KANSAS CITY — With prices of grain-based foods shares down last year, earnings multiples for the sector in early 2024 are lower than historical averages. Still, investment analysts interviewed by Milling & Baking News cautioned against expectations of a robust recovery for food stocks in the new year.

“I don’t think it is going to be an inspiring year,” said Robert Moskow, managing director, TD Cowen. “I think it will be characterized by below-normal sales growth and attempts by the companies to use productivity savings to expand margins. Some will be able to do that. Others will need to give those savings back to the consumer because they are in tough categories.”

While lukewarm about the sector in 2024, Moskow said food and beverage companies have more upside than downside in the new year because of the low valuations. A second analyst interviewed took a darker view of prospects for this year.

“This year is another year of going nowhere (for food stocks),” said Mitchell B. Pinheiro, director of research, Sturdivant & Co. “I just think it’s a nothing year for them. I was looking at the estimates for this coming year for the S&P 500 food, beverage and tobacco companies. Earnings are projected to have 4.5% growth; dividends, too. It’s not high single-digit growth. This is getting to utility kind of levels.”

The key factor taking the wind from the sails of large food and beverage company shares over the past year was elevated interest rates, Pinheiro said.

“I’ve been negative on food and beverage stocks for over a year,” he said. “The premise before had been simply that during the zero interest rate environment, the food and beverage stocks and staples offered a 3%, 3.5% dividend yield with some dividend growth. That was a very attractive place to be. Solid companies. A lot of people parked money in that. As soon as interest rates began to rise and you could get 4% to 5% in money market funds, treasury bills, that became stiff competition for those assets that were looking for a little bit of growth but mostly income. There were outflows in that entire group because of that. As long as you have 4% to 5% short-term rates, consumer product company stocks will go nowhere. Part of it is, these are fine companies, but from an investing point of view, their primary purpose seems to be income rather than growth.”

Compounding the effects on share prices of investors seeking higher-yielding assets are fundamental challenges food companies face, Pinheiro said.

Behavior at odds with data

“The consumer is definitely under pressure, regardless of what the economic data is telling me,” he said. “They are at least concerned about their own spending. That pushes them to the value channels, which generate lower margins for food and beverage companies. It pushes people to private label; it pushes people to buy on promotion. People are getting more thrifty. There is a little less waste.”

Similarly, Moskow said the lower-income segment of the population is changing behaviors.

“These consumers are under more pressure,” he said. “They aren’t loading the grocery cart like they did in the past.”

The strongest case to invest in food stocks at the present time is a contrarian one, Pinheiro said.

“I don’t know what the future holds; there always is a black swan,” he said. “There is always something that throws things off. If you can buy for a modestly lower valuation than historical averages, that’s a start. If we have severe recession, food stocks should perform relatively well.”

While food stocks have gained ground many more years than not, looking at the sector’s cumulative performance over the last 10 years is “remarkably underwhelming,” Pinheiro said.

“That’s a big chunk of time,” he said. “They are seen as safe places to be, but a lot of the safety characteristics are tarnished, I believe. They were tarnished in 2023, and I think they will continue to be for the next 12 to 18 months.”

Looking back at 2023, Moskow said the year played out for food companies better than anticipated in certain regards and worse in others. For example, he said pressure from retailers for food companies to roll back price increases proved milder than he had anticipated. Consumer behavior proved more detrimental to the branded food business than he had expected.

“The pushback from the consumer came very suddenly, all at once,” he said. “So far, I think the retailers are nudging vendors to institute more price rollbacks. But I don’t think they are doing it in an irrational fashion yet. I was encouraged when Kroger forecast price inflation of zero to 2%. They are not expecting deflation.”

He said Kroger has noted pricing is rarely negative (only twice in the last 50 years).

“However, I believe that the grocers, and the consumers themselves, will increase the pressure on food companies to lower their prices in the coming months if volume doesn’t improve,” Moskow said. “The promotional lifts have been unsatisfactory thus far. We are already starting to hear from more food companies sending their pricing into negative territory.”

