Potential Food Bargains

By Sham Gad | April 18, 2011 AAA

Any topic about food lately has had to do with food's rising costs. Grain commodity prices have been on a surge for months. Prices in the produce section of your local supermarket are going up. Farmers have to spend more to feed livestock so it's causing the price of meat to go up. Food companies and restaurants are doing everything they can to avoid raising prices but many indicate they will no choice but to do so.

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Sour Milk?
Yet certain food-related businesses look rather cheap if you are willing to take a long-term perspective. For example, Dean Foods (NYSE:DF) is the largest manufacturer and distributor of fresh milk and other dairy related products. Most store brand milk you find at your local supermarket comes from Dean Foods. Currently, Dean is being squeezed by rising input costs while at the same time dealing with low sales prices to customers, which is hurting profits. But this company, which has a market cap of $1.81 billion, does over $12 billion in sales annually. A slight improvement in margins will lead to a sharp increase in profit. Shares trade at $10, near a 52-week low. (For more, see America's Best Food Stocks.)

Cheap Groceries
While prices at your local grocer seem to be going up, it's not yet translating into profits at Supervalu (NYSE:SVU), the $2 billion grocery store chain. Debt of nearly $7 billion is not helping things, but Supervalu just reported full year adjusted EPS of over $1 share this week. With shares trading at $10.50, Supervalu looks very cheap if those earnings can be sustained. Supervalu's various brands generate over $30 billion in annual sales. Over time a 1.5% net margin translates into $450 million in profits against a market cap of $2 billion.

If Supervalu's debt churns your stomach, the small cap grocery store chain Winn Dixie (Nasdaq:WINN) looks even better. Winn-Dixie boasts a market cap of $368 million, no debt and $60 million in cash. The company generates over $7 billion in sales, implying a price to sales ratio of 0.05, in line with Supervalu but without all the debt. By comparison, Kroger (NYSE:KR), trades at a P/S ratio of 0.18 while delivering net margins of 1.3%. If SVU and WINN can sustain comparable net margins, shares could double and would still trade at a P/S ratio of 0.10, a significant discount to industry leader Kroger. (For more, see 5 Economic Changes That Fatten Your Grocery Bill.)

The Bottom Line
Food stocks aren't glamorous businesses, nor do they generate juicy margins or rates of growth. But they do generate massive amounts of stable revenues that don't require large margins to generate a significant amount of net income relative to current market valuations. That creates a very intriguing operate to benefit from the embedded sales leverage in these businesses. (For more, see 5 Agriculture Stocks That Pay Dividends.)

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