Organic Growth Means Big Business; Natural Reaction to Food Scares Fuels Double-Digit Expansion Rates

Organic Growth Means Big Business;
Natural Reaction to Food Scares Fuels Double-Digit Expansion Rates

May 19, 2001 The International Herald Tribune by Holly Hubbard Preston
YOU MAY have suspected that organic foods were good for your health and the environment, but could they enhance the well-being of your portfolio? In the past year, major food processors and supermarkets have poured into the natural-foods business, either by creating products or buying smaller companies.

They are reacting to rising consumer demand for organic foods, which reflects in part the mad-cow and foot-and-mouth disease scares that began in Europe.

Organics can cost 15 percent more than conventional products, but a growing number of consumers, especially middle-class ones, seem to find that an acceptable price to pay to avoid pesticides, growth hormones and other additives. For now, organics account for $20 billion in worldwide sales, no more than 2 percent of the food industry, according to the International Federation of Organic Movements, a global group of organic farmers, food processors and grocers based in Tholey-Theley, Germany.

In the coming decade, however, that portion is expected to grow to as much as 15 percent, resulting in annual sales of $100 billion or more, an annual growth rate of about 25 percent.

A big company that has made natural foods a core part of its business is Royal Wessanen NV, the Dutch-based food distributor that in October said it would shift its focus to the "health-and-wellness market." It has been buying smaller companies specializing in natural foods, notably the French distributor Distriborg SA and Tree of Life Inc. in North America where Wessanen has the bulk of its sales. Grocers like the organic movement because it attracts customers in an otherwise stagnant industry. David Shriver, a consumer retail analyst for Credit Suisse First Boston Corp. in London, said "growth in tins and packets in the center of the grocery store is on the zero for almost all food retailers."

At the biggest publicly traded grocer, Royal Ahold NV, Hans Gobes, a spokesman, said that there was almost across-the-board growth in demand for organic foods at its 9,000 stores around the world. Ahold is committed to carrying organic foods in "practically every category on our shelves," according to Mr. Gobes. He said organic produce accounted for 1 percent to 5 percent of sales at Ahold stores. Other supermarket operators increasing shelf space to organics include Carrefour SA of France, the British-based Tesco Ltd., and Wal-Mart Stores Inc. Tesco, which operates groceries in Britain, Central Europe and the Far East, has invested l12 million ($17 million) to subsidize organic foods in its British stores, encouraging consumers to try them. "We also want to bring down prices on organics because when the prices are higher you do not get the same volume," said Russell Craig, a spokesman. It is possible to overdo it. Another British grocer, Iceland Group PLC, tried an organic-only policy. Mr. Shriver, the CSFB analyst, said "that decision cost them two major profit warnings in the last five months." The company has given up trying to sell only organic products. Still, suppliers ignore the organics trend at their peril. Patrick Schumann, a food analyst for Edward D. Jones & Co. in St. Louis, put sell recommendations on the shares of two big U.S. food companies this month, downgrading H.J. Heinz Co. and Kellogg Co. because of their "overreliance" on mature product categories. Heinz has joined a cavalcade of international food processors -- including General Mills Inc., Mars Inc., Rank Hovis McDougall PLC, Nestle SA, Northern Foods PLC, J.M. Smucker Co. and Unilever Group -- that are creating organic food lines and buying organic companies.

Other companies, such as the Japanese frozen-foods distributor Nichirei Corp., are importing organic products. Recently, Heinz has taken one of the most aggressive approaches. It launched its own line of nearly 40 organic products in Britain six months ago and is now making similar rollouts worldwide.

It is committed, even though Rupert Maitland-Titterton, Heinz's general manager of organic foods in London, noted it might be cannibalizing sales of its conventional products and the cost of ingredients was "significantly higher than we want them to be." Heinz also owns 20 percent of Hain Celestial Group Inc., a New York-based maker of organic foods including Celestial Seasonings Teas. Britain was a sensible place to start. Demand for organic products is growing 55 percent a year, according to a London-based agricultural trade group, the Soil Association, which said they accounted for about 2 percent of sales. Britain was ground zero for the mad-cow epidemic and the recent outbreak of foot-and-mouth disease, and Europeans in general have been wary of foods with additives or that have been genetically modified, especially by U.S. companies.

