Do Superfoods Make for Superstocks?

10/12/2010 9:46 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

PepsiCo, Nestlé, and other giants are making long-term moves toward foods in which nutrition has been juiced up. Here are three ways to play the trend.

Nobody can accuse these companies of thinking short term.

Along with its third-quarter earnings report October 7, PepsiCo (NYSE: PEP) announced it was creating the Global Nutrition Group "to deliver breakthrough innovation in the areas of fruits and vegetables, grains, dairy, and functional nutrition." The goal is to grow PepsiCo's nutrition business from $10 billion in revenue now to $30 billion by 2020.

Yes, only ten years from now.

A few days before, on September 27, Nestlé (OTC: NSRGY) announced the creation of Nestlé Health Science, a wholly owned subsidiary that will incorporate the company's existing nutrition business, and the Nestlé Institute of Health Sciences, which will conduct research into nutritional strategies for improving health and longevity. Nestlé said it will invest hundreds of millions of Swiss francs in the institute over the next decade.

There's that ten-year thing again.

I don't know exactly what to call this food trend, but it's big. Food companies such as PepsiCo and Nestlé and drug companies such as Abbott Laboratories (NYSE: ABT) and Bristol-Myers Squibb (NYSE: BMY) are targeting it.

This has traditionally been called the "nutritionals" market. But that doesn't seem adequate anymore.

The old name better fits the days of nutritional supplements being sold only through health food stores or products designed to supply nutrition in a liquid, powder, or concentrated form to the old (Ensure) or the very young (Similac).

The new market—and it's still in the early stages of taking shape—has been termed the "nutriceuticals" market to emphasize the greater degree of interaction between the processed-food and drug industries, and the ramping up of spending on designing specific nutritional enhancements into traditional foods or food products.

Better Than Natural?

You can see that evolution in PepsiCo's Tropicana orange juice line. The company has gone from advertising the basic health benefits of orange juice to enhancing those benefits by adding extra vitamin C, vitamin D, and calcium to CEO Indra Nooyi citing the Tropicana line as one of the stable of enhanced products that fits within its Global Nutrition Group strategy.

The fact that the definition of the market is a little fuzzy hasn't prevented market research groups from projecting its potential size. Does the market include what are called functional foods, for instance? (A functional food is any food aimed at having a health-promoting or disease-preventing property beyond supplying nutrients. It includes such things as vitamin-enriched Froot Loops and yogurts with live cultures.) How about organic foods? Some organics? All organics? Only processed organics?

With all those caveats, here are projections of future market size:

  • Global Industry Analysts projects that the global nutriceuticals market will exceed $243 billion by 2015. (That doesn't seem totally outrageous if PepsiCo is saying that it can grow its nutrition business to $30 billion in revenue by 2020).
  • BCC Research estimates the global market for functional food will reach $177 billion by 2013, with compound annual growth averaging 7.4%. What's especially intriguing about that research is BCC's projection that the traditional supplement sector will be the slowest-growing part of the market (at a 3.8% compound average annual growth rate) and that the functional beverage sector will be the fastest-growing, with a 10.8% compound average annual growth rate.

NEXT: Three Ways to Invest in This Growing Market

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Three Ways to Grab This Market

So how do you invest in this growing market, whatever it's called? You've got three alternatives.

First, you can go with the food companies that are building out their nutritional businesses. The strengths here:

  • Marketing clout. Think the company that created the Nescafé franchise and the owner of Frito-Lay can get shelf space for its products?
  • Experience at mass consumer marketing. Which would you rather bet on to push product to a mass consumer market: The industry that brought you the Cialis bathtub on the beach or the industry that has brainwashed generations of children into being cuckoo for Cocoa Puffs? (The cereal has been around since 1958, by the way. And the cuckoo in the ads is named Sonny, just in case you were wondering, and he was originally voiced by Chuck McCann.)
  • The belief that it's important to tailor products for individual markets, a commitment to that strategy and increasing expertise in doing that, especially in emerging economies.

