Pondering A Paleo Portfolio

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Includes: CAG, CALM, CMG, CVGW, FOGO, GIS, JACK, K, KO, KUBTF, PEP, POST, SFM
by: Eclectic Wealth

Summary

The concept of Paleo-based diet principles, while still only a small market impact, shows solid durability and I believe it is increasingly likely to break out into broader acceptance.

An acceleration in Paleo-based eating would create significant economic winners with invest-able long opportunities, particularly in the casual dining market.

Short-side implications would likely be centered on the processed food industry.

While the future of early stage trends cannot be known with precision, investors should monitor for signs of accelerating Paleo adoption and factor that into their investment decisions.

Introduction

One of the ways I plan for investment opportunities is to look for the investment implications of durable trends that have proven to have staying power in a niche market and that may be poised to break out into a larger market. Premium coffee and tea, electric cars, video streaming, vaping, and medical marijuana-related compounds are several recent examples of an initially small niche accelerating into an invest-able trend. A trend which I believe is worth watching for a similar break-out is the set of diet and health related concepts that can loosely be grouped under the term “Paleo”. Delving into the different points-of-view surrounding Paleo is a large topic and not necessary for the scope of this article however I will give a brief background and market overview to set up the investment implications and interested readers can investigate the concept further. Whatever your personal views, an astute investor once told me “never use yourself as your only example” and I have found this to be consistently valuable advice as we tend to under-value things we don’t personally use and over-value those that we do, so having an understanding of both is important to expand horizons and contain enthusiasm.

Brief Background: What is Paleo?

At its most basic and general, Paleo is the concept that foods that did not exist in high-volumes prior to about 10,000 years or so ago should be viewed with great suspicion and are highly unlikely to be necessary for good health. Although our Paleolithic ancestors did not have our technology for dealing with acute injuries, they were by most accounts quite healthy compared to modern societies and similar characteristics can still be found in the few remaining non-industrialized societies. From this basic principle, specific foods can be evaluated to look for evidence as to whether they pose a risk.

What this has generally evolved to from a diet perspective is that the following food categories are viewed by Paleo principles as offering a poor risk/reward ratio for many people:

  • Foods with added sugars
  • Foods derived from the seeds of plants, particularly “vegetable oils” (which are actually seed oils) and many grains
  • Industrial food: almost everything with a long ingredients list of chemicals not commonly recognized as food
  • Some other foods fall into a category of lower risk and higher benefit, but still with cause for concern such as Dairy.

From this alone we can see that there never really was something called the “Paleo diet”, since these restrictions still allow for a huge array of foods, so Paleo eating is more about largely avoiding what we know our ancestors did not eat, rather than trying to approximate what they did eat. It’s not necessary or practical for the scope of this article to delve into the evidence for this approach, so interested readers are encouraged to evaluate that for themselves. A recent report from Credit Suisse is a good place to start for further reading since it provides a good overview of the investment-related impacts of Paleo influenced eating, as well as good summary of related dietary science.

Some Paleo-Related Investment Opportunities

So, with all of that out of the way, what are some specific investment possibilities to have on your radar should this trend accelerate? First, here are some long side ideas to consider, divided into what I would call solid suggestions and speculative suggestions:

Calavo Growers (NASDAQ:CVGW) – Avocados are one of the foods that are almost universally endorsed by almost all diet perspectives, even many that would not consider themselves Paleo, and they are an absolute staple of almost all diets with some linkage to Paleo principles. In fact the only diets I am aware of that are anti-avocado are those that believe in minimizing fats of all kinds. Given that, CVGW as a large producer of avocados is as much of a pure play investment in Paleo as I am aware of.

