Jeremy Grantham from GMO is predicting increasing scarcity of food products and resources that go into farming. This would result in higher prices we pay to buy produce. This is probably not a surprise to most of our readers as I suggested investments in the agriculture sector more than a year ago. So with higher prices, one could expect better revenues for fruit and vegetable producer/distributor like Fresh Del Monte (FDP) in the future. The question is, does that make the stock a good investment today?
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Quick Look at the Valuation
We will get the ratios quickly out of the way as they are not much relevant to this discussion. The stock at 0.92 times book value might appear a tad cheap but adjusting for about $400 million in good will on the books, we are looking at a stock price at 125% of the tangible book value, which is not too shabby but not attractive enough to invite interest. I would even argue that at 13.31 times earnings, investors may be over paying for the stock a bit today. Dole Foods is more richly valued than Del Monte, but it says more about Dole being a worse investment than FDP being a good investment.
Commodity Business and Place in the Value Chain
As a value investor, I tend to wave off entire industries or set of companies based on how they are positioned, unless a case can be made for tremendous undervaluation. In cases where investment thesis might revolve around future growth, one has to consider if this growth, even if it materializes, is worth paying for. We may anticipated a supply constrained food industry in the future, with higher retail prices. So Del Monte might sell similar amounts of product at higher prices, thereby generating greater revenues. Does this mean it will generate greater shareholder wealth?
Growth is never worth paying for, unless the company has some sort of a competitive advantage that allows it to keep a higher share of revenues for the shareholders as profits.
In this case, we are looking at a commodity business. A global commodity business with undifferentiated products. Companies that do not execute efficiently in this business lose money. Companies that are very efficient, earn a rate of return in line with the risks they take (capital structure) and whereever the demand and supply curves happen to intersect that year.
Fresh Del Monte sits in the middle of the producers (a banana farmer, for example) and the consumers (like us) who buy produce at a grocery store (there are other intermediaries, such as the grocery retailer, but it does not change the argument). Their profit is the difference between prices they receive and the prices they have to pay. Last quarter, for example, revenues rose 7% while the gross margins fell by 9%. While the prices were higher (for the increased revenues), the costs were even more so. Despite the scale, they typically do not have enough bargaining power either as a purchaser or as a seller to protect their margins, neither do they have a lock on the distribution of the produce to charge an above market rent. Neither do they generate demand nor create supply. They are just market takers.
Typically, in scenarios like these, businesses at the either end of the value chain (for example, fertilizer producers or farm holding companies, or on the other hand, a grocery retailer) has much more leverage on the prices to manage their margins. There may be players in the middle of the value chain that bring specialized skills or value that may be able to generate high margins. For everyone else, regardless of the size of the business, unless the stock is terribly distressed, we should pass as commodity businesses do not really create too much of shareholder value over time.
At Best a Proxy for Rising Food Costs – Not Enough Value in the Stock Itself
However, the stock is not expensive, and pays a 1.6% dividend. The company seems to be well managed and they continue to push for incremental margins by offering “new” products such as “fresh cut” produce (which is so quickly and easily copied, it is not even funny). Building a brand is difficult and success is uneven. With all this, if one chooses to invest in this stock today, one can expect to do as well as the industry itself might do over time. So it becomes a macro investment rather than a value investment and offers very little margin of safety from this perspective.
At this time I will pass.