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Natural Foods Outlook: Can Strategies Perk Up Growth Rate?

Zacks Equity Research
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Natural Foods Outlook: Can Strategies Perk Up Growth Rate?

The natural food products industry has been gaining from consumers’ growing preference for health and wellness. Shoppers have been enthusiastically filling their carts with natural and healthy food offerings, which include organic fruits, vegetables, juices as well as delectable like organic ice cream and much more. This has made the natural food space a booming arena.

Per the Organic Trade Association’s (OTA) survey, the U.S organic market has more than doubled in the past decade. In fact, OTA’s survey reveals that U.S. organic food sales delivered revenues of $45.2 billion in 2017, up 6.4% year over year. In fact, organic products account for almost 5.5% of food sales across retail channels in the United States.

Steady growth in the industry has been prompting companies to introduce innovative offerings that further enrich consumers’ palate. Technology and digital transformations are also playing a vital role in helping companies extend market reach.

In spite of such upsides, certain underlying headwinds have been causing bumps in the industry. Although natural food products have been expanding in size, we note that growth rate was lower in 2017 compared with a 9% rise in 2016. The downside was primarily caused by challenges in the dairy and eggs category.

Enticed by the growing prospects in the organic dairy market and the overall growth of natural food products, new producers started foraying into the arena. However, it didn’t take long for the companies to face an oversupply situation. Further, organic eggs sales were hit by stiff competition from cage free and pasture-raised varieties.

Since pasture-raised eggs include practices like providing poultry with adequate outdoor access, consumers consider these products to be more humane than organic eggs. This somewhat marred sales growth of organic eggs in 2017. The stabilization of these headwinds is expected to take some time.

Apart from this, players in the natural foods industry have been grappling with persistent rise in expenses. As companies explore new opportunities to lure consumers, research and development costs have been mounting. As cut-throat competition in the natural food space is forcing companies to invest more in product promotion, the cost burden is rising.

Additionally, freight costs have been a headwind to players in this space for a while. Well, these factors have been weighing on profitability and are expected to continue denting performance in the natural food products space.

How Has the Industry Fared in the Past Year?

While quite a few companies are reeling under higher costs and imbalances in demand for certain products, others have been able to offset the downsides with strategic efforts. These initiatives include optimizing resource usage and reducing expenses. Also, higher demand for natural and organic food products is driving the performance of many players in this space.

Notably, stocks in the Zacks Food-Natural Foods Products industry have collectively gained 24.2% in the past year, though it underperformed the broader Zacks Retail and Wholesale Sector’s growth of 29.5%. Meanwhile, the Zacks S&P 500 Composite has rallied 19%.

However, there was a marked variance in the performance of individual stocks within the group.

One-Year Price Performance

Valuation Picture

One might get a good sense of the industry’s relative valuation by looking at its price-to-earnings ratio (P/E), which is the most appropriate multiple for valuing stocks related to food, like that of natural food products, because earnings take into consideration all the necessary aspects effective in gauging performance.

This ratio essentially measures a stock’s current market value relative to its earnings performance. Investors believe that the lower the P/E, the higher the value of the stock will be.

The industry currently has a trailing 12-month P/E ratio of 21.1X, which is slightly above the one-year median level of 20.7X and below the one-year high of 23.3X in the past year. The trailing 12-month P/E ratio for the S&P 500 is 20.1X. This indicates that the stocks valuation is somewhat stretched.

Price-to-Earnings Ratio (TTM)

What the Earnings Projection for the Industry Unveils

Steadily rising demand for organic and healthy items present solid growth opportunities in the Food-Natural Foods Products space. However, it’s hard to ignore weak margins and profits stemming from high costs of operations as well as distributions.

But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead.

One reliable measure that can help investors understand the industry’s prospects for a solid price performance going forward, is its earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.

The Price & Consensus chart shows the market's evolving bottom-up earnings expectations for the industry and its aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.

Price and Consensus: Food-Natural Foods Products

This becomes clearer when we focus on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Please note that the EPS estimate of $1.28 for the industry for 2018 is not the actual bottom-up estimate for every company in the Zacks Food-Natural Foods Products industry, but rather an illustrative aggregate created by our proprietary analytics model. The key factor to keep in mind is not the EPS of $1.28 for the industry for 2018, but how this estimate has evolved recently.