The thing that makes Avocados particularly appealing to Paleo eaters is that they are a highly nutritious plant food that is high in fat without being high in carbohydrate or polyunsaturated fats, both of which can be a problem for many people at high levels. And, for the therapeutic variants of Paleo eating (e.g. diabetes, dementia, cancer and others) staying fairly high-fat and low carb is often essential. Additionally, avocado oil is one of the few oil options which Paleo eaters would consider healthy. For reasons that are too involved to go into here, Paleo eating emphasizes using naturally occurring fats as a person’s primary source of fuel, however mainstream diet advice has continued to promote an anti-fat (and hence carbohydrate heavy) diet with only the tiniest of token changes to reflect counter evidence. From an investment perspective, this creates a pent-up potential for a very large shift in demand if something should shift the prevailing diet patterns in a more fat-friendly direction.

Over the longer term additional competition for CVGW will likely occur, and there are limits to the use of Avocados due to their highly perishable nature, however a strong undercurrent of demand should give CVGW a good margin of safety.

Seasonal and crop factors, as well as an acceleration in demand have recently further boosted the price for avocados, and import restrictions on agricultural products from Mexico (something I consider highly unlikely) could create a risk for CVGW, however increasing demand should create a price floor and margin of safety over the medium term. Personally, I am watching for more favorable entry points to initiate my next position, however I believe CVGW should be on investors’ watch lists if you believe that the supportive trends will continue.

Chipotle (NYSE:CMG) and Qdoba (NASDAQ:JACK) – When I scan for eating options that allow someone to eat largely within Paleo principles as much as practical, both Chipotle Mexican Grill and Qdoba (owned by Jack in the Box, Inc.) appear to be good options. The main challenge in finding Paleo options when eating out is in finding healthy sources of fat and/or starch while avoiding vegetable oils, sugars and wheat products, and that is easy to do at either of these. Paleo purists would not consider beans or brown rice to be Paleo, but these are easy to minimize or avoid if desired. For those who are going lower carb or keto, the sour cream and guacamole (there are the avocados again) and individualized portion sizes make it easy to get a meal with a healthy balance of fats, protein and carbohydrates with no vegetable oils, breads, or added sugars which can be tailored to individual preferences (another key component of Paleo principles). While neither are perfectly Paleo and have menu advantages and disadvantages, Chipotle and Qdoba are two of the best directionally Paleo options that are widely available and easily investable.

From an investment standpoint, I prefer JACK due to the margin of safety provided by the more moderate valuation, what I perceive to be greater room for growth, underappreciated value in the stock, and lack of overhang from CMG’s health concerns, however I think each can be good investments depending on one’s trading approach. Both of these also likely have an unrealized marketing opportunity to appeal to the Paleo-minded. I will be looking to initiate positions in both of these, in the near future for CMG and post-earnings for JACK.

Fogo de Chao (NASDAQ:FOGO) Contrary to popular perception, Paleo eating emphasizes eating a diverse array of colorful plants (Paleo eating is quite compatible with vegetarian eating) and no place I am aware of provides a more complete variety of healthy vegetation at a reasonable price than Fogo de Chao. Even though the popular image of Fogo de Chao is of a meat-focused formal restaurant, I have eaten at Fogo de Chaos at many locations in the US and Brazil, at locations opened under both the original and new management, and I have never ordered anything more than the salad/salmon bar given how much of an excellent meal it is on its own. I think Fogo de Chao has a largely untapped market in plant-friendly eaters as well as directionally Paleo eaters. A risk worth pointing out is that a classic recipe for problems in the restaurant business is having new management take over a specialty restaurant, and after visiting several of the newer Fogo de Chaos, I would say this is a very real risk over the longer term. Creeping de-Brazilianization appears to be a problem in the newer restaurants however that may not be immediately noticeable to many customers. Fortunately the salad bar seems to have survived in its original state so far and hopefully it will continue to do so, which will keep Fogo de Chao one of the best options for upscale Paleo eating, especially for the business lunch market.

From an investment perspective the business seems to be performing well and acceleration in Paleo eating could easily provide a meaningful boost and attract or expand the appeal, especially for more vegetarian-oriented eaters. Unfortunately, the recent secondary offering has created an overhang of negativity for the stock and may outweigh the performance of the business in the near-term, however the tailwind from Paleo eating could be a major positive over the intermediate to long-term.

