FOOD PROCESSING INDUSTRYANALYSIS

The Food Processing Industry is a mature sector that loosely tracks underlying
demographic trends, such as population and income growth. Companies
generate revenue from the sale of food and ingredients to a whole host of
customers, ranging from supermarket chains and local bodegas to restaurants
and other players further down the processing chain.

This sector is praised for its ability to deliver consistently positive investment
returns. Indeed, over the past 20 years, Food Processing stocks have, on
average, delivered high single-digit annual total returns (share-price
appreciation and dividends), with much less volatility than the broader market
indexes.

It is, therefore, of little surprise that food stocks are well suited to fairly
conservative investors with low tolerances for share-price volatility. Defensive
characteristics, including stable growth, ample interest coverage, and solid
balance sheets, also establish these companies as "safe harbor" selections during
major economic and stock market downturns.
Top-Line Drivers

Food, of course, is one of life's basic necessities. As such, underlying demand

tends to be steady through prosperous and difficult economic times. That said,
food companies benefit from population growth. Also, higher aggregate
personal income affords people "richer" diets and those on the margin may rely
less on homegrown staples.

Proactive efforts are arguably most critical for top-line growth. Companies
endeavor to capture a greater share of household budgets through strong
branding and the strategic positioning of their offerings. Trend-right products
and re-formulations that are easy to prepare, portable, and healthful usually gain

good traction. Expansion into new geographic markets is also a key growth
driver. Cross-cultural expansion can prove difficult, though, given entrenched
regional cuisine and tastes.
Cross Currents

Though food demand is reasonably predictable, there are certain cyclical

undercurrents that present nimble investors the opportunity to strategically
position their food industry exposure for above-average investment returns. In
challenging economic times, for example, people tend to forego vacations and
restaurant outings. Consequently, food companies with significant hospitalitysector exposure often experience a falloff in end-market demand and lagging
share-price performance. Budget-constrained consumers might trade down
within the food sector, be it from expensive national brands to cheaper privatelabels or from pricey proteins, like steak and ground sirloin, to chicken and
eggs.
Sub-Segments

Food companies fall into various sub-segments, and painting them all with one
broad stroke can lead to surprising deviations from expected performance.
Investors should be cognizant of where a producer resides within the
commodity- "value added" spectrum. Poultry and other commodity-type
producers have little individual influence over product pricing, and are
susceptible to such vagaries as weather-related crop damage and cross-border
trade sanctions. Commodity-like producers are also constrained by long harvest
(in the case of grains) and life (livestock) cycles. Therefore, those companies
tend to have difficulty quickly adjusting "production" capacity. These factors
result in relatively high earnings and share-price volatility, as compared with the
rest of the Food Processing Industry. Through innovation and branding,
successful marketers of value-added goods face less direct competition and have
more control over pricing. Accordingly, they enjoy stable returns.
Cost Considerations

Success also depends on the ability to control costs and leverage fixed/nearfixed expenses. Over its history, the industry has, at times, suffered margin
pressure due to severe input cost inflation in the form of higher prices for
ingredients and fuel (used to power processing plants and distribute goods to the
retail trade). In periods of commodity-price deflation, however, the "stickiness"
of retail price hikes supports profitability. When input costs spike, value-added
producers, with their strong brands, are better positioned, and can pass along
much of the higher expense to customers. Makers of private label brands have
good cost leeway, given the absence of big marketing outlays.

Size matters for many of these companies. Distribution costs are often nearly
fixed. As such, a larger portion of each incremental sales dollar tends to flow
down to the bottom line. Processors with an expanding brand portfolio can
quickly realize significant economies of scale. A wide portfolio of popularly
selling brands also puts these companies in a stronger bargaining position, vis-avis major customers in the retail trade, which has increasingly invaded the
grocery space. Small food processors, however, as potential takeover targets,
may be the direct beneficiaries of industry consolidation.

Food Processing stocks are typically in vogue during recessions, when investors
shun more-economically sensitive issues. That said, they are susceptible to
sector rotation, when investors look to time the market bottom of cyclical
issues. On balance, food industry exposure does serve most investors well,
regardless of the economic backdrop. These generally stable franchises produce
fairly consistent, if unspectacular, investment returns throughout the business
cycle. Processors, the large names with strong brand portfolios, in particular, are
suitable for somewhat conservative investors. But numerous sub-segments do
enable more venturesome investors to strategically position their portfolios for
outperformance. Commodity-type producers, for example, may appeal to savvy
market timers. All in all, the Food Processing Industry has something to offer to
nearly everybody.