Time To Go Grocery Shopping? Not Yet.

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Includes: BGS, SJM, WMT
by: Dividend Stream

Summary

Grocery and food industry shares are down across the board on news of Amazon's acquisition of Whole Foods.

The industry had been facing difficulty before this was announced due to various similar factors.

Despite this, most of the quality names are not trading at meaningful discounts.

Last Friday morning my watchlist lit up in red. Seeing that the overall stock market was more-or-less flat, I dug in to see what was going on: Food companies and grocery store chains were taking it on the chin. I looked around to see what was happening and soon enough found that Amazon (NASDAQ:AMZN) had acquired Whole Foods.

Long story short, grocery store and food stocks are down because of a belief that Amazon's entry will result in greatly increased competition and much more e-commerce. Ultimately, many believe that these two things will result in less margins for grocers and food companies across the board. That's certainly how the market took it, because pretty much everything in this space is down at least a couple percentage points.

I like name brand food companies, because they are capital-light and oftentimes generate lots of excess cash flow. This is ideal for income-minded investors like myself. Grocery stores tend to have less margin and much higher overhead. But with shrinking purchasing power of the masses and the subsequent need for private label brands in the aisles, this puts considerable power into the hands of grocery chains, and so I'm at least willing to consider some of them, depending upon various other factors.

Let me cut to the chase. Even before the Whole Foods purchase, these two industries were undergoing some significant upheaval. Consumers aren't making as big of purchases at supermarkets; they aren't loading up their cars with big weekly purchases as much. Many consumers are no longer interested in manufactured food, instead opting for organic and simpler food. On another end of the spectrum, consumers are seeing their buying power diminish year after year, and are trading down to deep value. This has led to a something of an impasse for most food companies, and most are therefore having a good bit of trouble achieving top line growth of any kind.

Amazon's foray into the space by buying Whole Foods, whether it ends up working or not, is only going to add to this pressure. Therefore, if dividend investors want to get into this space, they should really hold off unless they can get the more well-positioned companies at a substantial discount. Is that possible? In this article I look at three of my favorite names in this industry.

I like Wal Mart Stores Inc (NYSE:WMT) because it is able to offer a deep value proposition in the grocery business, an important factor in today's environment. Because many of the 'supercenters' include big box general stores, however, Wal Mart remains somewhat vulnerable to e-commerce (although Wal-Mart does have a sizeable e-commerce presence of its own.)

Wal-Mart is able to grow revenue in this environment, which is no small feat. Last quarter topline revenue grew 1.4% and comparable sales are forecasted to be up at least 1.5% on the year. Operating income was up 1.3% in constant currency. This may not seem like much, but that topline growth is precious, and it reflects the excellent value proposition Wal-Mart is able to offer.

Unfortunately for us, Wal-Mart is still valued highly, despite being down 4.6% on Friday. Over the last ten years Wa-Mart has averaged 15 times trailing earnings. But right now it trades at 17.4 times trailing earnings, so it is still at a meaningful premium to its average valuation. As far as looking for diamonds in the rubble, Wal-Mart is a still-standing edifice that has yet to be reduced to debris. It's just not low enough right now.

JM Smucker Co (NYSE:SJM) is a foods company I've followed for a long time, most notably because of its solid name brand recognition it has and the very impressive cash flow which it generates. However, Smucker is suffering from a lot of the other things I mentioned above. As a result, net sales were down 1% year-on-year last quarter, and guidance is flat.

There is a good amount of cost synergies with Smucker, as well as cost savings, which together will boost EPS by mid single-digits this year. Still, cost-cutting will only go so far, and can only go on for so long.

In the meantime, Smucker is just about at its average valuation anyway. Shares trade at 16.1 times trailing earnings, but have averaged 16.8 times over the last ten years according to data from FAST Graphs. That's not much of a discount, and, all things considered, it's not worth getting off the fence for. Remember, if anything, Amazon's entry could make things worse, so investors have to be cautious here.

B&G Foods (NYSE:BGS) could be one exception. B&G is somewhat similar to Smucker, mostly in the sense that there's no top line growth and the company generates lots of excess cash flow. Despite organic growth from the recently acquired Green Giant brand, revenue declined 1.6% year over year in the last quarter, and overall revenue guidance for 2017 is flat. There isn't going to be much, if any, top line growth here, and B&G is facing the same pressures a lot of other name-brand food companies.

However, B&G is also traded at a very low valuation. B&G has averaged 19.2 times trailing earnings for the last ten years according to data from FAST Graphs, and right now B&G trades at just 17.4 times earnings, with a dividend yield of 5.1%. That's a discount of about 9% to its average valuation. Altogether that has been enough to get me off the fence. I dipped my toe back into B&G not long ago, and I may buy more if shares continue to drop as they have. Shares are down 16% year-to-date, and 7% of that drop came last week. B&G is a case where, even though there isn't much prospect for top line growth in my opinion, the valuation is low enough and dividend yield is high enough to be worth buying for income investors.

Conclusion

On the whole, the situation in the foods and grocery industries isn't very good, and it wasn't good even before Amazon decided to get in with the purchase of Whole Foods. Ultimately, I'm skeptical that Amazon will bring revolutionary change into this industry like many seem to believe, but given the entirety of the situation, income investors should look for a meaningful discount before buying shares in most of these companies. As it is now, most of the high-quality names here still aren't cheap enough.

If you're interested in any of these three companies, feel free to follow me here on Seeking Alpha. I am personally long B&G, and I intend on following all of these companies more closely in the intermediate future, especially if this volatility continues.

Disclosure: I am/we are long BGS.

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.