Three stocks sprouting in a growing organic market

Rising organic food consumption is pushing producers to expand their product offerings. They are claiming more aisles and greater shelf space at stores. From all indications, the trend is only going to grow and create bigger revenue opportunities for select companies well positioned in the organic marketplace.

General Mills (GIS) makes branded consumer foods. Some of its popular brands include Cheerios, Betty Crocker, Haagen-Dazs, Pillsbury and Nature Valley. The company’s portfolio includes ready-to-eat cereals (17% of revenue, 30% market share), where it owns three of the top five brands in the U.S., yoghurt (15% of revenue and 18% market share), baking mixes (11% sales, 50% market share ), and grain snacks (40% market share). More than 70% of General Mills’ revenue is generated in the U.S.

The five-star-rated firm continues to expanded to new geographies in pursuit of “growth in more on-trend categories like natural and organic products,” says a Morningstar equity report. The wide-moat firm, whose portfolio of organic foods includes Annie’s, Larabar, Cascadian Farm, and Liberté, has been boosting its presence in the natural and organics aisle with its acquisition of Blue Buffalo, a natural pet food brand.

“We have long appreciated Blue Buffalo's brand strength [as] the leading player in the quickly growing wholesome natural segment of the U.S. pet food category (representing 20% of overall pet food sector value), with greater than 30% market share,” says Morningstar equity analyst Sonia Vora.

The firm’s recent acquisitions to bolster its presence in the attractive natural and organics category are regarded by Vora as “strategically sound.”

General Mill’ returns on invested capital have averaged 25% over the past decade, considerably higher than the 7% cost of capital. This history of “excess returns, despite top-line volatility, should allow the firm to bolster its investments in more attractive geographies and categories, like snacks and organics, to weather changing consumer trends,” says Vora, who pegs the stock’s fair value at US$57.

Hormel Foods (HRL) is a protein-focused branded food company that owns brands such as Hormel, Spam, Jennie-O, Dinty Moore, Applegate, Skippy, and Muscle Milk. The firm generates a majority of its revenue in the U.S. from selling shelf-stable foods (19% of revenue), poultry (19%), other perishable food (56%), and is other shelf-stable (6%), primarily nutritional products. 

Hormel’s organic products portfolio comprises protein powders and shakes, chicken breast, peanut butter, and chicken nuggets. “The company holds the number-one market position in turkey, shelf-stable meat, pepperoni, natural/organic deli meat, guacamole, and canned stew and the number-two position in bacon, peanut butter, and protein beverages,” says a Morningstar report.

The company has its roots in animal proteins but has expanded to other types of proteins with acquisitions of Skippy peanut butter, Justin’s nut butters, and Muscle Milk. The company’s deli segment, which is enjoying a double-digit growth rate, was enhanced by the acquisition of Columbus, a premium deli that sells meat from animals raised without antibiotics.

“Hormel has shifted its mix to include more on-trend fare sold as fresh products on the periphery of the store (Jennie-O turkey, Applegate natural and organic meats and cheeses, and Wholly Guacamole, to name a few) where consumers are spending more of their time,” says Morningstar equity analyst, Rebecca Scheuneman.

While the U.S. is its primary market, the company has been expanding internationally. “Spam and Skippy both have international appeal and are being launched globally,” notes Scheuneman, who appraises the stock to be worth US$36.

Hormel’s recent acquisition of Brazil-based Ceratti, a producer of deli products, allows the company access to the fast-growing Latin American market.

Sprouts Farmers Market (SFM) is a grocery store that primarily sells natural and organic fare such as fresh produce, bulk foods, vitamins and supplements, packaged groceries, meat and seafood, deli, dairy, and other health products. 

With 300 stores across 19 U.S. states, the organic grocer is well positioned in the health and wellness market with 90% of its offerings in the natural and organic realm. “The firm strives to drive traffic to its stores by offering attractively priced produce (24% of sales) compared with conventional peers,” says a Morningstar equity report. Apart from lower prices (10% to 20% below conventional grocers), the company’s impressive performance can also be attributed to its self-distribution and partnerships with regional farmers, which ensure better-quality produce and improved margins, the report says.

Strong store economics and cash flow generation have helped the company grow at an above average rate over the last five years. Further, says Morningstar equity analyst Sonia Vora, “Sprouts has maintained an eye on growing profitably, as pre-tax cash-on-cash returns are 35% to 40% within three to four years.”

The company’s 2018 sales growth of 12%, a differentiated business model, and store base expansion prompted Vora to forecast “high-single-digit sales growth and 5% operating margins on average, as well as 20 to 30 new stores added annually,” bringing the store count to 500 by 2025.

Sprouts has been clocking average top-line growth above 20% over the past five years, says Vora, who pegs the stocks fair value at US$26.5. While the company can sustain this impressive growth, growing competition may put some pressure on the strong performance seen in the past, she warns.