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Food-Miscellaneous Outlook: Will High Costs Spoil the Broth?

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Players in the Zacks Food-Miscellaneous industry have bountiful offering ranging from fruits and vegetables to packaged items such as snacks, dairy products, spices as well as ready-to-cook meals among others. Owing to evolving tastes and preferences, food companies have been coming up with innovative offerings.

In fact, new food products are being accepted in the market, courtesy of impactful promotional skills. Lately, rising health consciousness has been propelling companies to augment organic and natural offerings. Further, the companies have been witnessing rising demand for pet food. We expect these aspects to continue driving companies operating in the food space, which are poised to gain from mergers and acquisitions.

In spite of these upsides, there are significant hurdles in this space that dent the performances of many companies. Food companies have been witnessing input cost inflation for a variety of commodities. Moreover, persistently rising freight expenses, stemming from lack of truck supplies and drivers, are acute concerns. These hurdles have led to strained margins for a considerable number of food players.

To top these, increased demand conditions have kept supply chain structures under pressure. Additionally, competition stakes in the food space have been steadily rising, as more companies enter the arena with novel offerings. Moreover, firms have been spending heavily on innovative offerings as well as unique promotional strategies, which raises cost burdens.

These headwinds have been weighing on profits of several members operating in the food space. Many have even lowered their near and long-term bottom-line projection, thereby raising concerns regarding the future of these food companies.

Industry Lags on Shareholder Returns

We note that the aforementioned headwinds have been eclipsing profitability, keeping investors on the sidelines. In fact, the Food-Miscellaneous industry, which falls within the broader Zacks Consumer Staples Sector, has underperformed the S&P 500 in the past year.

Stocks in the industry have inched down 1.4% in the past year. Meanwhile, the Zacks S&P 500 Composite has rallied 20.6%, whereas the Zacks Consumer Staples Sector has lost 6.1%.

However, there was a marked variance in the performance of individual stocks within the group. While many food companies are reeling under commodity, freight and promotional costs, few have been able to offset the downsides with strategic efforts such as optimizing resource usage and reducing expenses.

One-Year Price Performance


 

Though the industry’s performance hasn’t been impressive, firms continue to work on their ambitions to deal with cost hurdles with robust productivity enhancing programs and prudent investments. Such efforts are expected to bring back the industry in investors’ good books.

Valuation Picture

One might get a good sense of the industry’s relative valuation by looking at its price-to-earnings ratio (P/E), which is the most appropriate multiple for valuing Consumer Staples stocks like that of Food-Miscellaneous, because earnings take into consideration all the necessary aspects effective in gauging performance.

This ratio essentially measures a stock’s current market value relative to its earnings performance. Investors believe that the lower the P/E, the higher the value of the stock will be.

The industry currently has a trailing 12-month P/E ratio of 19.9X, which is slightly below the one-year median level of 20.5X and the one-year high of 21.9X in the past year. The trailing 12-month P/E ratio for the S&P 500 is 20.1X. This indicates that there is only a small window of value growth ahead. 

Price-to-Earnings Ratio (TTM)



Dull Earnings Outlook Keep Us Cautious

Steadily rising demand for food products, especially organic and healthy items present solid growth opportunities in the Food-Miscellaneous space. However, it’s hard to ignore weak margins and profits stemming from high costs of operations. This certainly weighs on the long-term of the companies in this space.

But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. The above ratio analysis shows that there is a slight value-oriented path ahead. However, one should look for good entry points based on solid fundamentals and other near-term factors.

One reliable measure that can help investors understand the industry’s prospects for a solid price performance going forward, is its earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.

The Price & Consensus chart shows the market's evolving bottom-up earnings expectations for the industry and its aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.

Price and Consensus: Zacks Food-Miscellaneous Industry




This becomes clearer when we focus on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Please note that the EPS estimate of $2.45 for the industry for 2018 is not the actual bottom-up estimate for every company in the Zacks Food-Miscellaneous industry, but rather an illustrative aggregate created by our proprietary analytics model. The key factor to keep in mind is not the EPS of $2.45 for the industry for 2018, but how this estimate has evolved recently. 