And now for the more speculative suggestions:

Kubota (OTCPK:KUBTY) – A small but growing part of Paleo eating is sourcing food from local farms when possible and participating in agricultural cooperatives. Some of this is due to necessity since, for example, true grass-fed meats and dairy can be hard to find in stores, and some is due to preference. Kubota is one of the leaders in mid-sized farm tractors and stands to benefit from a resurgence in small and mid-sized farms. Kubota is not without competition from the likes of Mahindra, Deere (NYSE:DE) and AGCO (NYSE:AGCO) however Mahindra is part of a much larger conglomerate, and Deere has the potential to suffer offsetting losses in its larger equipment if the market for grains should meaningfully decline. AGCO is worth consideration as well, however I view it as less focused on the medium-sized market than Kubota. Kubota is especially exposed to currency fluctuation for investors outside of the Japanese shares, however it is a quality company and stands to benefit from a further shift toward moderate-scale farming in North America. I would look to initiate a position close to the 200-day moving average, however it is at the top of a 4 year trading range so conservative investors may not get a pullback to establish a position if it decisively breaks out from its current range.

Cal-Maine Foods (NASDAQ:CALM) – Eggs are a staple of Paleo eating (sometimes referred to as Nature’s multi-vitamin) however they are also something that is very well-suited to local small-scale farming, which creates a degree of competition for CALM. Additionally, Paleo eaters prefer eggs that live in a pastured environment which allows the chickens to forage for food (chickens are not vegetarian, they are omnivores that eat bugs as well as plant matter) which makes for a more nutritious and better tasting egg. There will still be a large market for commercially-raised eggs and the market for eggs is likely to expand faster than small producers can expand, so there may well be a steady increase in overall demand that will make the egg producers worth watching for good entry points.

Sprouts Farmers Market (NASDAQ:SFM) – SFM has already benefited from Paleo trends and will certainly continue to do so however the buyout speculation created by the Whole Foods acquisition creates a premium valuation that will take time to grow into if a buyout does not occur. Other SA authors have covered that in depth such as found in the article linked here. Furthermore, aggressive competition from specialized on-line competitors with moderate pricing who aggressively target the health-aware consumer (like Thrive Market and Vital Choice) are likely to become an increasing threat to traditional grocery stores. Some products that will appeal to the Paleo-minded are hard to find anywhere other than stores like SFM (such as non-homogenized milk), however those products make up a tiny part of the store. I think there are better options for investing in this trend such as those listed above, however it is still worth monitoring if for no other reason than the market may view it as a beneficiary at some point.

Switching over to consider short candidates, it appears on the surface that the businesses who will suffer from an increase in Paleo are more easily identified than those which will benefit, however I believe identifying specific short candidates is somewhat harder than long candidates because of the widespread and highly diverse nature of what such a shift in eating patterns would entail. To identify short candidates, I made the following assumptions:

  • The companies most likely to be negatively affected are those which have been marketing to health-conscious consumers but who are selling predominantly “industrial” food.
  • The companies most associated with “junk food” such as Hostess Brands (NASDAQ:TWNK) are least likely to be affected since their customer base is not driven by health concerns, so change in healthy eating patterns is not as likely to have a major impact

With that, let’s look at some short candidates. The possibilities are almost endless, but here are a few of the most likely candidates:

Breakfast Cereal Producers including Kellogg (NYSE:K), General Mills (NYSE:GIS), and Post Holdings (NYSE:POST) – Breakfast Cereals are perhaps uniquely vulnerable to a swing toward Paleo diet principles since they combine into one product three of the primary things that a Paleo diet attempts to eliminate, specifically added sugars, most grains, and foods with a long list of industrial ingredients. The Paleo rallying cry of “eat food, not food products” could have been invented for breakfast cereals. Also, many Paleo advocates de-emphasize a traditional breakfast in favor of only eating when you are actually hungry or eating within a confined “eating window” of 8 hours or so, and breakfast is typically when many people are least hungry. Some of the other companies that are at risk have major international markets which will cushion the impact of a trend in one region, however breakfast cereals are much more prevalent in North America than they are in many other parts of the world. For example, an under-publicized aspect of the “Mediterranean” diet is a de-emphasis on breakfast in general and cereal grains in particular, so I believe the cereal producers are much more exposed to a change in trend in North America. All this combines to create another potential headwind for the cereal-makers who are already facing major growth challenges.

