get as a shareholder.
- the dividend yield -- or how large that payment is relative to what the stock costs.
- free cash flow -- or the amount of money a company brings in from running its business, minus capital expenditures.
- Overall valuation: Based on various metrics discussed below.
It's important to mention that evaluating a company's moat can be done in different ways depending on the sub-industry the business operates in. For instance, we will use comparable-store sales -- or growth after filtering out the addition of new stores -- for restaurants, and case volume for distributors.
As you read through this, you'll notice several themes popping up again and again. E-commerce and delivery is certainly one of them. The introduction of loyalty programs to keep customers coming back for more and harnessing the power of high switching costs is another. And you'll see that millennials -- the largest group of consumers in the U.S. -- are looking for something different from their food vendors: food that is healthy and organic, and comes from small, local companies.
Now, let's dive in -- starting with the smallest of the top 10 to work all the way toward No. 1: Amazon.
10. Yum! Brands
Yum! Brands is the parent company to some of the most well-known fast-food chains in the U.S. -- and the world. That list includes Kentucky Fried Chicken (KFC), Pizza Hut, and Taco Bell.
Three years ago, buying shares of the company would have given you exposure to the company's fast-growing China segment. Today you have to buy shares of a separate entity -- Yum China, which was spun off in late 2016 -- for that.
But don't underestimate the size of Yum! Brands' operations. At the end of last year, the company had more than 48,000 locations worldwide. KFC is by far the most important, accounting for 47% of the locations and 53% of sales last year.
It's substantial that all of the locations are also franchised, meaning individuals around the world pay an up-front fee and a portion of sales to Yum! Brands in return for using the company's brand, distribution network, and back-office tools. While this cedes some control, it drastically reduces overhead costs -- or the costs related to buying land, constructing buildings, paying for electricity and staff -- for Yum! Brands.
By far, the most important moat the company has is the value of those brands. Anyone can make chicken, tacos, or pizza. The thing separating the wannabes from Yum! Brands is name recognition. Forbes rates KFC as the third-most-valuable restaurant brand in the U.S. -- behind Starbucks and McDonald's -- with a brand value of $8.5 billion. Pizza Hut and Taco Bell didn't make the list.
Brand value is not the best type of moat to have, though. Former hedge fund manager Mike Alkin said in January 2018 that millennials are becoming the dominant consumer group, and they want three things:
- Products from small companies.
- Local companies.
- Organic companies, if possible.
By its very definition, this eliminates all of Yum! Brands' businesses. That doesn't mean the company will disappear overnight, but it does mean it's crucial to monitor the most important metric at a restaurant chain: comparable-store sales, or comps. This measures the amount of sales existing locations generate year after year -- while filtering out the results of additional stores.
The results are mixed, with Taco Bell performing exceptionally well -- though it's the smallest of the three big brands. Pizza Hut has done poorly, and KFC -- the most important of the three -- has produced modest results.
But comps don't reflect the full picture, so we also need to examine the company's financials. Currently, it has $500 million of cash and investments on hand, but more than $10 billion in long-term debt. While that kind of leverage is more acceptable because of Yum! Brands' franchising model, it doesn't provide much wiggle room if an economic recession were to happen.
Free cash flow -- the money a company puts in its pocket every year, minus any capital expenditures -- is more than $1 billion. Management used just 39% of free cash flow to pay shareholders their dividend, which implies the dividend -- which has ranged between 1.4% and 1.6% since 2018 -- is fairly sustainable and has room for growth.
Investors should shy away from buying shares of the company now. Currently, shares trade for 32 times trailing free cash flow and 36 times trailing earnings. To put that in perspective, the broader market (read: the S&P 500) trades for 22 times trailing earnings.
In other words, Yum! trades at a 63% premium to the market. And yet, it doesn't have a stellar balance sheet or a very wide moat. There are better places for your money -- even if you're seeking a dividend.
Sysco is a global distributor of food. If you buy meat, canned or frozen products, poultry, dairy, or produce at a retail location -- there's a good chance it got there on a Sysco truck.
The key moat that protects this business is low-cost production. The company has spent decades building out its fulfillment and distribution network so it can connect food suppliers with grocery stores and restaurants at a lower internal cost than any start-up could ever dream of.
