The recent acquisition of H.J. Heinz Company (NYSE:HNZ) for $28 billion could be validation for investors to stick with overpriced food and beverage companies. Shares of Campbell Soup Company (NYSE:CPB) popped 5% immediately following the announcement and ended the day with trading volume more than 6x the thirty day average. Investors shouldn’t anticipate another large food deal anytime soon. The Heinz deal was in fact the largest food deal in history. Prior to this, the Kraft Foods Group Inc (NASDAQ:KRFT) purchase of Cadbury in 2010 for $19 billion was the last large scale purchase. First, several of the more entrenched food and beverage companies are just too big to be acquired. Second, even medium sized deals are incredibly difficult to anticipate and just don’t happen that often. Instead, investors should focus on the fundamentals and valuation of the industry in gauging long-term return potential. The outlook in this regard for the food and beverage industry is subpar. Investors seeking a defensive industry for their portfolio should instead consider companies in the health care supply chain.
To prove this point I will did a little head-to-head comparison of a company in each industry.
Secular Tailwinds versus Secular Headwinds
In the red corner we have the leading soup company in the world- Campbell Soup. In the blue corner is the largest pharmacy benefit manager in the world- Express Scripts Holding Company (NASDAQ:ESRX)
I purposely chose two companies with similar P/E ratios as this is the overwhelmingly preferred tool among investors when it comes to valuation. I personally favor enterprise value to sales and free cash flow yield and it helps round out the income statement and statement of cash flows. The valuation on a sales basis is hugely skewed in favor of Express Scripts. Campbell’s wins on cash flow. Campbell’s does pay a dividend, but the 48% payout ratio implies that dividend growth can only match cash flow growth in coming years. Here Campbell’s faces secular headwinds with organic growth fluctuating around the breakeven line.
A couple key things dominate the growth numbers above. First, Express Scripts 2010 revenue number is skewed by the Medco Health merger. Secondly, both companies have robust operating leverage that allows modest sales increases to lead to outsized earnings increases. Still, Express Script’s operating income and EPS growth is substantially better than that of Campbell Soup.
It seems likely that both company’s growth trends will persist. Campbell’s will continue to face difficult organic growth headwinds given deep market penetration and will rely on acquisitions as exemplified by the recent Bolthouse Farms deal. Express Scripts has a plethora of tailwinds to its growth story. The company will continue to benefit as drug utilization increases with demographic changes. Generic penetration is set to really get a boost as the branded pharmaceutical industry sees numerous key drugs go off patent in the next several years. Higher generic drug utilization helps expand Express Script’s margins as well as grow the top line. Membership usage will also benefit from an improving jobs market and higher health care participation.
Winner: Express Scripts