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Why food is a dish best served in a Small Cap

Richard Hemming

If you are looking at ASX Small Caps being a part of your portfolio, one area that continues to stand out is the food sector. This industry has delivered some of the biggest returns for Under the Radar, generating gains of four times for Collins Foods, five times for Freedom Foods and six times for Collins foods and making big profits from other stocks like Tassal and Select Harvests. What is our secret sauce?

ONE OF THE BEST ASX SMALL CAPS YOU’LL SEE

That food is a stand out sector on the ASX was highlighted in the past two months by two of the best Small Cap operators in the space, one being the specialist almond producer Select Harvests (SHV), whose interim profit almost doubled on last year’s, while its dividend to shareholders increased 140 per cent.

An image of a Dollar Sign on a plate

Hearing the almond producer’s long serving CEO Paul Thompson spruik the half year result last week make us think we’d written his script IN JANUARY! “Very strong 2019 almond crop... excellent growing and harvest conditions... increased yields on mature and new orchards...”

Back then the stock was close to $6, and the prior year we had been buying at close to $5. We have been holding on and enjoying the ride since then. The stellar interim profit result for the six months to 31 March 2019 does beg the question: is this as good as it gets?

ONE HUNGRY ASX SMALL CAP

Another niche producer that has been flying high in food space for some years now is the Perich family controlled Freedom Foods (FNP). This company is raising $130m more equity capital and will have raised more than $400m in the past few years as it attacks the giant US and Chinese markets with its stable of specialist milk, snack, cereal and nutritional products (bodybuilding powder). Partly because of the capital raising, this stock at around $5 is well off its record $7 level back in 2018, so the opposite question might apply, as to whether there is real value.

BIG CAPS HUNGRY FOR SMALL CAP GROWTH

Before I answer these questions, it’s worth looking at the other big recent news in the sector, the sale of the 100-year old fruit and vegetable cannery SPC Ardmona by Coca-Cola Amatil for an initial price of $40m, having acquired it for $700m back in 2005. This showcased how bad CCA was in reading the food tea leaves. Who packs tinned fruit in their kids’ lunches any more? Sugar is on the way out and fresh food is prized.

It is now a fact that the food industry is evolving so quickly that big food is susceptible to getting left behind. Just look at Coca-Cola Amatil’s shares, which have basically gone nowhere over five years and the big fall in the giant Kraft Heinz stock over this period. These guys don’t set trends anymore and are forced to follow. This inevitably means taking over those who do have a real competitive edge; that is, if private equity don’t get there first.

RECENT ASX SMALL CAP TAKEOVERS IN FOOD

Recent takeover offers in the domestic space includes Capilano Honey (private equity), the Perth based seafood distributor Mareterram (MTM) by the South Africa’s Sea Harvest Group and Ruralco (RHL) by the Canadian fertiliser giant Nutrien (subject to ACCC concerns – see most recent note).

Many of these Small Cap food producers have the valuable ability to innovate, which necessarily means being nimble and able to take advantage of opportunities. Many also deliver from paddock to plate. They are specialists in adding value at all stages of the supply chain and can hold onto profit margin, despite being sold by the giant supermarkets. On the downside, unlike the food giants their earnings are much more vulnerable to cyclicality. When it’s hot it’s hot, but when it’s cold, watch out! Hence, an investor’s timing needs to be very good.

ALL FOOD ISN’T TASTY OR PROFITABLE

Just because you’re a Small Cap and in the food industry does not give you a free pass. There are plenty of stocks in the sector with market caps below $50m for a reason. Having been burned by the chocolate manufacturer Yowie (YOW) and the grape harvester Murray River Group (MRG), I can tell you that simply being in the sector is no guarantee.

Mind you, Capilano (CZZ), the salmon harvester Tassal Group (TGR), Select Harvests, Freedom Foods and others have more than made up for these errors. Which brings me back to value. As far as Select Harvests is concerned, when the raft of brokers upgraded to buy following the result, it gave me pause for thought, emphasising that this stock is no longer Under the Radar. Expectations are everything and when they’re high, it’s logical that disappointment can follow. Taking profits is never a bad thing, and you can see that this is what is happening in the past few days. Still, holding on to some stock in a quality food producer experiencing high demand is also a good thing. As for Freedom Foods, you really are backing the Perich family’s vision. I’ve profited from it in the past and I’m willing to take my chances on the future.

About the Author

Richard Hemming

Richard Hemming (r.hemming@undertheradarreport.com.au) is an independent analyst who edits www.undertheradarreport.com.au, which provides investment opportunities in Small Caps that you won’t get anywhere else.

Under the Radar Report is licensed to give general financial advice only (AFSL: 409518). The author does not own shares in any of the stocks mentioned.

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