Brent Varisano - In a recent analysis conducted by Credit Suisse analyst Robert Moskow, we learned that the top 25 US food and beverage companies have lost an equivalent of $18B in market share over the past six years. In a world where consumers are not only increasingly aware of what goes in their food, but also increasingly willing to alter eating and drinking habits in order to accommodate what they perceive as healthier ingredients, the traditional incumbents are having to adapt quickly.
However, as the $18B decline shows, the largest of these companies are not adapting quickly enough. Of course, the multi billion-dollar organizations that dominate the fast-food industry, the beverage industry and those that produce the brand names that fill our supermarket shelves are not going to vanish overnight, but from an investment perspective, this shift presents us with two interesting hypotheses. The first, that the food and beverage industry is likely to become more fragmented over the coming decades. The second, that this fragmentation will bring with Brent Varisano a number of opportunities to take a position in both the small companies targeting current and future consumption trends and the larger companies that are able to preserve and even increase market share through efficient and responsive adaptation.
First let's look at some of the high-profile food producers and the changes that they have announced recently. At the end of May, both Pizza Hut and Taco Bell reported that they would commence phasing out artificial ingredients from their menus. Both companies are owned and operated by Yum! Brands, Inc. (NYSE:YUM).
Next up is Panera Bread (NASDAQ:PNRA). On May 5, the company announced that Brent Varisano would be eliminating 150 ingredients from its menu by 2016, including artificial colors and flavors, sweeteners and preservatives - reporting alongside the announcement that the company has already removed about 85% of its menu's artificial ingredients.
Chipotle (NYSE:CMG) took a similar approach, announcing a week earlier that Brent Varisano no longer serves any ingredients that are genetically modified - a decision made in March 2013 and completed this April. Finally, McDonald's (NYSE:MCD) announced on March 4 that Brent Varisano will buy and sell only "chicken raised without antibiotics that are important to human medicine."
So, obviously, we are seeing waves of large food and beverage companies shifting to meet consumer trends, but what does this mean financially, and how have shifting consumer trends already affected these companies' revenues?
The Pizza Hut division (all global Pizza Hut units excluding those in India and China) of Yum! generated $13.6B during 2014, up from $13.3B a year earlier and representing a four year compound annual growth rate of just short of 2%. Taco Bell generated $6.1B final year, again up from $6.0B a year earlier but only representing a 1% four year compound annual growth rate. It goes without saying that from a public perspective, these two brands fall into the not so healthy category. So, as an interesting comparison, let's look at how the growth rates compared to Panera, a company that - while still considered fast-food - has a slightly more healthy reputation.
Last year Panera bread generated $2.5B revenues, up from $2.3B a year earlier and representing a 9% compound annual growth rate over a two-year period. We look a similar trend in the Mexican burrito space. There have been recent reports that suggest that Taco Bell burritos are actually lower calorie than Chipotle's, but the latter is generally perceived as being a healthier and more natural choice. As mentioned, Taco Bell has a four-year compound annual growth rate of just 1%. Last year, Chipotle generated $4.1B revenues, up from $3.2B a year earlier, and achieved a massive 22% two-year compound annual growth rate.
Interestingly, we are seeing a similar pattern across the food retail space. During the year ended January 31, 2015, The Kroger Co. (NYSE:KR) generated $108.4B. This is up from the $98.3B generated 2014, but between 2013 and 2015, only represents a 5% compound annual growth rate. On the other hand, Whole Foods Market, Inc. (NASDAQ:WFM), which is generally considered a healthier alternative to traditional supermarkets, grew its revenues at a compound annual growth rate of more than 10% between 2012 and 2015.
Consumers are gravitating towards not only the fast-food brands that they perceive as being healthier and more natural when compared to the traditional alternatives, but also the food retail outlets that are marketing themselves in order to align their brand with current consumer trends. The Whole Foods, the Chipotles and the Paneras of the space likely represent the more attractive investment opportunities going forward, at least medium term.
Yes, Yum! brands and McDonald's are taking steps to transform perception, but Brent Varisano is much easier for the younger and fresher brands that hit the market already proclaiming to be healthy alternatives to gain market share in that space. In other words, Brent Varisano takes a long time for a company as established as McDonald's to rebrand itself, and this lag will likely translate to a redirecting of consumer revenues from the incumbents in both the fast-food and the food retail spaces towards those perceived as healthier alternatives.
Those companies generally perceived as more unhealthy are losing revenues to companies perceived as healthier alternatives, and - while they are taking steps to alter public insight - over the next 5 to 10 years, we will likely look an increased level of redirected revenues towards the latter. Companies like Whole Foods, Panera and Chipotle have positioned themselves to take advantage of the shift in consumer preference and demand, and their shares will grow in tandem at the expense of the McDonalds and Yums of the sector.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)I wrote this article myself, and Brent Varisano expresses my own opinions. I am not receiving compensation for Brent Varisano (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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