But Bernard Geier, executive director of the International Federation of Organic Movements, said there was also rapidly growing consumer demand for organic foods in countries such as Argentina, Japan, China, Poland and Australia. Government backing is helping to fuel the industry's growth. Germany, Switzerland and Austria, for example, are offering farmers cash incentives to shift to organic production, which is seen as being good for the environment.

Rabobank NV, which functions domestically as a central bank for Dutch cooperative banks, has a program called the Green Project Scheme that offers qualified organic farmers and businesses preferential loan rates. The United States and Japan, which had been slow to jump on the organic bandwagon, gave major endorsements to the movement when they implemented organic certification programs for growers and wholesalers, establishing national standards for what can be called organic.

Investors seeking a piece of the action might consider Wessanen. The company is listed in Amsterdam and several other European markets and has American depositary receipts that trade sporadically over the counter. Wessanen has a spotty history as an investment. In 1993, the food producer merged with the beverages company Erven Lucas Bols NV and was known for a time as BolsWessanen.

When they joined, the companies promised annual earnings growth of 10 percent, which they failed to achieve. By 1997, the company decided to jettison the beverages and return to the food business, and then last fall it refined its strategy to focus on health-related food. The company is selling its considerable dairy operations: Last month it sold Marigold Foods Inc. and Crowley Foods Inc. for about $400 million, though the foot-and-mouth issue has delayed its disposal of Leerdammer Co. in Europe. The new strategy has met with a mixed reception from analysts. According to Bloomberg LP, while nine advisers have buy recommendations on the stock, five rate it a hold and four suggest selling it. Herbert Dorhout of Rabo Securities NV is in the buy camp, having switched his call from sell after Wessanen changed its focus to natural foods and bought its recent acquisitions in Europe and North America.

After the poor profits of the late 1990s, Wessanen has been through some "drastic management shifts," he said.

The company is still early in its transformation, he noted, so its profit in the coming quarters may not reflect all the benefits from the concentration on specialty foods, which the company has predicted would show earnings growth of at least 15 percent this year.

The stock price, however, has been rising, suggesting investor confidence is growing, he said. The shares, which closed Thursday at 14 ($12.35), have returned 42 percent to investors over the past year, though they are still trading at a modest 12 times expected operating earnings in the coming year. The stock also pays a 4 percent dividend. Mr. Dorhout noted that of the company's 3.9 billion in 2000 sales, about 2 billion came from the natural-and-specialty food segment, and only about a third of that from organics. But Mr. Dorhout likes the entire sector, which includes ethnic and delicatessen items. In common with organics, these are high-margin products that require value-added services. Wessanen, he noted, was working with upmarket retailers including Ahold and Safeway Inc. on distribution, and, in the latter case, managing the category for the American supermarket chain. A potential problem, Mr. Dorhout added, was that specialty foods are more susceptible to economic downturns than less-pricey alternatives.

In fact, that was a key reason cited this week by Hain Celestial, the company that is 20-percent owned by Heinz for a dismal earnings performance in its third quarter, when it earned 12 cents, less than half the 28 cents analysts had expected.

Hain said the slowing U.S. economy led retailers to trim inventories, though several onetime costs also were blamed for the weak showing.

Three analysts quickly slapped "strong buy" ratings on Hain, indicating its problems may be temporary.

Andrew Wolf, a retail consumer analyst at BB&T Corp.'s BB&T Capital Markets in New York, said a company in the field that he liked was United Natural Foods Inc. of Dayville, Connecticut, the largest publicly traded organic-food wholesaler in the United States. "It is all about the industry growth and sales productivity, and this company has both those things going for it," he said. He predicted it would report operating profit of 77 cents a share on $990 million of sales -- a 9 percent rise -- in the year ending July 31. For the following year, he forecast profit of $1.05 a share, based on the assumption the distributor would be able to keep adding mainstream supermarkets to its channel. United Natural closed Thursday at $17, or a modest 16 times Mr. Wolf's 2001 earnings projection. Mr. Wolf also likes Whole Foods Market Inc., a natural-food retailer with supermarkets in 20 U.S. states. "

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