Of the underperformance in food shares in 2023, Moskow said a tailwind that had been boosting share prices for the sector proved unsustainable. The speed with which consumers shifted from ignoring rising prices to significantly cutting back on their purchases surprised the marketplace.

SNAP cut as ‘catalyst’

“I think a primary catalyst was SNAP benefits getting cut,” Moskow said. “The math we did indicated that if all that money was translated into lower food spending, it would have been a 3% reduction in overall food spending. That’s a big number. I think companies that had been getting a lot of volume from low-income consumers suddenly found that volume disappearing on them. It affected everybody. I think it’s affecting companies that market those consumers and had trouble getting people to trade down to their brands, and I would put Conagra in that category. They actually have crossed the Rubicon with pricing in negative territory for the next couple of quarters.”

He said Chicago-based Conagra’s move goes counter to a “steadfast effort” by food companies seeking to hold onto pricing they’ve taken.

“They don’t want to give it back,” he said. “Because their costs are still rising, wages are moving higher. So, that’s their goal. Conagra was the first where they had to lower prices on enough of their portfolio or promote more so pricing goes negative.”

He expects better performance in 2024 from companies targeting higher income consumers or who have brands higher income consumers looking for savings would find attractive. Among the companies he is recommending, Moskow said TD Cowen’s “outperform” recommendation for J.M. Smucker, Orrville, Ohio, is an “out-of-consensus call.”

“A primary element of this recommendation is that they’ve done so well at Walmart — it’s now over 30% of their sales,” he said. “One reason is that Walmart has been attracting higher income consumers. I think they are willing to trade into brands like Jif, Uncrustables, Milk-Bone.”

Summarizing the outlook for the food sector in 2024, Moskow was guarded.

“There is probably more opportunity for modest margin expansion from productivity saving and stabilization of raw materials,” he said. “Whether that beats the overall market I’m not sure. It suggests some upside but not to an inspiring degree.”

While typically a skeptic about the prospects for share prices of most food and average companies. (“I normally have a lot of underperforms”), Moskow said the relative weakness of food and beverage over the past year makes the sector more attractive.

“The average valuation is 13 times forward earnings for US -focused food companies,” he said. “It is typically 16. What that means, you have potential for stocks to go higher in 2024 off of a lower base.”

Promotional activity has increased, as Moskow predicted for 2023, but he said discounts to consumers were not as deep as has been the norm in the past.

“I think 2024 will be a real litmus test to see whether that price discipline can hold,” he said. “I think it (maintaining price discipline) will be difficult to do it in a tough volume environment. Whether they can or they can’t will depend on the path of volume recovery, and we do have easier volume comparisons coming up.”

Lapping easier comparisons “could be helpful” in terms of near-term share price performance, but Pinheiro cautioned that “lapping weakness is not a strength” in and of itself.

“People will look at the two- and three-year stacked performance to get rid of a bad year,” he said. “We know that weaker comparisons are coming… All I know is negative volume is not good.”

Differing views on Ozempic

Concerns about Ozempic appeared to affect valuations in 2023 but now appear to be well understood and are no longer affecting the day to day of the stock trading. Moskow said the potential impact on food intake of the increasingly popular drugs appears overblown.

“We’ve done a lot of work, just trying to do the math,” he said. “We looked at what happens if penetration reaches 20 million consumers by 2030. Others are forecasting bigger numbers than that, but there is a lot of friction with using these drugs. There is the cost, and you have to keep taking the drug or you put the weight back on. I’m having trouble understanding how only 20 million consumers, how that would have a material impact on volume in the industry. Just mathematically, if these 20 million consumers reduce calorie intake 15%, that’s 6% of the population. And if these 20 million consumers reduce calorie intake by 15%, that’s less than 1% calorie reduction. I just can’t get it to add up to a material degree in relation to volume. By the way this is something that is going to happen three years from now, four years from now when the drugs are more available and more insurable. These food companies have a lot of years to prepare for it. There might be steps the companies can take to mitigate the impact.”

Even conceding the impact of GLP-1 drugs will be limited in the next few years, Pinheiro took a different perspective. He said the industry’s slow growth metrics could amplify even modest effects on consumption.

