Why Are Food Companies So Eager to Diversify?

Financial Markets Wall Street The Hershey Company
Richard Drew/APIn celebration of Halloween last fall, Hershey President and CEO J.P. Bilbrey rings the New York Stock Exchange opening bell.

If mashed together on a plate, beef jerky and chocolate would be an awful combination. But what's terrifying on the table can be a boon to the bottom line -- at least that's what Hershey (HSY) hopes by putting the two together in its asset portfolio.

This past January the firm acquired jerky specialist Krave Pure Foods for an undisclosed sum. Since the two foods aren't naturally synergistic and Hershey has never been much of an acquirer, the deal was surprising on the surface. Looking a little deeper, though, reveals that it was a sensible move following similar developments elsewhere in the food sector.

Stacking Plates

The industry has seen a host of big-ticket buyouts recently. Earlier this year J.M. Smucker (SJM) -- known for jams, jellies and coffee -- went outside of the human comestibles sphere: It bought Big Heart Pet Brands, maker of the famous Milk Bone dog biscuits and Meow Mix cat food (among others), for $3.2 billion in cash and stock.

Several months previously, conglomerate Tyson Foods (TSN) won control of packaged-food specialist (and Krave's fellow jerky purveyor) Hillshire Brands for around $8.6 billion, including debt assumption, by outbidding rival Pilgrim's Pride (PPC).

Hillshire itself was busy filling the shopping cart in the months leading up to the acquisition. It signed a $4.3 billion deal to grab Pinnacle Foods (PF), another packaged food company that holds Swanson TV dinners and Vlasic pickles among its portfolio (although Hillshire had to abandon that deal after it was hitched to Tyson). It also reached a $165 million agreement to buy breakfast-foods purveyor Van's Natural Foods.

The shopping spree could be seen as the industry incumbents roaming the aisles in search of growth. For companies that can afford it, buying a good, revenue-producing asset is a quick way to juice the top line.

Protein for Growth

And in recent times, available assets haven't necessarily been compatible with the portfolios of growth-hungry companies.

Take J.M. Smucker. Its revenues have been more or less stagnant over the past few years, and although profitability has grown nicely, this has been due to reduced expenses rather than organic sales growth.

%VIRTUAL-WSSCourseInline-908%The company's lack of diversification was a reason for its top-line sluggishness. Coffee, including the durable Folgers brand (itself an acquisition, made in 2008), accounts for nearly 50 percent of revenue.

The Big Heart buy can help put significantly bigger numbers on the top line. According to a recent report in The Wall Street Journal, the U.S. pet food business totaled around $21 billion in 2013, with Big Heart controlling about 13 percent of it. Big Heart's net sales were nearly $2.2 billion for fiscal 2014, or roughly 39 percent of Smucker's annual top line.

Hershey's troubles are more recent. The company -- maker of the eponymous chocolate bars, plus the Reese's line of treats and other iconic candy brands such as Kit Kat and Almond Joy -- posted disappointing results in its most recently reported quarter. Both revenue and net profit came in under analyst expectations, and going forward the company is projecting a fiscal 2015 bottom line that's also well below what analysts had previously forecast.

Hershey has always been associated with candy, since it's far and away the company's main product. Although the company has ventured into associated goods (Ice Breakers gum, Breath Savers mints, and Mauna Loa macadamia nuts) these brands are nowhere near as prominent as Hershey's and Reese's.

But no matter how many checkout racks and store shelves bulge with Hershey Bars, there's only so high the candy market can go -- particularly considering the dizzying number of competitors, and the increased health-consciousness of consumers.

Enter Krave. Hershey says that meat snacks (such as the treats its new asset makes) are a $2.5 billion market. According to Hershey, these products averaged 10 percent annual growth in the 2010 to 2014 period. That kind of growth is appealing for a company that has been selling a limited range of products for a very long time.

Many Mouths to Feed

Although the food business is huge, it's a tough industry to succeed in. There are a lot of players in the market, and many are competing for the same precious shelf space in supermarkets and convenience stores.

As a result, more than a few veteran companies are coming to the conclusion that it's best to bulk up in order to be competitive. Growth is the key right now, regardless of how the new items in the pantry mix with a company's mainstays.

Motley Fool contributor Eric Volkman has no position in any stocks mentioned, but wouldn't mind a chocolate bar just now. The Motley Fool has no position in any stocks mentioned. Try any of our Foolish newsletter services free for 30 days. Check out our free report forone great stock to buy for this year and beyond.