Current Fiscal Year EPS Estimate Revisions

As you can see here, the $1.28 EPS estimate for 2018 is up from $1.25 at the end of August and $1.25 at this time last year. Though the current estimate has increased recently, it has actually declined from its peak of $1.34 attained in the end of January. Quite apparent, the sell-side analysts covering the companies in the Zacks Food-Natural Food Products industry have been treading with caution while revising their estimates.

Zacks Industry Rank Blurs Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dim prospects in the near term.

The Food-Natural Foods Products industry currently carries a Zacks Industry Rank #179, which places it in the bottom 30% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Natural Foods Products Space: Earnings & Revenue Trends

The past earnings of the Food-Natural Foods Products space reveal that the group has been witnessing a rising trend. It’s worth noting that the industry’s earnings jumped sharply from the beginning of 2011 till the end of 2012, after which it has been improving at a moderate pace.

EPS - Food-Natural Foods Products Market

The top-line performance of the industry quite justifies the evolving demand for natural and organic products. From the figure below, it can be seen that revenues have been rising since the beginning of 2013. However, of late the growth pace in revenues has slowed owing to headwinds surrounding unsteady demand for certain products as well as stiff competition.

Revenues - Food-Natural Foods Products Market

Bottom Line

The OTA expects the growth rate for natural and organic products to remain somewhat sluggish, as the industry continues to mature. But even at this decelerated pace, the organic sector is expected to surpass the growth rate of the broader food market.

This is because health and wellness is increasingly becoming a priority in modern day lifestyle, attracting more consumers to the natural food products alley.  Moreover, as food science continues to advance, we expect companies in this space to come up with unique offering.

However, thanks to rising costs, volatile conditions for certain product categories like diary and eggs as well as stiff competition, companies in the natural food products space have been finding it tough to maintain margins and profitability at desired levels. Moreover, volatility in the ingredients and commodity’s market due to raised tariffs have added to the industry’s woes. Although few companies have resorted to cost-cutting programs and optimizing supply chain, such moves are yet to boost profitability.

Considering that chances of a near-term respite for natural food products companies are slim, we focus on a few stocks investors should pass up for now.

SpartanNash Company (SPTN): The stock, currently carrying a Zacks Rank #5 (Strong Sell), has lost 15.4% in the past year. The Zacks Consensus Estimate for the current fiscal EPS has declined 10.2% in the past 60 days. Moreover, the company carries an average negative earnings surprise of 3.2% in the trailing four quarters. The company witnesses challenges in the form of product recalls, unfavorable pricing environment and weak margins in the pharmacy business.

Price and Consensus: SpartanNash

Performance Food Group Company (PFGC): Though shares of this Virginia-based company have gained 15.3% in a year, it has underperformed the industry. Also, the Zacks Consensus Estimate for the current fiscal EPS has gone down 11.2% in the past 60 days. Further, this Zacks Rank #4 (Sell) company has an average negative earnings surprise of 1.6% in the trailing four quarters. We note that rising labor and fuel costs have been deterrents to the company’s performance

Price and Consensus: Performance Food Group

Nevertheless, strategic initiatives undertaken by some players have placed them favorably in the group. We bring you two such stocks that you may prefer to hold for now.

Notably, Sprouts Farmers Market, Inc. (SFM) has depicted a sturdy run. The Arizona-based company’s shares have surged 46.1% in the past year. Moreover, the company pulled off an average positive earnings surprise of 11% in the trailing four quarters. This Zacks Rank #3 (Hold) company has been gaining from store openings, advancements with ready-to-cook meals and efforts to bolster same-day deliveries.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price and Consensus: Sprouts Farmers

Vitamin Shoppe, Inc (VSI) is another Zacks Rank #3 company from this space. The company has delivered an astounding run, with its shares having more than doubled in a year. This nutritional products retailer has been gaining from strong digital sales, control over expenses and efficient product management which have been fueling sales in all major categories.

Price and Consensus: Vitamin Shoppe


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