Current Fiscal Year EPS Estimate Revisions

 

As you can see here, the $2.45 EPS estimate for 2018 has dropped from its peak of $2.59 attained at the end of March and $2.55 at the end of May. In other words, the sell-side analysts covering the companies in the Zacks Food-Miscellaneous industry have been lowering their estimates.

Zacks Industry Rank Blurs Prospects

The group’s Zacks Industry Rank which is basically the average of the Zacks Rank of all the member stocks, indicates continued underperformance in the near term.

The Food-Miscellaneous industry currently carries a Zacks Industry Rank #201, which places it in the bottom 21% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Our proprietary Heat Map shows that the industry’s rank has been volatile over the past eight weeks though it has remained among the bottom 50% all through.

 
 

Food-Miscellaneous Space: Earnings & Revenue Trends

The past earnings of the Food-Miscellaneous space reveals that the group has been witnessing quite an unsteady trend. It’s worth noting that during the latter half of 2017, the industry’s earnings began to improve, though it started declining since March 2018.

The recent fall was primarily caused by inflationary trends in commodity prices as well as higher logistics expenses. This combined with volatile tariff rates have led to adverse-mix, hence dampening the profitability of various companies operating in this space.

EPS - Food-Miscellaneous Market



 

The top-line performance of the industry has also been quite unstable. From the figure below, it can be seen that revenues sharply declined in the beginning of 2016, though it picked up pace from March. Since then, the revenue picture has been quite unstable.

Revenues - Food-Miscellaneous Market



 

Bottom Line

There’s no denying that companies operating in the food space have been reeling under escalating operating costs. While freight and commodity price inflation are major deterrents, there are few more roadblocks that can’t be ignored. Significant among them is the rising costs of investments, thanks to enhanced focus on product innovation.

When it comes to food products, consumers seem to get easily attracted to new and unique offering, making it difficult for existing products to move off the shelf quickly. Moreover, as society becomes more digitally inclined, companies are investing heavily in technology.

Additionally, regulatory authorities keep a constant check on the ingredients used in packaged food items. In fact, such inspections have led companies to recall products from the market. Hence, the companies are required to use ingredients that are pure and safe along with cutting down on preservatives and artificial flavorings. Well, the challenge for most food companies here is to ensure taste and quality to keep consumers interested.

Undoubtedly, these challenges make it quite a herculean task for food companies to ensure profitability. But as the saying goes, there is light at the end of every tunnel. Food companies enjoy certain privileges, since they are a vital part of consumer staples. As input costs, operational costs and freight expenses shoot up, few food companies have been hiking prices of products.

Moreover, consumers are seen to absorb such price hikes for certain food products, given their importance as a staple item. Another noteworthy strategy that companies have been undertaking are proactive measures to keep costs under control. Such efforts along with strategic buyouts, alliances and divestitures help building necessary strength to face industry headwinds and gather resources for investments.

While these initiatives make us optimistic about the long-term prospects of players in the food industry, we are cautious regarding the near-term scenario. That said, here are a few stocks from the industry investors should steer clear of.

Campbell Soup Company (CPB - Free Report) : This New Jersey-based company, carrying a Zacks Rank 5 (Strong Sell), has lost almost 12.2% in the past year. Also, the Zacks Consensus Estimate for the current fiscal EPS has gone down 10% in the past 30 days.
 
Price and Consensus: Campbell Soup



 


The Kraft Heinz Company (KHC - Free Report) : The company currently carrying a Zacks Rank #4 (Sell), has lost 27.5% in the past year. The Zacks Consensus Estimate for the current fiscal EPS has gone down 1.6% in the past 30 days.

Price and Consensus: Kraft Heinz



 

The J.M. Smucker Company (SJM - Free Report) with a Zacks Rank #4, has lost 5.6% in the past year. In addition to high costs, the company reels under lower net price realization, thanks to increased trade spend.

Price and Consensus: Smucker



 

General Mills Inc. (GIS - Free Report) also with a Zacks Rank #4, declined 11.1% in the past year. Coupled with industry-wide headwinds, the company’s performance has been toiling with weak yogurt business.

Price and Consensus: General Mills



 

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