On Tuesday morning, we learned that Pilgrim’s Pride Corporation (NASDAQ:PPC) proposed to buy out fellow packaged food company Hillshire Brands Co. (NYSE:HSH). The company proposed to pay $45/share, or about $6.6 billion for Hillshire, which is a 22 percent premium over Friday’s close.
This announcement comes shortly after Hillshire Brands made an offer to buy out another packaged food company – Pinnacle Foods (NYSE:PF) — about two weeks ago.
As a result, the market bid up Hillshire Brands’ shares to a level slightly higher than $45/share, which likely reflects the company’s dividend payment, and the possibility that the company may receive a higher takeout offer. Shares of Pinnacle Foods dropped over 7 percent as Hillshire Foods will likely not be acquiring that company.
Clearly there has been a lot of M&A activity in the packaged food space. In fact, there was another big acquisition about a year ago when a Chinese company — Shuanghui International — purchased America’s largest pork producer, Smithfield Foods. Furthermore, there has been general investor interest in many of these companies. Shares of the companies mentioned in this article, as well as peer Tyson Foods (NYSE:TSN), have all been relatively strong versus the S&P 500, and they have been even stronger when compared with the S&P MidCap 400 Index.
I think there are a few possible reasons for consolidation in the industry and investor interest above and beyond speculation on additional takeovers. Consolidation means two things — improved pricing power and shared technology leading to greater efficiencies. It is pretty obvious that when there are fewer competitors in an industry that these competitors have greater pricing power. It is less likely that another company will come in and undercut a major player’s prices, and the major players know not to rock the boat by starting a price war.
The technology aspect is less apparent, although if you had followed the Shuanghui International takeover of Smithfield Foods last year you would realize that one of the driving factors behind the deal was Shuanghui’s demand for Smithfield Foods’ technological expertise. A lot of research goes into maximizing meat production relative to input costs. Hillshire Brands also has technology that augments output, and Pilgrim’s Pride wants that technology. The combination of the two companies’ technological capabilities should improve overall efficiency for the new company. This is probably why Pilgrim’s Pride is willing to pay 25-times Hillshire Brands’ trailing earnings, and it is also why the market is bidding up shares of the former company despite the fact that companies’ stocks usually fall on the announcement of a large takeover.
From an investment standpoint, I think there are still opportunities in these packaged foods companies. Clearly it is too late for Hillshire Brands, but investors might want to look at other options such as Tyson (NYSE:TSN), which is the largest American company in the sector. Shares of Tyson are up 19 percent already this year despite the fact that shares trade at just 13.7 times 2014 earnings estimates and despite the fact that analysts expect earnings to grow. While Tyson is probably not a takeover target it is the leader in the industry, and it should benefit as the number of large competitors declines.
Hormel Foods (NYSE:HRL) — maker of Spam — is another potential beneficiary. The stock is down recently after the company reported earnings that missed analyst expectations, but it is still showing impressive earnings growth in the low double digits. Not bad for a defensive stock. The shares trade at 21.3-times 2014 earnings expectations, but analysts expect the company to grow its income over the next couple of years.
Ultimately, the packaged food business is changing. With prices rising companies are forced to either pass these increases on to the consumer and risk losing out to competitors, or they have to find ways to increase efficiencies in order to maintain their profitability and to please their shareholders. While we will see price increases we are clearly seeing these companies take steps to improve efficiencies as well. This is ultimately good from an investment standpoint, and I think that investors can buy shares of the companies mentioned in this article on weakness.
Disclosure: Ben Kramer-Miller has no position in the stocks mentioned in this article.