After the $7 billion deal for Smithfield: 5 food stock picks with China exposure

05/30/2013 6:14 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

It’s not about the pigs.

More precisely, Shuanghui International’s $7 billion deal to buy Smithfield Foods (SFD) isn’t just about the pigs.

The big driver here is China’s recurring scandals over food safety, whether it’s melamine in powdered milk and baby formula or rat-meat being sold as lamb or excessive levels of antibiotics in chicken. Large numbers of Chinese consumers simply don’t trust domestic food suppliers and will go to astounding lengths to buy overseas products that are thought to be safer. That’s led to rationing of formula sales to Chinese travelers in New Zealand, a formula smuggling ring in Hong Kong, and online purchases of milk and formula from Germany on Taobao that can result in a two-month wait before delivery.

Chinese food companies know they have a problem. They can see it in their sales numbers. For example, China Mengniu Dairy (2319.HK in Hong Kong), the country’s largest dairy producer, saw sales drop 3.5% in 2012 and operating profits fall 16%.  The company blamed the decline on food safety problems in China.

And the stakes are really, really high. China’s baby formula market alone was $15.4 billion in 2012 and grew by 29% that year. International sellers of baby formula took 50% of the market last year and are projected to increase their share to 55% in 2013.

And this is just the market for baby formula. There’s also milk and yogurt, chicken, water, and, of course, pork.

Some Chinese food companies have responded by forming joint ventures with international companies. China Mengniu, for example, has formed a joint venture with France’s DANONE (DANOY in New York or BN.FP in Paris) to sell DANONE’s yogurt in China. China Mengniu has about 16.8% of that market now with DANONE at just 1.6%. Projections are that yogurt sales in China will grow by 57% by 2015 to $11.6 billion. (DANONE now gets 6% of its sales from China, the company’s fourth largest market.)

The final extension of this trend is, of course, the $7 billion purchase of Smithfield Foods by Shuanghui International.

I’d look at international food companies such as DANONE, Nestle (NSRGY), Mead Johnson Nutrition (MJN), and Abbott Laboratories (ABT) for deals that give them more access to China’s market in exchange for Chinese companies being able to add overseas brands to their lineups. (Abbott Laboratories is a member of my Jubak’s Picks portfolio http://jubakpicks.com/ ) Also keep an eye on the IPO of Synlait Milk, the New Zealand subsidiary of China’s Bright Dairy & Food. And as long as you’re in New Zealand, take a look at Fonterra Cooperative Group (FSF.AU in Sydney and FSF.NZ in New Zealand.) The New Zealand milk producer is the largest exporter of milk in the world.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund did own shares of Fonterra as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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