“Clearly it won’t have a short-term impact,” he said. “It doesn’t have to. If you think about it, volume growth in the industry is like population growth, a little under 1%. That’s the standard, average. There isn’t a lot of room for error before you go negative. You don’t need a lot of volume degradation to get below 1%. I think these drugs are real. They are appetite suppressants. People eat a lot less.

“If 10% of the US population is on this at any one time, volume consumption of food will be down for that group. It’s enough to knock food and beverage companies into a negative volume growth. It’s more of a long-term risk, but it’s out there. Every investor asks about it. Therefore, it will probably negatively affect valuations. Modestly, but it’s an effect.”

While concerned about Conagra’s negative pricing and what that means for its margin outlook, Moskow said he has the company rated “neutral,” suggesting the challenge already is factored into the company’s depressed stock price.

“It’s trading well below its normal multiple,” he said.

Expanding on what he described as his contrarian positive outlook for Smucker, Moskow said he believes doubts about Smucker’s purchase of Hostess Brands, Inc., Lenexa, Kan., and how the transaction came about are misplaced.

“The market view on Smucker is that they overpaid on Hostess and quite possibly might mismanage it,” he said. “I think that’s too negative of a stance. The Hostess business has been expanding its capabilities in innovation, consumer insights, in-store merchandising and manufacturing capacity. I think it has been handed over to Smucker in good condition. It’s hard to see that in tracking data because market share is down. Their biggest competitor McKee has rebounded from supply chain disruption with strong in-store market presence and has regained share Hostess took away. As we look into 2024, if Hostess can get back to its normal game plan of resonant product innovation, strong merchandising support, I think there is a path here for them to get back into positive territory for top-line growth and then generate a lot of synergies for Smucker.”

Moskow said the chatter in the investment community has been Smucker impulsively decided to pursue Hostess. This narrative was boosted by a Hostess filing that described Smucker as an 11th hour bidder, well into a process in which other consumer packaged goods companies were in advanced discussions with investment bankers about acquiring Hostess.

“The backlash was they went after Hostess without enough forethought,” Moskow said. “I would argue they had been evaluating Hostess for over a year.”

While the transaction leaves Smucker highly leveraged, cash flow generated by Hostess will pay down the debt quickly, he said.

General Mills’ ‘cyclical lull’

Shares of General Mills, Inc., Minneapolis, fell sharply in 2023 and recently reached a new 52-week low. In Moskow’s view, the performance is one of a good company experiencing a “cyclical lull.”

“This is a company that performed really well during the pandemic and gained share in multiple categories at once,” he said. “That came from strong innovation, strong execution and consistent marketing support. Unfortunately for them, not all of it was sustainable. As smaller companies and private label normalized supply chain, they got back on shelves and took that share back. So, North American retail is going through a slower period. I don’t think they did anything wrong — you just can’t outgrow your long-term algorithm forever. Eventually competition comes back.”

Beyond cyclical challenges, Moskow said General Mills needs to find ways to shore up its Blue Buffalo pet food business. The company is sustaining volume declines in the super premium segment and has struggled to gain traction in the wet pet food category.

The split of Kellogg Co. into two separate businesses conceptually makes sense, Moskow said, but he raised questions about execution.

“I think they legitimately have increased the growth potential of the business by exiting US cereal,” he said. “They have highly differentiated brands and a legitimate emerging market platform that is under appreciated by the street probably. What holds me back is the US retail business for snacks underperformed so significantly in 2023, I guess I’m just not clear how it could suddenly lose so much volume share. I think they raised prices too high, especially on Pringles. I also feel the business got distracted during the spinoff. It inhibited their ability to get the merchandising they thought they would get.”

He described 2024 as a potential rebound year if Kellanova executes more effectively across its business, with strong “innovation behind their big brands.”

Emerging markets strength is central to Moskow’s continued upbeat outlook for shares of Mondelez International, Inc., Chicago. He credited the snack maker with demonstrating strong pricing power and introducing premium brands and local brands into emerging markets simultaneously.

