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Why would anyone invest in food producers?

They are less defensive than you would imagine.

Only three food producers listed on the JSE have beaten the JSE All Share Index over the past five years: poultry market-leader Astral Foods, AVI (which generates a quarter of its operating profit from apparel and footwear), and Pioneer Foods. Of course, one might argue that without the near-30% decline this year because of the listeriosis outbreak, Tiger Brands would be in this list (its share price was up 38% in the five years to end-December), but investors would’ve still been holders at the point the news broke.

Even excluding Tiger’s hiccups, the two large listed diversified fast-moving consumer goods groups have hardly beaten the index by much over this period.

The performance of listed food counters has been “mixed”, says Nadim Mohamed, investment analyst at First Avenue Investment Management. He points out that, for example, you’d have “reaped excellent returns up until early 2017” holding Pioneer Foods but “given it all away thereafter”. Even Astral, for example, only surged in 2017 and 2018 to deliver a return about five times greater than the market.

There are also few silver linings ahead, says Anthony Clark, small and medium market cap analyst at Vunani Securities. “The deflationary cycle in soft commodities may be turning … but there is clear evidence of increasing cost push in selected food stocks. Astral, Pioneer Foods (and de facto Zeder) and Quantum Foods will see rising costs compared to 2017/18 results/earnings.”

Could investors be better off – and avoid the volatility caused by external factors such as droughts – by simply buying the index?

 

Five-year move

Astral Foods

+197%

AVI

+99.5%

Pioneer Foods

+40%

JSE All Share Index

+34.6%

Tiger Brands

+10.6%

RCL Foods

+8%

Clover

+2.8%

Oceana Group

-9.7%

Crookes Brothers

-27.5%

Tongaat Hulett

-30.2%

* Excludes Rhodes Food Group and Quantum Foods, which listed in 2014, Premier Fishing and Sea Harvest, which listed in 2017, and Libstar, which listed this year.

“The view of food producers being defensive is derived from the fact that, regardless of economic conditions, people still have to eat and the consumer will not stop buying staple items such as bread,” says Mohamed.

“In our opinion, it is specifically the branded food producers that possess defensive characteristics on the basis of their pricing power. Pricing power affords them some flexibility to influence the price-volume equation and achieve a reasonable level of profitability even if consumer demand is weak or input cost inflation is high.”

He cites the example of AVI Limited’s beverage business (tea, coffee, creamers), which managed to grow operating profit 9% in the six months to end-December, despite raw materials such as Rooibos increasing by 24% and tea increasing 13%. “This is an outstanding result in a period where consumer spend was constrained and competitor activity was intense. The strength of their brands – Five Roses, for example – allowed them to increase price at a higher rate than volumes would decline, which helps preserve profitability. 

“Items where brand is less of a factor in the consumer purchase decision are more vulnerable as their price-volume relationship is more elastic, which means they often have to give up price and volume at the same time in a tough economic environment. Also, competitors tend to give up price at the same time, which further exacerbates elasticity.

This is why strong brands are so important to all three major diversified food producers: Tiger, Pioneer Foods (which has successfully diversified away from what was essentially a commodity grain business) and Premier Foods (owned by Brait). In the case of some producers like AVI and Clover, brands are their entire business.

Mohamed says “a portfolio of brands helps with diversification against an isolated issue or shock that could constrain demand in the short term. For example, Tiger Brands has a strong brand presence in the pesticide market with its Doom brand. However, in its last set of results, it reported that the category was under pressure due to a delayed pest season. Under such conditions, not even a strong brand can protect from profitability declines. 

“A portfolio would diversify against such idiosyncratic events. The key with a portfolio of brands is that all brands need to be of similar strength in terms of the psychological conditioning they create in the minds of the consumer to reduce search costs and enable pricing power.”

Mohamed says that “having second or third tier brands in the portfolio would put it at risk of giving away margin to large customers such as retailers, and being more exposed to substitution by private label equivalents.”

For Tiger, Pioneer Foods and Premier, branded grocery operations remain dwarfed by grains businesses, at least from a revenue point of view. At Pioneer Foods, groceries comprise 27% of revenue (and 31% of operating profit), Tiger’s groceries as well as snack, treats and beverages units are 25% of revenue, while at Premier Foods, groceries and international comprise 18% of revenue. This shows how successful Pioneer has been in shifting its portfolio away from commodity grains.

But margins in the non-commodity units aren’t exactly stellar. At Pioneer Foods, which owns Weet-Bix, ProNutro, Liqui Fruit, Ceres, Safari, Lipton, Moir’s and Marmite, among others, operating margin in the most recent six months was 11%. At Tiger Brands, with Koo, All Gold, Mrs Ball’s, Crosse & Blackwell, Black Cat, Beacon and Maynards, it was a similar 11.5% in the year to end-September 2017 (a period deliberately chosen as it excludes the impact of the listeriosis outbreak on Enterprise Foods).

Mohamed says the conundrum is why these diversified producers continue to operate two very different businesses: “The competencies required to enhance the moat in grains are very different to branded groceries. The former is focused on cost efficiency whereas the latter requires greater focus on innovation and branding.

“It is somewhat difficult for an executive team to be good at both and allocate resources effectively to both areas. We think the structure of having both in a single entity is a function of the way in which food producers in Africa have evolved historically. However, we suspect that a pure-play branded grocery player will attract a higher valuation than one combined with a grain portfolio.”

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Hi Hilton,

Great article.

Do you know the respective reliance (%) of the above companies on their grain portfolios?

Thank you.

AVI has returned 140% over 5 years with dividends reinvested.
That’s 19.16% a year. Pretty good for me.
If you reinvest your dividends even Oceana gives one positive returns which you have as -9.7%.

Long-term investing requires more than just looking at the share price on a given day.

Re-invest your dividends and stay invested, this is a life time game.

Correction
222% over 5 years – 26% per year for AVI. Thats with divi’s reinvested.

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