2022 was a strong year for food and beverage stocks – and particularly the biggest manufacturers in the industry.
On average, including dividends, General Mills, Kraft Heinz, Campbell Soup, Kellogg, and Conagra Brands returned 22.6%. The S&P 500, on the same basis, was down 18%.
At the beginning of 2023, however, that performance flipped. All five of those names are down so far in 2023 (on average by about 4%). The S&P, even after ugly trading on Tuesday, is up roughly the same amount.
There’s a relatively simple explanation: at least in the early going of 2023, investors have gravitated toward riskier, higher-reward plays. As a result, they’ve sold off their safe, defensive, food stocks and bought more speculative companies with higher growth prospects.
That story makes sense. The story surrounding foodservice distributors, however, seems driven more by the behavior of their customers than by their investors.
STRENGTH IS SURPRISING FOR FOODSERVICE DISTRIBUTORS
Given broad market weakness, those stocks too did well last year, if not quite as well as their manufacturing counterparts. PFG and SpartanNash gained over 20%, Sysco and US Foods were basically flat, while United Natural Foods struggled to a 21% decline.
That strength was somewhat surprising. A consumer pressured by inflation ostensibly would pull back on takeaway spending, which in turn would hit the biggest foodservice distributors. End consumer weakness can threaten the industry: Sysco, for instance, saw its stock nearly halved between the beginning of 2007 and March 2009, as the scale of the financial crisis became clear.
Yet the group showed relative strength in 2022 – and has been even better in 2023. All five distributor stocks are positive YTD, with an average return of 5.6%.
This isn’t a case, necessarily, of investors anticipating growth ahead. Rather, they’re responding to already torrid results.
In 2022, US Foods’ Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) jumped 24%. The company expects a further 11% to 15% increase in 2023. At Performance Foods, Adjusted EBITDA soared 63% in fiscal 2022 (ending June); the company projects 25% to 32% growth in fiscal 2023.
All three companies posted particularly strong results in the calendar fourth quarter; even Sysco, the largest and most mature of the businesses, saw its Adjusted EBITDA rise 24% during the period.
Two factors appear to be at play. The first is that the away-from-home customer simply isn’t going anywhere. Some investors no doubt predicted that, at some point, spending would shift back into the grocery channel as consumers dealt with inflation. It hasn’t happened yet – and the market is starting to act as if it won’t happen at all.
Indeed, restaurant stocks themselves have done particularly well of late. Of the 45 publicly-traded restaurant stocks with a market cap of at least $50 million, only two are negative so far this year. One is QSR concept Wendy’s, the other adult entertainment chain RCI Hospitality.
But the second is that the actual arithmetic of inflation may help distributors. All three companies have tiny profit margins: EBITDA is roughly 4% of sales for Sysco and US Foods, and barely 2% for Performance. When prices are rising double-digits, it – perhaps counterintuitively – may be easier for distributors to capture a slightly larger spread.
And a fraction of a percentage point on a combined ~$170 billion in annual sales makes a material difference to profits and to the underlying stock prices.
CONSUMERS REMAIN RESILIENT
All three companies said on their recent earnings calls that they were able to pass along pricing. Sysco chief executive officer Kevin Hourican flatly said that “I am not worried about deep discounting. That is not the recipe for success in this industry.”
In that, of course, distributors are not alone. A key reason why food manufacturers performed so well in 2022 is that they, too, avoided price competition. In home or away from home, the U.S. consumer remains impressively resilient.
And that’s been the biggest tailwind for food distributors to this point – though it likely remains the biggest risk going forward.
Vince Martin is an analyst and author whose work has appeared on multiple financial industry websites. He’s the lead writer at Overlooked Alpha, which offers market-wide and single-stock analysis every week.
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