Hold These 3 Food Sector Stocks For Big Gains In 2014

 |  Includes: GIS, MKC, NSRGY
by: Winning Strategies

The food sector has been experiencing volatile commodity prices, which have led to stagnant growth in the top line and fluctuating margins and profitability. Kellogg (NYSE:K) and Kraft Food Companies (KRFT) have seen this impact in the recent quarter, and both are finding challenges in growing top line. In spite of these challenges, cash flows all over the industry have remained strong, leading to healthy mergers and acquisitions activity in various sections of the supply chain. Companies in this industry are continually working on divestitures, acquisitions, cost cutting and innovations to optimize operations for higher top and bottom line growth.

Possessing the ability to generate strong free-cash-flow and liquidity, food sector companies are able to successfully navigate their way through difficult operating cycles. Fitch expects low- to mid-single digit top line growth with a higher growth rate among companies with heavier emerging market exposure. Fitch also believes that global packaged food companies have the capacity to leverage their capital structures to uphold current credit ratings regardless of macroeconomic factors such as high unemployment and reduction.

In this article, I came up with three of the best operating companies in the packaged food industry: General Mills (NYSE:GIS), the McCormick & Company (NYSE:MKC) and Nestlé SA (OTCPK:NSRGY). Let's dig into their business models, business strategies and financial statements to see whether these companies fit with Fitch's high ratings for this industry. Additionally, I'll look at their ability to sustain returns for investors to identify whether they are good stocks to hold for steady gains.

How General Mills is an Attractive Stock to Hold

Operating in the consumer foods industry, General Mills manufactures and markets branded and unbranded food products to the foodservice and commercial baking industries. The company has three operating business segments by type of customer and geographic region as follows: U.S. Retail; International; and Convenience Stores and Foodservice. They have made several acquisitions recently-particularly, international yogurt business Yoplait and Yoki Alimentos in Brazil.

With a strong product portfolio and product innovation, General Mills has a solid business plan for 2014. It is anticipating strong sales and earnings growth, as well as returning significant cash to shareholders. The company is looking to generate low single-digit growth in net sales, mid single-digit growth in segment operating profit, and adjusted diluted EPS of $2.87 to $2.90.

To achieve this growth, the company has a strong line-up of consumer-focused news and differential product innovation, including new cereals, new yogurt items, and comprehensive plans for other key categories, including baking products, dinner mixes, and snacks. Its recent acquisitions of Yoplait and Yoki Alimentos in Brazil have solidly positioned the company for future growth. Further, it is looking to maintain strong levels of product innovation and marketing activities all over the world to support its product portfolio. Finally, the company is also looking to enhance margins through significant supply chain and administrative cost savings initiatives.

In 2014, General Mills is looking to return significant cash to shareholders through dividends and buybacks. Its buyback activity is expected to decrease the shares outstanding by 2% in fiscal 2014. Indeed, the company is in a strong financial position to achieve its growth plans. With an 8% growth in its top line and 6% growth in its operating margin in the recent quarter, the company is on track to achieve its full year growth level goals. Strong top and bottom line growth enhances its cash generating potential, and as such, the company has been generating massive free cash flows to cover both dividend payments and buybacks. In TTM, its free cash flows are at $2.2 billion, while dividend payments are at $897 million and buy backs are at $1 billion. Based on this performance, I strongly believe General Mills is well set to sustain its returns in the form of dividends backed by its strong product portfolio, product innovation, cost cutting and efficient marketing and also in the form of capital gains, boosting investor confidence by consistently generating solid financial performance.

How McCormick & Company Is an Attractive Stock to Hold

McCormick & Company is engaged in the manufacturing, marketing and distribution of seasoning mixes, spices, condiments and many other flavorful products in the food industry. McCormick has significant global exposure, as approximately 40% of its sales are coming from outside of the United States. Using a straightforward strategy, the company operates in two business segments: industrial and consumer. Its strategy is to consistently invest in its business to generate top and bottom line growth in combination with cost-cutting measures from its Comprehensive Continuous Improvement [CCI] program.

As per its CCI program, McCormick is working on improving efficiency and reducing costs to enhance margins. Further, it's keeping its focus on category growth, new distribution and share gains, acquisitions and innovations. The company is looking to use cost savings to support investments in growth opportunities as well as enhancing its marketing activities. In 2013, McCormick is looking to reach marketing spending around $13 million. Employing these supporting activities, their long-term goal is to grow top line by 4% to 6%, operating income by 7% to 9% and earnings per share by 9% to 11%.

Looking at its financial situation reveals more about how the company is faring so far. In the recent quarter, its top line increased by 4% led mainly by its recent acquisition of Wuhan Asia Pacific Condiments Co. (WAPC). Operating income has grown by 3% over the past year quarter, led mainly by CCI cost savings. Finally, for the full year, the company is projecting to increase top line by 4% to 6% and operating income by 5% to 7%.

At the moment, the company is offering a quarterly dividend of 0.37/share, which looks completely safe given current levels of free cash flows. In TTM, its free cash flows are at $324 million, while dividend accounts for only $176 million. Its price to cash flow ratio of 21 also demonstrates this trend. With the potential to generate massive cash flows and a payout ratio of 46%, McCormick has a lot of room for dividend increases. Additionally, McCormick's business plans and financial performance have been generating solid capital gains, as over the past five years, its stock is up by 133%. Given its current long-term growth plans, the company is likely to keep boosting investor confidence.

How Nestlé SA Is an Attractive Stock to Hold

Nestlé manufactures and markets just about every basic foodstuff all over the world, including coffee, water, cereal, yogurt, ice cream, baby food, chocolate, frozen foods, seasonings, cookies, performance nutrition, and even pet food. These are the kinds of products that face no threat of technological obsolescence, and are generally affordable to a decent sized chunk of any country's population.

In the current challenging environment, the company is reinforcing the fundamentals of its business to drive growth by innovation, distribution and consumer engagement. Nestlé is also seeking to drive growth through operational performance, including strengthening its portfolio, improving resource allocation and escalating structural efficiency. With this strategy, Nestlé is continuing its growth momentum and looks to generate 5% organic growth on a long-term basis.

As can be seen in the last quarter results, Nestlé's real internal growth has regained momentum. On top, Europe continues to grow and Asia and Africa have picked up speed. In Europe, Nestlé has shown 0.7% organic growth and 1.5% real internal growth, while Asia and Africa are on top with 5.6% organic growth and 5.5% real internal growth. All in all, Nestle has been able to generate a strong, consolidated organic growth of 4.4% and real internal growth of 3.0%, consistent with its long-term growth targets.

This strong top line growth enables Nestlé to generate massive cash flows year after year. In the TTM, its operating cash flow is standing at $15.5 billion and free cash flow is standing at $13.9 billion. With its free cash flows at twice its dividend payments, the company's strong financial situation is allowing it to work on a buyback program and invest in growth opportunities. Further, its very low debt to equity ratio enhances its cash, which currently stands at only 0.1. With the current annual dividend of 1.81/share, its payout ratio stands at only 48%, which offers a lot of room to increase dividends. At the moment Nestlé is trading at ever higher levels-still, its valuations suggest more upside potential as the stock looks undervalued based on P/E and P/B ratios 18.7 and 3.3, respectively, while industry averages are at 20.4 and 4.3.

Final Notes

Though the industry has been facing number of challenges in the form of increased input costs, competition from private labels and economic volatility, these three companies are making solid progress by chasing the right business strategies. General Mills, McCormick and Nestlé all have solid plans in place to generate consistent long term growth.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.