Winning The Organic Food Game

By Will Ashworth | March 31, 2009 AAA

As 2008 came to a close, the organic food and beverage market slowed as the sputtering economy ate into household budgets. While sales were up 12% in 2008 to $21.1 billion, that's down from 16.9% in 2007, and industry observers expect 2009 to be tougher still. Yet, winning the organic food game is still possible for investors, let's look at how it can be done.

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A Good Compromise

Some consumers feel organic foods are too expensive, especially given the state of the economy, and are switching to less expensive alternatives including private label grocery store brands. For those that think they can't afford organics, there is a solution. According to a survey by J.D. Power & Associates, grocery stores are introducing high-quality organic products right alongside their regular private label offerings and customers are taking the bait.

Janet Eden-Harris of J.D. Power & Associates said that "it's clear that consumers have begun to discard the idea that private label brands are of lower quality than traditional brands, which provides an opportunity for retailers to differentiate themselves with high-quality, reasonably priced store brands." Survey respondents felt Safeway (NYSE:SWY), Whole Foods (Nasdaq:WFMI) and Trader Joe's provided the highest quality private label products of any major grocery chain in America.

Brand Names Get Squeezed
It's estimated that 20% of all items bought in grocery stores and at other retailers are private label brands. This is saving consumers almost $16 billion annually, just by choosing an alternative to the highly advertised national brands. Giant food producers like ConAgra (NYSE:CAG) need to be careful they don't price their products too high, forcing former customers into the open arms of retailers like Wal-Mart (NYSE:WMT), which spent the past year refining its Great Value private label products to meet and exceed customer expectations. Already the largest grocery brand in the nation, a home run by the Bentonville behemoth will make life miserable for name-brand food manufacturers.

Private labels haven't taken over just yet, but it's getting interesting. Kroger's (NYSE:KR) most recent quarter saw it generate 27% of its total sales from private label, Safeway is licensing its O Organics store brand to other grocery chains and sales of private-label items grew 10% in 2008, almost four times those for name brand products. That's very healthy growth in a slowdown.

A Slight Pause
At the turn of the 19th century, we all ate organic food because processed foods didn't exist. Personally, I think we can get back to those days. Manufacturers, distributors and retailers will most certainly figure out how to make organics available at a reasonable price. For instance, Newman's Own Organics' originally made chocolate bars with organic sugar from the island of Mauritius, the only place on the planet where it was grown. Today, they grow organic sugar right here in the United States. That drops the price considerably. Another example from Newman's Own Organics' is coffee. The company provides fair trade java to 650 McDonald's (NYSE:MCD) locations in the Northeast. Even the golden arches are getting into the act. However, sometimes two steps forward can mean one step back.

In February, organic food producer Hain Celestial Group (Nasdaq:HAIN) reduced its 2009 revenue projections. Originally expected to be as high as $1.3 billion, the company feels the economic slowdown could drop top-line sales to as low as $1.18 billion. Analysts are expecting the annual revenues to be $1.21 billion. Bottom-line profits could be approximately 10% lower than originally thought, between $1.38 and $1.42 a share, and much lower than analyst estimates of $1.50. Though the profits are expected to be lower, they are still very respectable. (For more on analyst expectations, read Analyst Recommendations: Do Sell Ratings Exist?)

Bottom Line
Some in the press are using this recession as a signal that organics are just a fad, and that consumers will always pick price over quality. However, if some recent private label offerings are any indication, they couldn't be more wrong. The poor economy will hurt the organics business, but that doesn't mean it won't continue to grow. (To learn more about places to look when the markets turn south, read Industries That Thrive On Recession.)

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