By Mark Bern, CPA CFA
This article is designed to complete my assessment and explanation of the Food Processing Industry as it is necessary, I believe, to include a discussion on why some of the other large, widely-held companies within this industry did not make the master list. If you have not yet read the initial article of this series entitled "The Dividend Investors' Guide to Successful Investing," you may want to take a look at it to understand the selection process and explanations of the metrics I use.
I will start out by saying that all the companies that did not make my list are not bad companies. Some may have excellent prospects but pose too much risk. Others are solid companies but just don't exhibit the ability to perform at the levels I demand. And then, of course, there are companies that just aren't as well managed currently as they have been in the past. The future may hold greater promise for any of these companies, but by my metrics these are not the companies I want invest new money into at the current time.
I am going to include a metrics and a brief discussion for each of the following companies: Nestle (NSRGY.PK), Kraft (KFT), Unilever (UL), Campbells (CPB) and Nutrisystems (NTRI). I will also provide a brief discussion of why a few other major players in the industry failed to make the cut.
Metric | Nestle | Industry Average | Grade |
Dividend Yield | 3.4% | 2.6% | Pass |
Debt-to-Capital Ratio | 11.0% | 32.4% | Pass |
Payout Ratio | 72.0% | 42.0% | Fail |
5-Yr Average Annual Dividend Increase | 21.6% | N/A | Pass |
Free Cash Flow Per Share | -$0.34 | N/A | Fail |
Profit Margin | 10.6% | 6.3% | Pass |
5-Yr Average Annual Growth in EPS | -14.1% | 8.5% | Fail |
5-Yr Average Annual Growth in Rev. / Share | -1.0% | 5.5% | Fail |
Return on Total Capital | 13.5% | 10.0% | Pass |
S&P Credit Rating | AA | N/A | Pass |
Four failing grades should be explanation enough, even though free cash flow is close to being positive (and thus could be awarded a neutral rating). One of my concerns with Nestle is the payout ratio combined with the rapidly increasing dividend. This appears to me to be management's attempt to prop up the stock price while earnings are not keeping pace.
Metric | Kraft | Industry Average | Grade |
Dividend Yield | 3.0% | 2.6% | Pass |
Debt-to-Capital Ratio | 39.0% | 32.4% | Neutral |
Payout Ratio | 50.0% | 42.0% | Neutral |
5-Yr Average Annual Dividend Increase | 4.3% | N/A | Fail |
Free Cash Flow Per Share | -$1.39 | N/A | Fail |
Profit Margin | 7.3% | 6.3% | Pass |
5-Yr Average Annual Growth in EPS | 3.5% | 8.5% | Fail |
5-Yr Average Annual Growth in Rev. / Share | 8.3% | 5.5% | Pass |
Return on Total Capital | 7.5% | 10.0% | Fail |
S&P Credit Rating | BBB | N/A | Pass |
Four fails and two neutral (and I was being generous here) does not make for a good report card. If my children fared as poorly, they would get grounded. Seriously, though, while Kraft has a storied history and will probably be with us for much longer, the company is underperforming its peers in too many categories to be considered a quality company at this time.
Metric | UL | Industry Average | Grade |
Dividend Yield | 3.7% | 2.6% | Pass |
Debt-to-Capital Ratio | 33.0% | 32.4% | Pass |
Payout Ratio | 49.0% | 42.0% | Neutral |
5-Yr Average Annual Dividend Increase | 7.6% | N/A | Neutral |
Free Cash Flow Per Share | -$0.01 | N/A | |
Profit Margin | 10.1% | 6.3% | Pass |
5-Yr Average Annual Growth in EPS | 8.4% | 8.5% | Pass |
5-Yr Average Annual Growth in Rev. / Share | 4.2% | 5.5% | Fail |
Return on Total Capital | 20.0% | 10.0% | Pass |
S&P Credit Rating | A+ | N/A | Pass |
Unilever almost made the list with six passes and only one fail. But I have to draw the line somewhere and I usually like it best when the projected total returns are above 10 percent. UL, at 8.7% projected total return (by my own model projections) falls just short of its peers in this regard. It is certainly an above average company, but it just doesn't quite measure up to the three companies from the industry that made the list.
