I pay close attention to consumer brands for the following reason:
“The best stocks to buy create a product that nobody else can legally produce then delivers that product using super-efficient distribution channels. This results in hard-to-replicate economies of scale. The product is protected by trademarks, patents, and copyrights, allowing the company to price higher than it otherwise could, accelerating the virtuous cycle as it generates higher free cash flow that can then be used for advertising, marketing, rebates, and promotions. Most people don’t reach for the knockoff Hershey bar or Coca-Cola bottle. They want the real thing, with the price differential being small enough there is no utility trade-off on a per-transaction basis.”
The disproportionate amount of wealth that got created for American investors over the past hundred years have come from the pharmaceutical, tobacco, oil, beverage, and consumer staple sectors of the economy. To receive those abnormally strong returns, however, you must be willing to hold those businesses through thick and thin, and each category carries its own set of risks.
Pharmaceuticals have drugs go off patent,leading to unusually high short-term volatility. Tobacco companies encounter perpetual additions to the taxation and regulatory framework that governs their sale. Oil stocks are inherently volatile and pay high extraction costs. Beverage stocks are known to be great deals, and rarely go on sale. Consumer staples have entered a world of prolonged slow growth, making it absolutely essential for investors to get the price right in the first instance.
Campbell Soup fell 12% on Friday based on the news that its CEO unexpectedly resigned, soup volumes are stagnating, and the costs of production may increase due to the projected enacting of certain tariffs. As a result, the price of Campbell Soup stock fell to $34 per share. In 2016 and 2017, the high for Campbell Soup was a stock price of $67 and $64 respectively. The price of Campbell Soup stock has since fallen from 22x earnings to 10x earnings.
That price adjustment was necessary. Soup sales are dominant and entrenched, but the growth component is not there. You have to get a good price. Campbell Soup’s revenues have only increased by 2.5% annually over the past decade, and earnings per share have only increased by 4.8%. The current business subsidiaries that fall under the Campbell Soup corporate umbrella, in the aggregate, are likely to continue growing at this same rate.
My own projects for Campbell Soup, and nearly the entire food industry, is that you get the dividend, 2-5% annual earnings per share growth, and a little bit of P/E expansion over the long haul (perhaps adding one percentage point to total returns).
If you buy Campbell Soup today, I expect that you will get the 4.0% dividend, 3.5% earnings per share growth, and 1% from P/E expansion from the current rate of 10x earnings to somewhere in the 13x earnings range. If someone buys Campbell Soup at $34 per share, the most likely outcome is the receipt of 4% annual cash payouts that grow annually at about the rate of inflation, for total annual returns through 2023 for total returns around 8.5% annualized.
The type of investor that is most likely to benefit from the purchase of Campbell Soup stock is someone whose family portfolio has developed a higher than usual allocation to tech, financial, and industrial stocks in recent years and are looking to add a stable cash generator to their investment collection.
If I had to rank food stocks over the next five years according to possible total returns, I would guess that Kraft Heinz should do the best, followed by Campbell Soup, then General Mills, then Kellogg. Over ten years, General Mills should occupy that two spot rather than Campbell Soup (the reasoning is that Campbell Soup is more attractively valued than General Mills, but General Mills has the growthier collection of subsidiaries. In the shorter run, the valuation spread will deliver the higher returns, and in the longer run, the characteristics of the underlying businesses themselves prove more determinative of returns). For the time being, I am not rating J.M. Smucker because it is so reliant on Wal-Mart for the distribution of its foods that it has hard to predict (in some geographic areas, Wal-Mart is half of Smucker’s sales).
If you own no food stocks, and intend to do so, now might be a good time to add Kraft-Heinz, Campbell Soup, or General Mills to your portfolio because of relative valuations. During deep recessions, these stocks will be cheaper, but cyclical businesses and financial institutions tend to trade for fractions of a dollar and tend to offer superior rewards. During the boom of the past few years, food stocks got a little bit too pricey in a way that did not incorporate their low earnings growth. Right now, the valuations of the Kraft-Heinzs, Campbells, and General Millses of the world can fairly be described as “the high end of fair value”. The promise of high single-digit returns awaits.
My own preference is to purchase shares of Colgate-Palmolive, which currently trades at $62 and has a much higher earnings per share growth rate over the next ten years. Though it’s 2.7% dividend yield is lower than that of the other food stocks, I would trade a point of dividend yield for five percentage points of annual long-term earnings per share growth any day.
Nevertheless, the valuations of the food stocks have moved into intelligent investment territory after a three-year span of trading at valuations that could not be justified due to low earnings growth projections. If we sliced up every investment category into quintiles based on a blended score of valuation, earnings per share growth, and earnings stability, food stocks are transitioning from the third decile to the second decile. More optimal long-term investments exist, but not many.
This is a publicly available version of an article shared with The Conservative Income Investor’s Patreon followers on May 19, 2018.