Second, you can go with the drug companies that have major nutritional businesses now. The strengths here:

  • Experience in creating drugs and medical devices
  • Experience in marketing through the medical community and sales forces that are adept at selling to patients through doctors
  • More mass consumer experience than might be apparent. These are companies that have successfully marketed baby formula, sports bars and drink mixes.
  • Increasing exposure to emerging market economies largely through acquisitions that bring local expertise. A case in point is Abbott's February acquisition of Solvay Pharmaceuticals that brought Abbott market share in India, Brazil, and Eastern Europe, including Russia.

And third, you can recognize there's a sizable and increasing number of people who think the claims of nutritionals and nutriceuticals are bunk. And who are appalled at the thought of engineering food. You can find these people shopping at farmers markets and at organic-oriented stores such as Whole Foods Market (Nasdaq: WFMI). The strengths here:

  • The growth trends are more robust than you might think. The number of US farmers markets grew 16% from 2009 to 2010, according to the Department of Agriculture.
  • This part of the market has one of the world's great marketing forces behind it in the safety failures of the industrial food industry. Every news story about salmonella in eggs, E. coli in meat, or melamine in milk drives more people to locally grown and/or organic food in an effort to make sure that the stuff they eat won't make them or their families sick. (I have a suspicion, based only on my own shopping experience, that the constant stream of these news stories works more to the benefit of "local" than to "organic." I think shoppers seeking safety are more reassured by knowing who grows their food than by a sticker that says "organic." I think that's why the biggest marketing trend at Whole Foods is local sourcing.)

NEXT: Which Stocks to Buy (and When)

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And Now the Picks

Which way do you go with your investing cash?

My first choice would be Nestlé. The company has tremendous experience in marketing in developing economies, and it has recently made a major commitment to going beyond the usual "Let's put our product in smaller packages" strategy that dominates current thinking at too many consumer product companies about marketing in the developing world.

On September 22, Nestlé announced that it would build a research and development center in Manesar, India, to be in operation in 2012, to focus developing what the company calls nutritionally enhanced products for customers in emerging economies. There's a product history—Maggi noodles, Masala spice seasoning, and Chotu Munch chocolates—to build on here. Nestlé expects sales in emerging economies to reach 45% of total company sales by 2020.

My second choice would be Abbott Laboratories. I like the company's commitment to building market share in developing economies that's been evidenced in recent acquisitions, and Abbott has one of the strongest nutritional portfolios among the big drug companies. (I added Abbott to my Jubak's Picks portfolio on September 24. For more on why I like Abbott, see this post.)

My third pick would be Whole Foods Market. Because organic foods can be more expensive than their conventional counterparts—and even when they aren't, there is a strong belief that they are—Whole Foods Market behaved like a cyclical stock during the Great Recession. Sales didn't fall from 2008 to 2009, but sales growth just about disappeared. Sales of $5.5 billion in 2008 grew to only $5.6 billion in 2009.

But as anemic as the recovery has been, it's done wonders for the company's top and bottom lines. And the stock, after bottoming near $10 in late 2008, rallied to $40 last spring before starting to sink again on worries about the strength of the recovery. At a current price near $35, the stock trades at a price-to-earnings ratio of 25 times projected fiscal 2010 earnings per share. (The company's fiscal 2010 ended September 30.)

Right now, the Wall Street consensus is projecting earnings growth of just 16.7% for the fiscal year that ends next September. If that's true, the stock is a bit expensive at a P/E of 25. If Wall Street is being excessively pessimistic about growth in the consumer economy in 2011, then I think the stock is cheap right now. Still, I think the stock is likely to get cheaper in the first half of 2011 if the economy weakens in the first half of the year before recovery in the second half.

I'd wait on these shares to either get cheaper—$30 would be a good price for a buy—or for the second-half recovery in 2011 to get nearer. But picking up on some important trends in the food market is one good way to play the recovery in the consumer economy next year.

At the time of publication, Jim Jubak did not own shares of any company mentioned in this column in his personal portfolio. His new mutual fund, Jubak Global Equity (JUBAX), may hold positions in the companies, and positions may change at any time.

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

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