“What may be underappreciated in Mondelez is that there have been distribution gains on that business, distribution momentum around the world,” he said. “They are putting more and more resources to enable them to penetrate more into the interior, into smaller cities and more traditional channels. Even in the US and Mexico, they are gaining distribution. They are gaining distribution here as well. I think that comes from strong resources deployed in the right way. I think they will have another year of above normal sales growth in ‘24 on top of an extraordinary year in 2023.”

Impressed by Lamb Weston

New in Moskow’s coverage universe is Lamb Weston Holdings, Inc., Eagle, Idaho.

“I’ve been very impressed by the business model, by the rational nature of the industry structure,” Moskow said. “There is very high capacity utilization, over 95%. This is a company that keeps expanding margin through pricing power, mix enhancement and product innovation. The valuation is trading below its normal average. I think there is more upside there. People are worried about demand slowing, but most of their volume is at quick-service restaurants. Those are very stable.”

A longtime buy recommendation for Flower Foods, Inc., Thomasville, Ga., has yet to bear fruit, Pinheiro said, characterizing 2024 as a key year for the company.

“I’ve been a perma-bull on Flowers Foods,” he said. “It’s been nothing but perma-wrong. They have everything going for it in terms of big picture positives, such as more than population growth as their volume bogey. You have geographic expansion, a presence in strong categories with Dave’s Killer Bread. They do well in the premium categories where consumers were very premium oriented, at least for a while. They are in the right areas. They have strong brands, with which I think they can continue to growth their share. They’ve been embarking on the long margin enhancing, bakery of the future, to get margins up from 10% to 12% to 12% to 14%. They haven’t been able to get there. It’s been frustrating for bulls on the stock. This is the time they should start to show some return from these investments.”

These expectations come at a time Flowers and other bakers face stiffening private label competition, Pinheiro said.

“I’m still optimistic longer term,” he said. “If you want growth, you need more than population growth. Because they are geographically limited, or had been, there is a lot of the population left to move into in terms of growing the share — California, The Northeast, the Upper Midwest and the Midwest. They are advantaged that way. We’ll see.”

Strong in whiskey, ingredients

Pinheiro recommends MGP Ingredients, Inc., Atchison, Kan., as an attractive investment. The company had been performing well before 2023.

“I’m not exactly sure why investors aren’t more enamored with this company,” he said. “They have ridden and continue to ride the American whiskey growth trend. They were very strong through COVID and post-COVID. They’ve socked away free cash flow into more aged bourbon into their warehouses. Aged bourbon gets more valuable, at least it has. They have bourbon aging, rye aging, and it’s only getting more valuable. They are buying authentic brands in the whiskey space that they can layer onto their national distribution. It’s a brilliant strategy, and it’s been paying off.”

MGPI’s exit from the industrial alcohol, “white goods,” business also is a positive, Pinheiro said.

“By doing that, they will raise their margins by 600 basis points,” he said. “It’s an incredible margin enhancing move.”

MGPI’s ingredients business, generating double-digit sales growth with strong margin growth, also impresses Pinheiro.

“They’ve gone from like the teens to 30% gross margins in the last couple of years,” he said. “They continue to ride the wave of specialty wheat proteins and specialty wheat starches as ingredients in growing sub-categories. The stock, I don’t understand why, trades at under 12 times cashflow. Average packaged foods companies trade at slightly over 13. MGPI’s growth is stronger. Margins are terrific.”

Attractive Utz dynamics

While maintaining a neutral rating on Utz Brands, Inc., Hanover, Pa., due to valuation, Pinheiro called the business a “terrific small cap with a lot of growth dynamics Flowers has.”

“They had their core markets on the eastern seaboard and into the Midwest,” he said. “There are lots of markets they have a very low share in. Expansion markets will add to the growth. They will continue to optimize their networks. They’ve taken a couple plants offline, and that will help their fixed cost leverage. I think you’ll see nice margin improvement.

“They are in the snack biz, which has been very resilient when the consumer is under pressure, in recessions. I just think the stock is a little ahead of itself.”