One of the best ways to measure how the company is doing is by looking at the growth of case volume (the amount of "stuff" being shipped) and inflation (whether or not the company is paid more per case).
For a mature company like Sysco, these growth rates are solid. Both the volume of products shipped and the price paid have -- with one exception in 2017 -- been positive.
The balance sheet isn't stellar: The company has $500 million in cash and investments, versus more than $8 billion in long-term debt. But that's not uncommon for a company investing heavily in infrastructure. Sysco can rely on relatively stable demand regardless of the economic climate (people need to eat, even during a recession).
The company produced $1.7 billion in free cash flow over the past year -- a figure that has grown more than 60% since 2015, a very encouraging sign. Less than half of that free cash flow was used to pay the company's dividend, which has yielded between 2% and 2.4% since January 2018. The best part? The stock actually trades at a discount to the broader market, at 21 times earnings.
But there's an important caveat: One of the reasons investors aren't paying more for shares is that they're worried about competition. Amazon is the king of fulfillment and distribution, and while it hasn't historically focused on food, the acquisition of Whole Foods indicates it will likely head in that direction.
While Sysco's moat protects it from start-up competitors, it doesn't make it safe from an Amazon incursion. Amazon has plenty of other businesses -- such as the lucrative Amazon Web Services -- that could subsidize a food distribution network. Sysco has no such defense.
For this reason, investors should be wary of buying shares until Sysco demonstrates it has a plan to protect its market share.
8. Kraft Heinz
Kraft Heinz was formed in 2015 when Warren Buffett's Berkshire Hathaway joined private equity group 3G Capital to merge two food conglomerates: Kraft Foods and Heinz.
The combined company is home to famous food brands including:
- Philadelphia cream cheese.
- Heinz products -- ketchup and mustard being the most popular.
- Kraft products -- including macaroni and cheese, cheese singles, and mayonnaise.
- Oscar Mayer hot dogs and lunch meats.
- Maxwell House coffee.
As with Yum! Brands, the key moat here comes from the brand value of these products. Unfortunately, none of them land on Forbes' top 100 list, and they are all exposed to the same shifting trends noted earlier: a preference by millennials for products from small, local, and organic producers.
One of the best ways to measure how the company is doing is via its organic net revenue growth (the blue line in the graph below). This factors out the effects of new brands bought by the company, or old ones it divests. This metric lets us know how popular existing brands really are.
You can see the company has had a tough time growing its key brands. In fact, trends have hovered below 0% growth for most of the past three years. And any pricing power (yellow line) the company might have had is disappearing. Consumers are more willing to go with off-brand food, which means Kraft Heinz is lowering costs to get people to buy more (red line). Those trends aren't great.
Neither is the company's balance sheet: more than $1 billion in cash, but over $30 billion in debt! And while free cash flow clocked in at $1.75 billion last year, that wasn't enough to cover the company's dividend, so the payout was slashed earlier this year.
Kraft Heinz also announced accounting irregularities that it was correcting -- which is never a good sign. Those irregularities make it difficult to accurately value the company. While it currently trades for 21 times last year's free cash flow, that might be pricey for a company with as little organic growth as Kraft Heinz currently has. The new dividend yield -- which hovers over 5% -- might be appealing, but investors seeking consistent and organic growth should pass.
Most people wouldn't think of Target as a food company. It's where you buy clothes and home furnishings and toys -- not groceries. But a look at the company's financial statements proves otherwise: Food and beverages accounted for roughly 20% of the company's 2018 sales. Furthermore, food draws customers into the store, where they buy other higher-margin goods.
Target is another company that has struggled mightily in the face of Amazon and the rise of e-commerce. Over the past 10 years, Target's stock returned only half (124%) the growth of the S&P 500 (239%). In the past, the company's brand and network of physical locations provided a moat: It was prohibitively expensive for a competitor to build out as many locations as Target. But when e-commerce came along, those brick-and-mortar locations turned from assets to high-cost liabilities.
That said, Target has made strides at taking advantage of its physical reach, and it has finally adopted an e-commerce strategy that appears to be taking hold.
In measuring comps (blue line), Target includes its e-commerce sales. You can see Target's pricing power (yellow line) has almost completely eroded. If that were the end of the story, it'd be bad news. But the company's e-commerce strength -- which started showing up in 2017 -- has increased the volume (red line) of products being sold markedly.
