Are Investors Paying Too Much for Consumer Brands?

Are Investors Paying Too Much for Consumer Brands?

Companies with famous brands, especially those in the food and beverage industry, have long maintained premiums in the stock market. Their loyal customer bases and pricing power seemed to assure steady profits and strong growth. However, changing consumer tastes and competitive incursions might be eroding that advantage. There's some evidence that suggests iconic brands might not be able to produce the same returns that they have historically. Could that mean that these famous names are overpriced? Let's take a look.

Bland growth in well-known names
Growth trends in the food and beverage industry, relative to historic norms, have been disappointing. Two of the most recognized names in the space posted surprisingly sluggish gains in their latest quarterly reports.

The Coca-Cola Company , the world's largest beverage company, reported that adjusted revenues grew a modest 4% in its most recent quarter, and 3% year-to-date. While adjusted operating income grew 8% in the quarter and 6% year-to-date, tepid volume increases were concerning. Worldwide volume growth, a main indicator of consumer acceptance, came in at a weak 2%, which matches the year-to-date average.

The company may be optimistically priced given the lackluster top-line and volume growth. At about 20 times earnings, compared to the Dow Jones Industrial Average's 17 times earnings, Coca-Cola isn't a bargain. On an enterprise value (stock market value plus debt) to sales ratio, it is currently trading around 4.2 times. This may be a bit too enthusiastic. Using 2007 as a base case year, the best comparative period before the great recession took hold, Coca-Cola averaged a basically similar enterprise value ("EV") of 4.4 times sales on much better volume growth of 6% and revenue growth of 8%.

Coca-Cola's circumstance is not unique. PepsiCo , a world class food and beverage provider, also showed mediocre improvement. Comparable revenues grew 3.3% in PepsiCo's most recent quarter, a drop from an average 3.9% growth rate year-to-date. Though comparative earnings per share increased 12% for the year so far, quarterly operating profits rose only 3% thanks to increased advertising expenditures. Sales volumes were also uninspiring. Snack products volume grew 3% in the quarter, while beverage volumes gained a meager 1%. On a year-to-date basis, the figures are similar.

PepsiCo shares trade at a full 19 times earnings. The company's EV of around 2.3 times sales is not a huge discount from its base 2007 historical value. Back then the company produced stronger snack volume growth of 6%, beverage volume growth of 4%, and revenue growth of 7%, all of which helped push its average EV to 2.8 times.

Small brands with catalysts may provide better upside
The languid growth provided by these firms, especially when compared to past performance, might indicate that investors are paying an excessive premium for large iconic brands. Smaller food and beverage firms with their own stables of well-known products and possible upside catalysts may offer a more opportunistic way to play the brand idea.

The Hillshire Brands Company , a leader in meat-centric food products for the retail and foodservice markets, could be an example. The company generates more than $4 billion in annual sales with a brand portfolio that includes familiar names such as Jimmy Dean, Ball Park and Hillshire Farm. Facing the same stifling consumer trends as the more recognized giants, recent quarterly sales were down 2.1% versus the prior year. Adjusted operating income decreased a whopping 23.2%, driven by reduced volume and necessary brand building advertising costs.

While Hillshire looks fairly valued with an EV of 1.2 times sales relative to a historical 1.3 ratio, it may offer some upside possibilities. The company, spun off from Sara Lee Corp. in June of 2012, doesn't have much of a stand-alone track record. That fact and the company's recent frail result are valid reasons for the stock market's current lack of interest.

Hillshire is trying to change that apathy. It's taking steps to reach a younger consumer base by offering healthier poultry and even no-meat products. One example is their Aidells business, an organic, hormone-free and antibiotic-free line of chicken and turkey sausages. Another creative idea is a vegetarian low-calorie flatbread product. If Hillshire can get some traction with its expanded product strategy and improve sales, even slightly, that might be an impetus for greater stock market interest and a higher share price.

ConAgra Foods has well-known brands such as Chef Boyardee, Healthy Choice, Orville Redenbacher's, and Peter Pan. Also struggling in a sluggish environment, the company reported that last quarter's adjusted earnings per share were down 16% from 2012. The poor performance was mainly because product volumes dropped 3% and the loss of a significant customer reduced commercial business profit by 7%.

ConAgra seems fully priced with an EV at 1.4 times sales versus an average of 1.3 times sales in the base comparative 2007 year. It could deliver some positive surprises, however. The company quickly revamped its merchandising plans and hopes to regain consumer sales with increased advertising. It also looks to cut administrative expenses to boost future earnings.

Another catalyst might be the benefits available from its Ralcorp acquisition. ConAgra purchased Ralcorp, a leading maker of private-label cereal and other foodstuffs, in January. Besides significant fiscal synergies, the buy also increases the company's exposure to some of the fastest-growing retailers which offer private-label brands. If the integration goes as planned and ConAgra can reduce its buyout-related debt, the shares might shoot higher.

What next?
Large iconic brand names have usually deserved a premium in the stock market. However, a changing business environment producing slower growth might be making those premiums less worthy. Well-recognized brands still have exceptional value. However, smaller companies with potential upside catalysts, like Hillshire or ConAgra, might offer better opportunities for investors looking to play the consumer brand theme.

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The article Are Investors Paying Too Much for Consumer Brands? originally appeared on

Bob Chandler has a long position in Hillshire Brands. The Motley Fool recommends Coca-Cola and PepsiCo. The Motley Fool owns shares of PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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