The festive season is over and many of us have resolved to prioritise healthy habits as we enter 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% (as of 14 January 2025 in dollar terms).
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) rather than 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 US Food and Drug Administration has adopted a tougher stance on food labelling and 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 Jr. – 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 the level seen in countries such as France, Germany or Belgium (around 40%), this would have a negative impact on the growth prospects of the major food groups, whose annual sales growth would be on average 1.3% lower than the status quo, i.e. sales growth of barely 1% per annum.
It would also have an upward impact on costs.
Alternatives to processed ingredients tend to be 10% more expensive. And in a world where consumers are extremely inflation conscious (even if year-on-year changes are slight) this raises questions about future margin trajectories of the food producers.
However, the broader context is of course that the cheaper ‘market costs’ of junk food fail to account for the social costs created by the negative externality of junk food, 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 (also known as GLP-1) has already led to concerns over the evolution of consumer behaviour as they lean towards healthier options. Some studies indicate up to 30% reduced spending at grocery stores for GLP-1 users and 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 and will engage with investors on this topic. Danone, Unilever and PepsiCo notably tend to rank better on addressing malnutrition in all its forms.
While positive, the reality is the biggest challenge of food companies is that the bulk of revenues come from a handful of product lines (for a company like Nestle, 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 is likely to be a negative factor for companies in the sector over the long term.
Diverging diets
The polarisation of consumer spending can also be seen in the broader agri-food sector. Especially as there is, unfortunately, 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 to buy healthier alternatives.
‘Top-end’ food retailers such as Costco, Amazon and Sprout Farmers tend to trade at a premium, with price/earnings ratios of between 30x and 50x, given the reduced price sensitivity of their customers who tend to benefit from higher average incomes.
At the other end of the scale, retailers that cater for customers who are unwilling or unable to pay more – such as Dollar General or Dollar Tree – are more exposed to the headwinds facing the entire sector. They are trading 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 three months. This trend was reinforced as concerns over an economic slowdown have receded. Unsurprisingly, the large food companies most exposed to regulatory environment and the risk of malnutrition have performed most poorly.
In this environment, with organic growth unlikely, the strategy of food production firms is to pivot to cost-efficiencies and seeking external growth via deals and associated merger synergies. This is illustrated by the growing number of mergers and acquisition reports in the sector, such as Mondelez and Hershey in confectionery and Post Holdings and Lamb Weston in frozen potato products. We can expect more in 2025.
With some premium grocery retailers trading at record prices and unprecedented valuations – despite relatively low margins – 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. We remain cautious on the sector.
Kevin Thozet is a member of the investment committee at Carmignac. The views expressed above should not be taken as investment advice.