Wholesale Food Distributors Push Higher, But Why?

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I BD's Wholesale-Foods group has been a healthy performer of late, rising to an 8 ranking on Friday, up from a 114 ranking eight weeks ago. The performance shows the group rising 7.8% in that period -- outpacing nearly all of the 197 industry groups tracked by IBD.

The stocks driving the bulk of the group's gains includePerformance Food Group ( PFGC ), and thinly traded issues such asCore-Mark Holdings ( CORE ) andFarmer Brothers ( FARM ).

But none of the stocks in the group is exactly setting the world on fire, and earnings reports over the past week underscored the industry's challenges.

The biggest stock in the group by market cap,Sysco ( SYY ), hasn't produced a double-digit sales or earnings gain in years. Among other things, Sysco has been hurt by "intense competitive pressures, volatile commodity costs and soft consumer spending," Morningstar analyst Erin Lash said.

The group's second-biggest player, and arguably its most flashy stock --Keurig Green Mountain ( GMCR ) -- has seen its earnings slip three quarters in a row. Revenue has been flat or declined in two of the past three quarters. It owns the Keurig K-cup franchise, andCoca-Cola (KO) holds a 16% stake in the company.

Keurig has been plagued by a difficult transition to its Keurig 2.0 brewing system, and the Kold beverage machine, which is key to its relationship with Coke, has generated disappointing sales.

Even the best financial performer in the group, Performance Food, has averaged only 9% annual revenue growth over the last three years.

On Wednesday, the Richmond, Va., distributor reported a 64% earnings gain for the third quarter, well above forecasts, but revenue growth of 6% stopped short of analyst expectations. Shares briefly spiked to a new high, then dropped sharply. Despite a loss for the week, the stock on Friday traded 9% above its Oct. 1 IPO price.

What ties stocks in the Wholesale-Foods group together? Not much, beyond the fact they all, to some degree or another, distribute food or related products to retailers.

So why have shares of wholesale food stocks been moving higher? Part of the explanation is valuation, analysts say.

Some stocks in the group, such as former high flyers Keurig Green Mountain andUnited Natural Foods (UNFI), have been in months-long downtrends, making them cheap buys compared with peers. Green Mountain shares sank 30% on Aug. 6 alone after it gave weak guidance and got hit by several downgrades.

Susquehanna analyst Pablo Zuanic said in an Aug. 6 note that the initial price drop "may be overdone." But he also said it reflected a "crisis of confidence in management being able to right this ship" and hinted at "the risk of future market share and profit margin erosion, given the continued strategic missteps by the company."

Despite the decline, Keurig earns a respectable B Accumulation/Distribution grade from IBD. This shows institutional investors have been moving into the stock during its rebound from an August low.

Core-Mark Holdings and Farmer Bros. are both climbing out of consolidations begun early this year. Core-Mark's earnings are rebounding sharply, partly due to cheap gas prices driving more consumers to the convenience stores and gas stations to which it distributes its products. Analyst consensus calls for a 46% earnings gain this year. Shares are up 28% this year.

Farmer Brothers' earnings are expected to accelerate, from a 31% gain last year to an estimated 69% increase for 2015. But shares of the distributor of coffee and spices tumbled on Friday after it reported late Thursday that its fiscal-first-quarter earnings rose 56%, in line with expectations, but revenue slipped 2%. Analysts had expected a 3% revenue gain.

The results showed ongoing success in Farmer's cost-cutting efforts, which include relocating its coffee roasting operations from Torrance, Calif., to Northlake, Texas. But demand remains spotty in its client industries, including restaurants, hotels and fast-food outlets.

The stock consolidated across most of this year, then rocketed 50% to a Nov. 4 high following a big fiscal-fourth-quarter earnings beat announced Sept. 9.

Shares traded down 10% on Friday, stopping short of a test of support at the stock's 50-day moving average.

The Prospects Of Buyouts

The Wholesale-Food group might also be benefiting from a couple of macro trends -- lower fuel prices and an improving economy.

Cheaper prices at the pump are good for any industry that must transport goods over long distances. And an improving economy and job market tend to prop up the restaurant industry -- a key end market for many food wholesalers.

Meanwhile, the prospect of consolidation in the group is providing an additional, speculative lift.

Although Sysco fell short in its $8.2 billion buyout bid of US Foods over the summer, the company "still has opportunities to do acquisitions, given both its cash flow generation and its capacity," Lash said.

Others in the group might be on the other side of the buyout equation. RBC Capital Markets analyst William Kirk noted in a Sept. 15 report that United Natural Foods "could be a takeout target, should competitors prefer purchasing distribution infrastructure rather than building it."

There's also speculation that Coke will eventually gobble up the rest of Keurig.

Competitive And Fragmented

All nine stocks in the Wholesale-Food group technically deal in wholesale food distribution. After that, the similarities pretty much end.

Sysco and Performance Food are the only stocks that fit the traditional definition of wholesale food distributors. They have their own distribution networks and sell a variety of foods to restaurants, retailers and institutional clients, such as schools and health care facilities. Major products include frozen, processed and prepared foods; dairy items; poultry, fish and meat; fresh produce; and baked goods.

The rest of the group is a melange of different specialties.

Keurig Green Mountain distributes single-serve K-Cups and other coffee and tea products, primarily to supermarkets and other food retailers. United Natural Foods sells organic/natural products to groceries, health-food stores and other retailers.

Core-Mark's focus is on snacks, fast foods and groceries distributed to convenience stores. Farmer distributes coffee and spices to restaurants, hotels, hospitals and fast-food outlets.G Willi Food International (WILC) distributes kosher products, canned vegetables and fruits to supermarkets and others food stores.

The other two stocks in the group areAmcon Distributing (DIT), which sells food, tobacco products and other consumer goods, andCoffee Holding (JVA), which deals in coffee.

Industry tracker First Research pegs the U.S. wholesale food market at around $800 billion. It's a scattered industry, comprised of an estimated 34,000 establishments. These range from small local operations to divisions of large corporations.

In addition to Sysco, major players include privately held firms US Foods, C&S Wholesale Grocers, McLane and Supervalu. The 50 largest companies generate about half of industry revenue, First Research says.

The Risks

Although lower fuel prices are helping to ease costs at many distributors, that has been partially offset by a truck driver shortage, Lash says.

This shortage "is driving transportation and logistics costs higher for Sysco and others," she said. "It's an industry hazard that reflects a few different factors. One is sheer demographics due to an aging group of workers. There's also increased regulatory oversight in terms of driving times, putting additional upward pressure on costs. This is unlikely to abate over the near term."

One thing industry watchers will keep an eye on in coming months is how food prices trend.

"We have seen double-digit food inflation in protein, dairy and seafood, although dairy costs have been less of a factor more recently," Lash said.

When food inflation is modest -- say 3% or so -- it's easy enough for distributors to pass the higher costs along to customers through slightly higher prices, Lash says.

But when inflation goes into double digits, it's not as easy. The reason: Wholesale food customers such as local and regional restaurants and grocers have a hard time raising their prices enough to offset the higher expenses "without a negative impact on traffic trends," Lash said.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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