We review 3 potentially attractive food producers.
I recently decided to a look at the food producers sector and came across these three interesting companies.
Cranswick
Cranswick (LSE: CWK) is a pork producer that has been restructured in recent years. The pet food business was sold off and so was the original milling business. It ceased pig farming altogether and refocused on high quality pork products.
Subsequently, Cranswick has invested heavily in modernising processing facilities and expanding production capacity. Let's look at capital expenditure (capex) versus its depreciation charge:
| | 2006 | 2007 | 2008 | 2009 | 2010 |
|---|
| Capex (£m) | 14.1 | 12.0 | 25.3 | 21.0 | 20.3 |
| Depreciation (£m) | 8.1 | 9.3 | 10.1 | 13.9 | 11.9 |
| Ratio | 1.7x | 1.3x | 2.5x | 1.5x | 1.7x |
Sales growth has been strong and its products have been well received as pork is seen as being a 'lower cost' meat. That said, operating margins have been slipping over recent years from 7.7% in 2006 to 6.2% this year.
But now that its capital expenditure programme is largely completed, I would expect both margins and free cash flow to improve. Increased scale should lead to more efficient production and better use of working capital.
However, as with any food producer, it is subject to substantive input price risk. Pig prices look set to rise if feed prices continue their recent steep increase. The main ingredients of feed are wheat, barley and soya -- wheat has risen over 50% in recent weeks, as a consequence of the drought in Russia. World wheat production forecasts have been cut and the price of soya and barley has risen in sympathy, despite record production figures.
Cranswick suffered a severe drop in its share price in 2008 when it reported higher feed prices, and I think that is why its share price has been weak recently. I would look for any negative news and consider buying if it is sold off aggressively. You could buy a fertiliser, potash or agribusiness company in order to hedge future crop price rises.
Genus
Genus (LSE: GNS) is a leading animal genetics company and a darling stock of the investment industry. I've met hedge fund managers who only trade using quantitative algorithms, but can't resist holding this on their personal account.
The story with Genus runs like this:
- China...
- increasing middle class...
- demand for meat/protein...
- cattle/hogs use much more feed...
- feed prices rising...
- meat producers need efficiency improvement...
- increased end demand for Genus.
All of which is wonderful for its long-term growth potential, however this growth is not without cyclicality. Furthermore, the story is well known and Genus usually looks fully valued.
As noted above, feed prices have risen recently. If this continues, food producers will find it harder to pass on price increases. While the long-term demand trend looks good, there are plenty of substitutes for meat and it is a price elastic good. Rising feed costs would not be good news for Genus in the short term, because producers would reduce demand for its products.
Longer term, it should be less of an an issue. As cattle/hog prices adjust higher due to reduced capacity, feed demand should fall and the cycle should begin again. As it does, I suspect there would be an increased awareness of the benefits of greater productivity achieved via Genus's products.
Genus currently trades on a P/E of 22 for the year ended 30 June 2010 and 19 for the following year. Rather like Cranswick, its outlook statements are usually either very cheery or very gloomy. So, I would view any short-term weakness as a potential buying opportunity.
PureCircle
PureCircle (LSE: PURE) produces stevia, which is a natural sweet leaf that, when refined, provides a very low carb alternative to sugar. This is ideal for a world seemingly devoted to eating foods that increase diabetes risk.
Stevia is already very popular in Japan and other parts of Asia. PureCircle hopes to receive EU approval this year. In the US, it already has a 'no objection' FDA ruling.
At the end of July, PureCircle warned on profits, citing a shift in its sales strategy from trading partners to end users. It has already had some success in this regard, with an impressive list of supply agreements to companies such as PepsiCo, Merisant, Ferminich, Danone and Unilever (LSE: ULVR).
Utilisation is low and it continues to invest in increasing production capacity. In a sense, it needs to do this because stevia is a natural product and has no patent protection.
The real question lies over future sales. Large companies frequently sign supply agreements, but they don't necessarily lead to huge orders. I think investors should look to see signs of stevia-based product launches, before considering any purchase.
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