When it comes to investing, many investors have different reasons to own different sectors of the stock market. Some investors prefer the aggressive return possibilities for technology, but other investors want stock market exposure in the slow and steady companies with decades of performance from a variety of brands or units. Food is one area that investors have flocked to over time for predictable cash flows and dividends.
A new Credit Suisse report calls for a selective approach in the packaged foods group. Its 2020 preview indicated that big food companies look to be fresh for the year ahead.
The brokerage firm announced that it is shifting its view on food to a more neutral stance for 2020 because two of the main drivers of the negative thesis for the past three years have eased off. First, profit margins and sales growth are now in positive territory, and second, big grocery chain customers like Kroger and Walmart are becoming less aggressive on pricing and taking a more constructive stance toward their food vendors’ spending.
This is a much better situation than a couple of years ago when the retailers were demanding bigger price discounts, threatening vendors with private labels and charging new fees for inventory handling and late deliveries. As a result, Credit Suisse thinks investors can take a selective approach to food names in 2020 without worrying too much about a thematic pullback across the group.
The firm believes that Mondelez International Inc. (NASDAQ: MDLZ) and Kellogg Co. (NYSE: K) are well-positioned for margin expansion. On the other hand, Kraft Heinz Co. (NASDAQ: KHC) and others need to reset lower.
Kellogg was raised to an Outperform rating from Neutral and the target price was raised to $78 from $60. Credit Suisse sees Kellogg as poised to see a positive inflection in 2020 because it believes that the company’s portfolio changes and reinvestment spending over the past two years have set the stage for sustainable revenue growth, margin expansion and high-single-digit earnings growth.
Mondelez has an Outperform rating with a $60 price target. Positives included a “local first” strategy being on-track to deliver results, an improved margin structure to be sustainable close to 17% and financial flexibility coming from joint ventures.
While the report is selectively positive, Credit Suisse said that volatile conditions in emerging markets pose the largest risk to the firm’s estimates and target prices.
In the report, Credit Suisse went on to say:
Food companies have reacted to the dynamic operating environment by investing in e-commerce and digital marketing, reshaping the mix of their portfolios, and adjusting their supply chain footprints.
From our perspective, Smucker, Kraft Heinz, and B&G Foods still need another year of investment to return to a path of sustainable organic growth. In contrast, Kellogg and Mondelez appear to have invested sufficiently and are now growing at a strong enough pace to generate operating leverage in the year ahead.
Still cautious on General Mills, Conagra, and Campbell. All three of these companies are in a better position than they were a couple of years ago, but we do not find their risk/reward compelling. Conagra’s distribution trends are better than we expected, but we harbor doubts about the quality of the portfolio. General Mills has stabilized its U.S. Retail business, but the risk of a consumer backlash against grain-free pet food formulations keeps us on the sidelines. Campbell is reinvesting in the soup category, but we question whether it will be sufficient to generate sustainable topline growth for the portfolio.
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