I'm not going to put my own money on Target -- as it still has to compete with Amazon and Walmart, and those are two of the most formidable foes in the world -- but I also wouldn't bet against it.
With $1.2 billion in cash versus $13.4 billion in debt, the company is highly leveraged. But it's otherwise quite healthy. The dividend yield has hovered above 3% for much of the past year; only 55% of the company's $2.4 billion in free cash flow was used to make that payment; and shares trade for 16 times trailing earnings -- a significant discount to the broader market.
Mondelez has a lot in common with Kraft Heinz: It's the parent company of some of the most well-known brands in the food industry, including Nabisco snacks, Ritz crackers, and -- perhaps above all else -- Oreo cookies.
Like Kraft Heinz and Yum! Brands, however, Mondelez has seen its moat attacked by shifting preferences toward small, local, and organic producers. Shares of the company have responded in kind -- returning only half (20%) of what the S&P 500 has (40%) over the past three years.
Like Kraft Heinz, Mondelez offers investors a key metric to watch: organic net revenue growth.
These trends aren't terribly impressive, but they aren't setting off any alarm bells either. As long as the company can sustainably grow sales at or above the level of inflation, the company itself should be fine.
Unlike Kraft Heinz, Mondelez has a healthy balance sheet: $8.5 billion in cash versus $12.9 billion in debt. That offers wiggle room should an economic crisis hit or demand drop significantly. The company's $2.9 billion in trailing free cash flow is also a strength. Less than half was used on the company's dividend -- which has yielded between 1.8% and 2.3% since the beginning of 2018. That means it is sustainable and has room to grow.
The company's price tag may raise eyebrows. After a steady run-up in 2019, shares trade for more than 28 times trailing free cash flow. If the company were better protected by more than just brand moat -- or if it were showing stronger organic growth -- it might be worth that price, but that's not the case right now.
It might seem odd to include Starbucks in a list of food stocks, but the company's food offerings accounted for one-fifth of sales last year, and its coffee shops are a common destination that likely takes customers away from other fast-casual chains -- earning it inclusion in this list.
At the end of last year, there were more than 29,000 Starbucks locations worldwide, half of which were licensed under franchising models and half company-operated. The flexible approach makes opening new locations in different countries much easier.
It's also crystal clear that Starbucks has become a major element in our daily lives. Thirty years ago, founder Howard Schultz realized Americans didn't have a "third place" -- outside of work and home -- to gather. He also saw that most Americans weren't enjoying all that the coffee culture had to offer.
By building out locations on a massive scale that offered both specialty drinks and a comfortable place to gather, the company became a cultural phenomenon. Shareholders have enjoyed returns of 26,000% since the company went public in 1992.
Like other chains on this list, Starbucks' key moat comes from brand value. It's considered the second-most-valuable restaurant brand by Forbes, its logo alone worth $17 billion. The company has also consistently reported positive comps.
An important word of caution here: Starbucks has been able to keep comps positive not by drawing in more customers (red line) but by consistently raising prices (yellow line). That has been enough to satisfy investors over the past three years, but there's no telling how long that approach can continue.
The business of running a coffee shop can be brutal. Small, local, and organic coffee roasters are starting to dominate the scene. That's great for local economies and the millennials craving neighborhood options, but less great for Starbucks shareholders.
So far this year, you could hardly tell this was the case. Shares rose 37% during the first half of 2019. And if we back out the effect of a massive payment from Nestle, free cash flow has been very strong as well: $3.34 billion. If we include the deal -- which calls for Nestle to market and distribute Starbucks packaged goods globally -- free cash flow was a whopping $10.5 billion. Only 54% of the $3.34 billion was used to pay the company's modest dividend, which has yielded between 1.5% and 2%.
But the share price seems far too high. While it's true Starbucks is a great company that's protected by a high-class brand, any business lost to local businesses in North America or Europe, or to start-ups like Luckin Coffee in China, could be a major obstacle. At 32 times free cash flow and 34 times earnings, shares -- in a company that isn't even growing traffic in existing stores -- are just too expensive.
Costco is a destination for many families. That's because, once you pay the annual membership fee of $60, you have access to bulk goods at lower prices than you'll find almost anywhere else.