Metric | CPB | Industry Average | Grade |
Dividend Yield | 3.4% | 2.6% | Pass |
Debt-to-Capital Ratio | 69.0% | 32.4% | Fail |
Payout Ratio | 47.0% | 42.0% | Neutral |
5-Yr Average Annual Dividend Increase | 9.2% | N/A | Pass |
Free Cash Flow Per Share | -$0.08 | N/A | Neutral |
Profit Margin | 10.4% | 6.3% | Pass |
5-Yr Average Annual Growth in EPS | 7.8% | 8.5% | Neutral |
5-Yr Average Annual Growth in Rev. / Share | 5.3% | 5.5% | Pass |
Return on Total Capital | 24.6% | 10.0% | Pass |
S&P Credit Rating | A- | N/A | Pass |
Campbell is a good, solid company but just doesn't quite meet my requirements. The biggest problem is the lack of flexibility provided by the debt, which is significantly above the industry average. The dividend yield and growth are tempting. I may be a little picky by giving the company only a neutral rating on free cash flow when it is so close to being positive, but that really didn't come into the decision. I also feel as though the payout ratio, while receiving a neutral rating is a slightly negative factor in that it may limit future dividend growth to less than what the company has been able to achieve historically. If you hold CPB in your portfolio, I would recommend holding as the company has done nothing to warrant a sell. It is still a good company, just not quite the cream of the crop.
Metric | NTRI | Industry Average | Grade |
Dividend Yield | 6.5% | 2.6% | Pass |
Debt-to-Capital Ratio | 0.0% | 32.4% | Pass |
Payout Ratio | 61.9% | 42.0% | Fail |
5-Yr Average Annual Dividend Increase | 0.0% | N/A | Fail |
Free Cash Flow Per Share | -$0.35 | N/A | Fail |
Profit Margin | 3.5% | 6.3% | Fail |
5-Yr Average Annual Growth in EPS | -26.0% | 8.5% | Fail |
5-Yr Average Annual Growth in Rev. / Share | -1.8% | 5.5% | Fail |
Return on Total Capital | 13.5% | 10.0% | Pass |
S&P Credit Rating | NR | N/A | Fail |
I decided to include NTRI because of the high dividend yield. But just look at all those fails! Don't get me wrong, though, as I do believe that the company has some good potential. But that potential comes with too much risk for my blood. If you are conservative investor I don't think NTRI is a suitable investment.
Now I promised to provide some guidance on why a few other companies did not make my list and so here it goes. Tyson Foods (TSN) has very volatile earnings, a low profit margin relative to its peers that is also very erratic, a low dividend that has not increased over the past 12 years and a slightly negative cash flow. There's just too much risk in this issue for my liking.
Smithfield Foods (SFD) does not pay a dividend (something I usually demand from my investments) and its earnings have been very volatile. Hormel (see article here) is a much better managed company, in my opinion.
Sara Lee (SLE) is splitting into two companies at the end of this fiscal year (June 30, 2012). Also, the company has been selling off pieces of the company over the past two years in preparation for the split causing erratic results of late. This has resulted in less than desirable earnings and dividend consistency. There is just too much uncertainty for me to make a quality judgment until I have some history of the new entities to assess. I expect that the tea and coffee business will offer some good potential, but I would also like to see what dividend policies are before I consider either company.
Ralcorp (RAH) is changing its business model again after the spinoff of the Post cereal business on February 3rd. The company is going back to its roots and will operate primarily as a producer of private label goods. This will affect margins and several operating expense categories. I am choosing to stay on the sidelines until the company has provided a couple of years of results under the new business model. At this time there is too much uncertainty for me.
Kellogg (K) is another company that will probably be around long after I am gone. But that doesn't mean it is one of the best investments available. It is a good company with good management, but the debt is too high for my tastes (74 percent of capital) and the payout ratio is above the industry average (49 percent compared to 42 percent). The company also has negative cash flow by the method I used to calculate it. While the dividend is tempting and has been rising at a nearly eight percent compounded rate, other companies in the industry offer better prospects with less risk, in my opinion.
Well, there you have it. This concludes my assessment of the food processing industry. Next up will be the integrated oil industry. Thanks for reading and, as always I enjoy your comments so keep them coming. Only through sharing our ideas, experiences and perspectives can we all learn to be better investors together. I wish you all a successful investing future!
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
