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Table of Contents
Agribusiness & Packaged Food Sector Comparable Valuation 2
2009 CAGNY Preview 5
Key Issues for 2009 5
Will The “Food Trade” Re-Emerge in 2009? 6
2008 Performance 8
Expect Another Year of Eating-In More 10
Headline CPI Prices Will Be Worse Than What Packaged Foods Report 11
Good Brands Will Do the Best Job of Maintaining Pricing 12
Earnings Quality Matters 14
Expect More Private-Label Volume Growth 16
Why Currency and Pension Expense Matter Even More Than You Think 17
Don’t Expect a Windfall from Margin Expansion 18
Will There Be Another Round of Consolidation? 20
Who Has the Most Cost Savings in Their “Tank?” 20
Private-Label Share Gains 21
Well-Positioned Categories 25
Tough Categories 25
Turnaround Stories Face a Tougher Road When Economy Is Bad 26
Management Has Gotten Better 26
Why Quality Matters 29
Food Safety Recalls Are Raising the Cost of Doing Business 30
State Governments May Introduce Obesity Taxes 30
Commodity Costs 31
Shareholder Value 42
Company Reports 50
Campbell Soup Company 51
ConAgra Foods, Inc. 70
General Mills 90
H.J. Heinz Company 112
Kellogg Company 136
Kraft Foods, Inc. 153
McCormick & Company 175
Additional Company Notes and Models 198
Archer Daniels Midland Inc. 199
Ralcorp 208
Tyson 214
Investor Relations Contacts 218
2009 CAGNY Preview
Key Issues for 2009
The challenge consumer staples investors face this year is that the U.S. is already 13
months into a recession, so the bigger opportunity for outperformance in 2009 is in earlycycle
sectors, not the defensive ones. But that’s okay. We think investors can still get 10-
15% upside from food stocks this year if they pick companies that deliver on their
promises for fundamental improvement in the second half. With P/E multiples now
languishing close to historical lows of 13-14x, we think there is plenty of downside
protection. But you have to pick the companies that are going to deliver.
Will profit margins expand? Food companies have experienced 200 bps of operating profit
margin erosion over the past four years. How could they get any worse? We get that
question every year. The problem we see is that food companies don’t really have pricing
power. They can react to rising commodity costs with price increases, but they lose
momentum when the pricing window closes. Higher commodity costs are still running
through their P&Ls.
Who is at risk of consumers trading down? Last year commoditized categories like
milk and cheese experienced the biggest trade-down to private label. But what’s next?
Could retailers decide to expand their private-label programs in heavily branded
categories? Brand managers risk losing their point of differentiation as they direct less
money into advertising and more into coupons. Heinz and ConAgra have hinted in this
direction.
Have currency headwinds hurt U.S. food companies’ competitiveness? If U.S.
management teams cut their marketing spending or delay projects because of currency
headwinds, they will lose market share. Nestle and Danone have taken market share from
Heinz, ConAgra, and General Mills by using the benefits of a stronger U.S. dollar to dial up
promotional activity. Hershey’s leverage over Mars-Wrigley this year may be
underappreciated.
Who is getting better at trade spending efficiency? With retailers and consumers
clamoring for price relief, we believe that higher trade spending is inevitable. This is a
huge bucket of spending, and not every company is good at measuring the return on
the investment. What are the new tricks that food companies have for getting positive
ROIs on that spend? General Mills, Kraft, and Heinz say they have made big strides
toward cutting trade spending. How long can that last?
Cost control. In a lean economy it is important to run a lean operation. Companies that
claim to have a big reservoir of cost savings from restructuring projects never seem to
drop the savings to the bottom line. Kraft cited $200 million of incremental savings in 2009
from restructuring projects but still lowered guidance. We prefer companies where cost
control is part of the culture (like Kellogg and perhaps General Mills now, too).
Emerging markets haven’t blown up (yet). Russia, China, and Brazil have been the
primary fuel for food company growth over the past several years. They have poured
money into these markets under the impression that they will grow forever. Will they need
to slow this investment? And if so, where will they redirect the funds? Brazil and China
have been holding up very well, but Russia is cracking.
Could the obesity tax re-emerge? This issue could surprise a lot of people this year.
The State of New York has introduced legislation that proposes higher taxes for
carbonated soft drinks sales. Massachusetts is entertaining the possibility of ending
the tax exemption for soda and candy. State governments need tax revenue, and food
that is not so good for you could be an easy target. So far, the talk is more rhetoric
than reality.
Will there be another round of consolidation? In the past, the food industry has turned
to consolidation when valuation multiples dipped to low levels and companies needed
to find quick ways to cut costs in a challenging market. But getting financing for a
mega deal today is much more difficult than it was during the last round of
consolidation. Campbell and Heinz are often talked about as logical partners. Hershey
seems to be out of the running. The fact that trusts and families control a large
percentage of these companies usually presents an obstacle to deal-making.
Our advice: stick with quality. The falling commodity cost environment presents a golden
opportunity for companies with high-quality brands in rational categories with “sticky”
pricing. But the ones with weak brands in commoditized categories will have trouble. This
strategy worked pretty well in 2008 and we think it will work again. We like Kellogg,
General Mills, and Ralcorp because the cereal category has been rational. Kraft, ConAgra,
and Sara Lee face an uphill battle. Heinz may work again, but not until management
lowers expectations for FY 10. We want to get more constructive on Campbell and
McCormick.
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