In fiscal 2018, the amount collected from membership fees ($3.14 billion) was slightly higher than the company's net income ($3.13 billion). What does this mean? It means that after you account for operating expenses like paying employees, covering the electric bill, and everything else that goes with running warehouses, Costco didn't make a penny off the things it sold.
Normally, that'd be bad for business and great for consumers. But because of that all-important membership fee, Costco is able to run sustainably -- attracting new customers with low prices while still turning a profit.
Over the past nine months, something else has been happening: Comps have improved so much that membership fees are no longer the sole profit drivers. The things being sold are actually adding incrementally. As a result, membership fees accounted for 90% of total net income over the past three quarters.
Costco's moat comes from several factors. There are high switching costs involved -- where else can you find similar bulk deals? While competitor BJ's Wholesale (NYSE:BJ) also derives all of its profit from membership fees, it had only 216 locations at the end of last year. Costco operated 762, which means it's far more accessible to the public. There are network effects and low-cost production dynamics: The more people who belong to Costco, the better the bargaining power the company has, which further lowers prices. And the company has a fairly powerful brand -- the eighth-most-valuable in the retail sector, according to Forbes.
It's worth pointing out, however, that none of these competitive advantages is devastatingly wide. But even so, when combined, they help offer solid protection against competition.
That means there are two levers for growth at the company: comps and increasing membership fees. The membership-fee category can grow from a combination of new members joining and tactical increases in the annual fee.
As you can see, both of these are trending in a very positive direction, making Costco a very healthy company. The fact that it has a positive net cash position (cash and investments minus long-term debt) of $3 billion and churns out $2.6 billion in free cash flow doesn't hurt, either.
Over the past 12 months, the company has used about 39% of that cash flow to pay its modest dividend -- which is usually hovering around a 1% yield.
Costco appears to be a very appealing company to invest in, except for its stock price. As of July 2019, shares trade for 34 times earnings and 46 times free cash flow. That's a hefty price tag for a company that primarily relies on increasing membership rolls to drive profits. I wouldn't bet against the company, but right now, it's just too expensive to justify buying shares.
Everyone knows about the Golden Arches. But do you know how valuable they actually are?
McDonald's has arguably one of the strongest brands in the world. When it comes to restaurants, it is easily the most popular. Forbes rates it as not only the most valuable restaurant brand, but the 10th most valuable brand across all industries. That popularity has led to ubiquity in the U.S., where there were 13,914 locations at the end of last year, and abroad, with 23,941 international stores. And the company franchises more than 90% of its locations, leading to efficiencies by reducing overhead costs.
But the company's brand isn't ironclad. In 2004, the documentary Supersize Me caused people to question the benefits of McDonald's fare. The fast-food chain has updated its menus in response, but that doesn't change the fact that McDonald's -- like most companies on this list -- doesn't fit with millennials' preferences, since it's not small, local, or organic.
As you can see, that hasn't stopped the company from increasing comps (blue line), thanks almost entirely to increased prices (yellow line). Only recently has the amount of traffic coming through McDonald's (red line) stabilized.
The company also spent $300 million on Dynamic Yield earlier this year to help personalize menus to individual customers and -- hypothetically -- drive further growth in comps.
McDonald's balance sheet sports $3.5 billion in cash and investments, and it has brought in a very solid $4.6 billion in free cash flow over the past year. But that is overshadowed by a $45 billion mark of long-term debt. And while the modest dividend -- often yielding between 2% and 2.5% -- is safe, paying it ate up 72% of the company's free cash flow over the past 12 months. While that's far from a "danger zone," it means McDonald's has less room to grow its payout than most others on this list.
If there's one thing that scares me away from McDonald's the most, it's the price tag. Shares trade for over 35 times trailing free cash flow. The fact that the company's traffic growth has been negative or flat for most of the past five years makes me believe it isn't worth paying that premium for shares.
Walmart is a food company in disguise. A whopping 55% of all U.S. sales last year -- both in-store and online -- were groceries. The company uses its scale to get food for cheap and sell it for cheap. While shoppers are getting their groceries, the company can try to hawk some of its higher-margin wares. And if customers are buying groceries online, the company can include ads for other Walmart products on the screen.
The retailer benefits from two key moats. The first is brand value. While some have serious problems with the way the company has traditionally done business -- killing Main Street mom-and-pop shops and having a tenuous relationship with labor unions -- it still has the most valuable brand in the entire retail sector, according to Forbes. And with over 11,000 locations worldwide, the stores are ubiquitous.
