Do food stocks offer a margin of safety?
Before discussing food stocks as investing opportunities, let me just tell you why I am researching the sector at the moment (March 2019).
I like to invest in sectors that offer businesses with a margin of safety. This means that:
- there is a tailwind because of what is going on in the world (more people);
- businesses are already profitable and established (dividends and positive earnings);
- what will happen is relatively predictable (you are going to eat tomorrow);
- there are moats with high barriers to entry (logistics, scale, legacy etc.).
On the other hand, you have also very interesting sectors like Software as a service that are bound to grow, but I have no idea which provider will be a winner and whether it has a moat strong enough to insure long term profitability. If we look at the price to sales ratios of such tech stocks, we can see that there is a long way to go before those become profitable.
Source: Justin Swierczek
The main difference between the two investing approaches is the approach to risk. With a margin of safety, you try to limit your downside but you also limit your upside on a specific stock. However, you are not necessarily limiting your total portfolio return. Buying stocks with price to sales above 10, implies a big potential for a total loss while buying food stocks limits the downside in many cases. Therefore, I am researching the food sector with the hope that I find something interesting to follow and maybe buy.
Food stocks – sector overview
I always like to go through long lists when researching a sector. Looking at each individual company gives me a good comprehension of what is going on in the sector.
Just from a quick look at some food stocks traded on the NYSE shown in the above list, I have concluded the following:
- There is a lot consolidation where 6 out of 30 businesses in the above list have been taken over in the last few years. Consolidation means two things, a young market or an aging market. In this case, it is the latter where companies like Campbell Soup, Kraft Heinz, Tootsie Roll are finding it difficult grow. This forces them into expensive acquisitions that are usually a poor allocation of capital.
- The second thing I found is that brand strength is declining and people look for new, different things. This leads to declining sales and many value traps. One example that I discussed before the actual stock decline, is Kraft Heinz.
- It is not easy to find a business that is really getting traction within the new trends, as those change quickly.
Investing in the food sector
So, what are the tailwinds in the food sector?
- The decreasing availability of land;
- An anticipated increase in commodity prices over the long term due to finite resources and a growing, increasingly wealthy, global population;
- The shift towards meat based diets, increasing the need for grain based feeds;
- The creation of markets in farm-related carbon credits and water rights;
- The increasing levels of investment by land-poor and food-deficient countries, attempting to protect food supplies;
- The increasing value of farmland.
I don’t know why, but I am not fully convinced about the above tailwinds. I look at food prices, and see them mostly go down.
The keys here are technology and investments. Each country subsidizes food production, which leads to heavy investments and overproduction. Further, improvements in technology, GMO etc. leads to more production that leads to lower prices, especially if there is nice global weather as we have had the last few years.
So, again value investing comes in handy here. You have to look for an investment where, you win big if food prices increase, but you still win if food prices stay low for the next 10 years.
Also, something tricky when it comes to food prices is ethanol and biodiesel. Politicians can simply say we will have to use other forms of energy, or oil prices can stay low, and a big part of demand for food would vanish.
On the other hand, there are many different trends in the food industry that we cannot put them all under one hat and call them food. There are organics, ingredients, flavours, spices, processed foods, private labels etc.
Bunge Stock Analysis
BG is a food trader and processor, grains, soy, corn with some other adjacent businesses.
Many are waiting for a stock market crash to buy things on the cheap. Well, you have one here.
Source: BG Stock Price 5-year chart
The business is 200 years old and has been constantly rewarding investors. Over the last 10 years, 50% of the current market capitalization has been returned to investors.
Source: Bunge IR
They business model is focused on increased volumes in food trade and processing.
Source: Bunge IR
We have seen volatile food prices in the past, consequently BG’s cash flows have also been volatile.
On top of everything, there have been rumors that Glencore or Archer Daniels will acquire BG. As these things take time, perhaps it will push the stock price up in the short term but I still have to research it in depth and compare to other opportunities like the already mentioned ADM, Wilmar and some others food businesses traded around the world.
To conclude on investing is food, it all boils down, like in most cases, to the specific business, the quality of the management, the moat, the cash flows, the growth, risk and of course, the price you pay. So, there is no point in discussing what will happen, will we eat more of this or that, the focus has to be on the businesses and I am going to analyse a few businesses for you, to give you an indication of what can be found and what are the dangers.
BG is a completely different investment now at $50, then it was at $90. So, let’s continue looking at businesses and focus less on things we cannot know and forecast.