ConAgra Brands (NYSE:CAG) – Almost any producer of “food products” would appear to be vulnerable to Paleo eating, so why single out ConAgra? My reasoning is that it is people who were already health conscious who are most likely to change their buying patterns based on wider appreciation of Paleo principles and ConAgra has been a beneficiary of that demographic in the past. ConAgra’s Healthy Choice line would on the surface seem to be very appealing to health-conscious consumers and it was at one time a key driver of ConAgra’s growth, however close inspection of the Healthy Choice ingredients list reveals a lot of the typical “industrial food” ingredients and Paleo red-flags such as vegetable oils. None of ConAgra’s brands would appear to benefit from a Paleo shift in buying patterns, Healthy Choice may be particularly vulnerable, and many of their other brands fall into the “industrial food” category that “no-label” eating attempts to minimize.

Coca-Cola (NYSE:KO) and PepsiCo (NYSE:PEP) – Too obvious perhaps, however at least half of the brands for both Coke and PepsiCo stand to be seriously damaged by a move away from sugary or industrial foods. Many people who are health conscious have already moved away from these types of products, however another wave of awareness, driven by children’s health perhaps, would make both of these companies particularly vulnerable. In their defense, they both have immense international markets that are likely to continue to grow long into the foreseeable future, however investors riding their growth should be on the look-out for an acceleration in the move away from sugar and be prepared to reduce positions accordingly. A counterpoint to this idea is that health-conscious consumers should have already moved away from sugary drinks (and chips), however to the extent that they haven’t, minimizing such foods is a commonly reported first step towards healthier eating, and the guideline of “don’t drink your calories” is another aspect of Paleo eating that could hit the soft drink makers particularly hard.

In summary, I don’t think Paleo will become the dominant driver of any of these investment ideas anytime soon, and as always you should only invest based on your own trading style and in-depth research, however I do believe Paleo may provide an additional degree of support and momentum for each of these if its adoption accelerates.

What Could Cause this Trend to Accelerate?

For the purposes of investment, the durability of this trend and the loyalty of its adherents, based on the continued publication of books consistent with the concepts and the rapid proliferation of related conferences, is enough to qualify it as something worth watching for investment impacts. To give an objective measure, as I write this, 5 of the Top 20 on Amazon’s Health-related recent releases best-seller list are clearly Paleo focused and two more are Paleo-neutral, but would still create a market for the investment suggestions I cite in this article.

One of the things that makes Paleo a bigger market trend than it may appear is that Paleo principles are encompassed under the branding of many different diets, thought-leaders and conferences. A quick book search for Paleo or Primal will turn up dozens of books, however many books and approaches incorporate at their core the same basic concepts but with differing language, emphasis and extensions for specific health issues. A few examples include:

  • Perfect Health Diet
  • Primal Diet
  • Wheat Belly/Un-doctored Diet
  • Grain Brain Diet
  • Bulletproof Diet
  • The Wild Diet
  • The No Label Diet
  • The Paleo Autoimmune Diets
  • The Wahls Diet for MS
  • Elimination Diets
  • Ketogenic Diets
  • Mediterranean Diets

So, as it relates to invest-able ideas, Paleo principles are a much bigger trend than anything linked to the word Paleo. I have no basis for quantifying the likelihood of this trend accelerating in the near term, however as investors, we can be aware of the potential and monitor for signs that the trend may be accelerating. If I had to guess what is most likely to accelerate this trend it would be some sort of Paleo-for-kids movement taking hold among parents which would be especially powerful due to its generational effect. The important thing for investors is to have companies that could be excessively helped or harmed on their watch-lists and to factor the impact of this trend into their analysis.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CMG over 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.

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