By Sam Stovall
The past week brought a few more changes to the the list of industries with six-month relative strength rankings of "5" -- meaning they are in the top 10% of all industry groups based on trailing six-month price performance. (See the table below for the top-ranked industries as of Nov. 2, 2001.)
One group that was added to the list was the Packaged Foods industry, a traditional defensive haven for investors. This group is followed by S&P analyst Rick Joy, who has a positive near-term outlook. Year to date through November 2, the S&P Foods Index gained 0.1% versus the 16.9% decline for the S&P 1500.
Joy says that while valuations in the industry have benefited from a massive consolidation in the food industry, continued outperformance is likely to be selective and related more to the group's defensive appeal in a slowing economy. The consolidation has been rapid, with 13 mergers among publicly traded packaged food companies since the beginning of 2000. And that has eliminated all of the obvious takeover targets, according to Joy. While there is still potential to see acquisitions of smaller niche companies, the lack of large buyers left in the marketplace is leading investors' attention away from merger speculation and toward fundamentals: market share and earnings growth.
For 2001, Joy anticipates that the continued low market prices for corn, soybeans, and wheat will help to offset high fuel and energy costs for most companies involved in the food processing business. Industry profit margins are likely to show improvement due to cost savings accruing from mergers and acquisitions and aggressive restructuring actions undertaken by most of the major companies in recent years. Joy says the impact of low commodity prices will vary among companies, but heavy grain users -- such as cattle and poultry processors, baking companies and pet food manufacturers -- should benefit the most from low prices.
Joy notes that the shares of branded food manufacturers, which are much more insulated from the effects of changes in agricultural commodity costs, have generally performed well in recent months. Given the defensive nature of the group and the recent wave of merger and acquisitions activity, he thinks these issues will likely continue to outperform the broader market averages in the near term.
And in the longer term? Joy says the packaged food industry's ability to meet evolving consumer lifestyles and tastes should enable these companies to sustain their long, successful record of higher sales and profits. In addition, rising U.S. and world standards of living, increasing world trade liberalization, and the significant adoption of progressive economic policies throughout the world should provide U.S. food packagers adequate opportunities for long-term growth.
Stovall is senior investment strategist for Standard & Poor's