Investing in the Food Sector

As social awareness of the importance of healthy eating increases, the food investment market is evolving. Large ‘fast food’ companies are suffering the consequences of social awareness about food and health.

Kevin Thozet, a member of the investment committee at Carmignac

The festive season is over, and many of us have resolved to prioritise healthy habits as we entered the new year. But the performance of some well-known US ‘junk’ food producers suggests a focus on health is far from a January fad.

For companies whose business model is effectively ‘buy commodities’ (whose prices are rising) and ‘sell an identifiable trademark’ (whose brand equity is depreciating), the environment is difficult.

Coca-Cola’s share price has given up 15% from its highs. Over the past year:

• Hershey is down -15%,
• Mondelez -20%,
• Pepsi -10%, and
• Kraft Heinz -20%.

Generally, their European counterparts are faring better, but dig beneath the surface and this can be explained. Unilever (shares up 20% over one year) is increasingly focused on hygiene and personal care (25% of sales and growing) over food, and Nestlé’s coffee and pet food divisions (accounting for 20% of sales, with annual growth of +10%) are in the driving seat.

The Risk of Legislative Indigestion

Ultra-processed food accounts for 60% of the average American's daily calorie intake—this rate is 30 to 50% lower in Europe, albeit increasing. And ultra-processed foods tend to be associated with an increase in obesity, type 2 diabetes, cardiovascular disease, and risk of cancer.

The FDA (Food and Drug Administration), the US government agency responsible for ensuring food safety, has adopted a tougher stance on food labelling. Related legislation, such as the TRUTH in Labelling Act, is moving forward on the back of bipartisan support in Congress.

The appointment of Robert F. Kennedy Junior—who wants to transform the eating habits of Americans and explicitly compares processed food to poison—as Health Secretary in the new Trump administration could accelerate such a trend.

The Secret Ingredient for the Winning Recipe

Long-term sales in the agri-food sector as a whole are expected to grow at an average of +2.5% per annum.

If the proportion of ultra-processed foods consumed by American households were to fall from 60% of daily intake to 40% (the level seen in countries such as France, Germany, or Belgium), this would have a:

• Negative impact on the growth prospects of the major food groups, with annual sales growth 1.3% lower than the status quo—i.e., sales growth of barely 1% per annum.
• Upward impact on costs.

Alternatives to processed ingredients tend to be 10% more expensive. In a world where consumers are extremely inflation-conscious, this raises questions about future margin trajectories for food producers. However, the broader context is that the cheaper ‘market costs’ of junk food fail to account for the social costs created by its negative externality, which is estimated to be around 3% of global GDP.

Pouring Salt Into an Already Open Wound

The advent of new-generation appetite-suppressant medical treatments (GLP-1) has already led to concerns in the sector over the evolution of consumer behaviour towards healthier options.

Some studies indicate:

• Up to 30% reduced spending at grocery stores for GLP-1 users.
• A staggering 70% decrease in fast food, confectionery, or soda.

Some well-known food producers have made efforts to address the fat, salt, and sugar content of their products. Danone, Unilever, and PepsiCo notably tend to rank better on addressing malnutrition in all its forms. However, the biggest challenge for food companies is that the bulk of revenues come from a handful of product lines (e.g., for Nestlé, 80% of total sales are generated from 11% of Stock Keeping Units (SKUs), while 33% of SKUs generate 1% of sales).

While short-term demand is unlikely to change, the evolving and tougher regulatory environment and cultural shift towards health-consciousness are likely to be negative factors for companies in the sector over the long term.

Diverging Diets

The polarisation of consumer spending is also evident in the broader agri-food sector, where there is a direct link between food quality and income levels.

Consumers are increasingly aware of the harmful effects of ultra-processed foods, but not everyone can afford healthier alternatives.

‘Top-end’ food retailers, such as Costco, Amazon, and Sprout Farmers, tend to trade at a premium, with price/earnings ratios of 30x to 50x. These retailers serve customers with higher average incomes who are less price-sensitive.

At the other end of the scale, retailers such as Dollar General and Dollar Tree, catering to consumers who are unwilling or unable to pay more, are more exposed to headwinds facing the sector and trade at much lower multiples.

Investment Implications

This environment has contributed to the underperformance of the consumer staples sector relative to the consumer discretionary sector over the last three months, according to Bloomberg. This trend was reinforced as concerns over an economic slowdown receded.

Unsurprisingly, the large food companies most exposed to regulatory risk and malnutrition concerns have performed most poorly.

In this environment, with organic growth unlikely, food production firms are pivoting towards cost-efficiencies and external growth via mergers and acquisitions (M&A). Recent deals include:

• Mondelez and Hershey in confectionery
• Post Holdings and Lamb Weston in frozen potato products

We can expect more M&A activity in 2025.

With some premium grocery retailers trading at record prices and the historic food and drink companies facing multiple headwinds, we prefer to stay away from food and distribution stocks in favour of consumer staples companies with exposure to household and personal care products.

When junk food and financial markets collide, our health and our portfolios are likely to pay a high price.