As long as more lowly-rated food groups maintain modest earnings and dividends growth, they will remain good value

Over recent weeks some of the key quoted Irish food companies such as Kerry Group and Glanbia have reported very solid sets of financial results. In general, food companies have to battle hard to generate profit growth in businesses that are generally characterised by low profit margins and intense competition.

Companies such as Kerry Group and IAWS have successfully diversified into sectors of the food manufacturing chain that generate much higher profit margins. Kerry is now a global player in the highly specialised food ingredients business, while IAWS has successfully developed its par-baked range of food products.

As a result, Kerry and IAWS now enjoy operating profit margins that are significantly higher than those available in the more basic food-processing activities. For example, Kerry's operating profit margin of over 8 per cent compares with Glanbia's margin of just under 4 per cent. The reason for Glanbia's lower margin is that its focus remains in the processing and marketing of dairy and meat products, which are a low-margin, commodity-type business.

In current turbulent market conditions, food stocks are considered a safe haven by many investors. This has largely been borne out by the Irish-quoted food stocks in 2002. For example, Kerry's share price is up by approximately 6 per cent so far this year and Glanbia's price is up by over 14 per cent. This compares with the decline of more than 26 per cent in the ISEQ-Overall index over the year-to-date period.

The table provides some key investment data for the quoted Irish food stocks. By far the largest company as measured by market capitalisation is Kerry Group, with a market capitalisation of €2.7 billion. Next largest is IAWS, which has grown very rapidly in recent years driven by acquisitions such as its purchase of Cuisine de France. Glanbia and Fyffes are both capitalised at just under €0.5 billion and the minnow of the sector is Donegal Creameries, with a market capitalisation of just €22 million.

Although all of these stocks are food companies, the differences between the individual companies are probably greater than their similarities. Fyffes imports and distributes bananas and other fruit and vegetables. Its main product, bananas, is a highly regulated market subject to several international trade treaties. By contrast, the main driver of Kerry's business is its food ingredients division where its customers consist of the large multinational consumer food groups.

This diversity is reflected in the valuation ratings that the stock market applies to each company. Kerry and IAWS are the most highly rated companies with price-earnings ratios (PERs) of 13 and 14.2 respectively. Both companies also offer very low dividend yields, reflecting the fact that they retain most of their earnings in order to achieve more rapid earnings growth. When compared with similar international companies these ratings seem reasonable. For example, a food ingredients company such as McCormick & Co trades on a PER of 16 with a dividend yield of 1.2 per cent.

Fyffes trades on a significantly lower PER of just over nine times earnings, which is similar to comparable overseas companies such as Dole Food and Del Monte. These companies have to cope with extremely low operating profit margins as well as having to cope with a very varied seasonal pattern of production. However, the demand for fresh fruit and vegetables seems set to grow strongly over the medium term given the healthy attributes of the product.

Glanbia also trades on a relatively low PER, although it operates in a completely different market segment to Fyffes. It has been trying to increase its presence in higher value-added food products (such as yoghurts) with some degree of success. Nevertheless, a high proportion of its activities remains in lower margin businesses such as dairy processing. This is reflected in its relatively low PER of just over eight.

However, from the investor's perspective there is a key attraction to investing in food companies that operate primarily in low margin businesses. This is the high dividend yield on offer from the three more lowly-rated companies. Glanbia, Fyffes and Donegal Creameries offer dividend yields ranging from 3 per cent to 4.7 per cent, which are very attractive in the current environment of very low interest rates. As long as these companies can achieve even modest growth in their earnings and dividends they are likely to produce very good long-term returns to their shareholders.