Saturday, November 10, 2012

High Yield Food Companies

I must confess that while listening to ConAgra (NYSE: CAG) on its conference call I got an eerie sense of deja vu. I couldn’t quite put my finger on it, but then it hit me. It's management had mentioned the ability to hike the dividend thanks to its high cash flow generation and I knew that I had heard this argument somewhere before.  Frankly I think chasing high dividend food staples is a useful tactic that is being rewarded this year so I decided to find some more names for investors to consider.

Before doing that I want to discuss ConAgra’s latest results.

ConAgra Results

ConAgra delivered a good set of results, increased the dividend and raised EPS guidance to $2.03-2.06 which equates to 10-12% growth.

Within Consumer Foods (62% of sales) acquisitions contributed 8% of sales growth but organic sales were flat. Organic volumes declined 4% and there was a 1% currency hit while favorable pricing/mix contributed 5% growth. In other words, all the growth came from acquisitions which the company was able to finance out of its strong cash flow. After hearing this I got another of my -now famous- feelings of deja vu.

General Mills (NYSE: GIS) said pretty much the same thing in its results recently too! This is no coincidence. The simple fact is that the US food sector is very tough at the moment and standing still organically is an achievement in itself. In General Mills case, it has gone for growth via internationally focused acquisitions while ConAgra has made strategic acquisitions in food categories offering growth such as snacks and alternative breakfast bars. What both have in common is that commodity input costs are abating and they can look forward to some easing of margin pressure.

Turning to the Commercial Foods (38% of sales) segment it seems that ConAgra served up a hot potato. Literally. Its Lamb Weston potato operations reported sales up 5% with good volume growth and a whopping 37% profit increase on a comparable basis. It seems to have hit a sweet spot in terms of servicing demand for away from home eating and fries are hardly the most economically sensitive of foods.

In conclusion, ConAgra continues to leverage its mix of value brands and health brands in order to counteract weakness in other consumer categories such as frozen foods. The company is distinguished by having a private label business which specializes in nutrition and snack bars for store-owned brands. Management has discussed expansion opportunities for private label in the past and don’t be surprised if they make an acquisition in this space.

Where Next in the Food Sector?

Investors could analyze the risks and opportunities in the food sector until kingdom come. They could knock up discounted cash flows until the beans got fed up of being counted and decided to start sprouting. They could quote Benjamin Graham until they are blue in the face.

By now, you get the picture. There really is only one thing supporting these companies right now and that is the dividend. With this in mind it’s interesting to repeat the ‘ConAgra trick’ and see who has the free cash to support higher dividends in the food sector.

The lower the Dividend/Free Cash Flow ratio, the greater the chance it could be increased.

I was surprised to see Campbell Soup Co (NYSE: CPB) make this list. I’m not the biggest fan of the company principally because I think the underlying growth is not strong and its product and category mix looks more challenged than the other companies. Organic revenue and earnings growth has been hard to come by for Campbell and I think it's set to continue.

Then again who cares?

Investors are rewarding stocks for paying high and stable dividends and Campbell has the room to increase them. It certainly looks a better bet than Kellogg (NYSE: K). This company appears to have little room to aggressively raise its dividend and appears more troubled than most with issues over a weak cereal market and stagnating European sales. In addition it's had issues with getting its pricing right this year.

B&G Foods (NYSE: BGS) is also worth a brief mention because it too is seeing its sales growth being largely generated via acquisitions. In common with the rest of the food industry it has had to adjust its distribution in order to shift sales to where the consumer is increasingly buying its groceries from, namely, dollar stores and mass merchants. These are common themes in the industry, but the difference with B&G is that it has a lot of net debt in relation to its market cap and servicing it will constrain dividend increases.

The Bottom Line

I’m going to leave the last word to my first word and in doing so invoke some deja vu in you. ConAgra remains the pick of the high yield food sector. It generates a lot of cash flow and has relatively good prospects in a challenged environment. If you want yield and stability in your portfolio then ConAgra looks the best of the bunch to me.