The other moat comes from low-cost production. Like Target, Walmart entered the age of e-commerce with a stumble. For the longest time, the company's expansive brick-and-mortar reach gave it an enormous leg up on the competition. Once people started shopping online, however, that asset quickly became an enormous liability.
Recently, though, Walmart has shown an uncanny knack for leveraging its locations to boost its e-commerce game. Following the $3.3 billion acquisition of Jet.com in 2016, the company has shown enormous growth in e-commerce.
The importance of this growth cannot be overstated. It shows Walmart has figured out a way to squeeze value from its physical locations in a time when they have mostly become a drag on retailers.
Walmart has had to take on sizable debt to make the transition: It has $64 billion in long-term debt versus $14 billion in cash. At the same time, it generated a whopping $15.4 billion in free cash flow over the past year. It also offers a dividend that's usually in the 2% range and has lots of room for growth (40% of free cash flow was used to pay it over the past year).
Most importantly, I think the stock is reasonably priced. Shares trade for 21 times trailing free cash flow and 23 times trailing earnings. In other words, Walmart is trading on par with the rest of the market. Given its e-commerce growth, it's a good bet to beat the market over the next five years.
Finally, we have Amazon. It's nearly impossible to describe everything Amazon does in a few paragraphs. To really understand the company, you need to know its mission statement since day one: "to be the earth's most customer-centric company."
That is the best way to wrap your head around how an online bookseller became a global leader in e-commerce, shipping, cloud services, and -- with the acquisition of Whole Foods -- a grocery operator with more than 500 stores worldwide.
The moats surrounding Amazon are many -- and they are all a mile wide:
- Amazon Prime introduces high switching costs: There's nowhere else you'll get the same shipping, streaming, and other benefits for such a low annual price.
- The company's fulfillment network introduces low-cost production: No other company can ship products as fast for a lower internal cost than Amazon.
- As more third-party vendors join Amazon's platform, network effects have boomed: Amazon is the first and only stop for many e-commerce buyers. That draws in third-party vendors, which draws in more customers -- a virtuous cycle.
- Finally, Amazon has an enormously popular brand -- the fourth most popular in the world, according to Forbes.
Due to all these moving pieces, it is nearly impossible to pinpoint a single metric that can tell you the entire story of how Amazon is doing. That's especially true when it comes to food: Whole Foods may be a small piece of the overall pie, but there's a good chance it's the first step in a multi-decade foray into the food sector.
Perhaps the best thing to watch is free cash flow. Since founder and CEO Jeff Bezos started the company, he's said maximizing long-term free cash flow is the top financial priority.
While the metric has had ups and downs, it's clear Bezos is making good on his promise. The company's free cash flow over the past 12 months clocks in at just more than $20 billion. The company doesn't offer a dividend, and it has slightly more long-term debt ($42 billion) than cash on hand ($38 billion).
The stock trades for just under 50 times free cash flow, which many would say is too expensive. But don't count me in that group. Amazon has been my highest-conviction stock since 2012. Today, it accounts for almost 20% of my real-life holdings.
Simply put, I don't think another company exists that has the same moat as Amazon. When the moat is this strong, I care far less about valuation, and far more about owning a piece of the company. That's why, even though the Amazon's market cap hovers near $1 trillion, I still think the stock is a buy today.
Some might argue that Amazon's stock has no room left to grow. While I understand that concern, it ignores one crucial aspect of the business: optionality. In essence, what this means is that Jeff Bezos is notorious for tinkering and testing products to see if Amazon can truly improve customer service. This curiosity knows no bounds; I have little doubt it will extend toward shipping, advertising, and deeper into food in the coming decade. There's no telling what could be next, but the company will have incredible leverage to offer the best possible service for the lowest possible price -- driving out incumbents.
A final word on food stocks
I'm not particularly optimistic about most of these food stocks. Anyone can grow food. Any company can come out with a food product that people like. In the past, brand value was a big deal. Today, millennials are turning that thinking on its head.
That's why Amazon and Walmart -- and to a lesser degree Target and Costco -- are the ones with the best chances of succeeding over the long run. If you're looking to invest in large food stocks, these are the best places to start.