What Tyson’s Bid for Hillshire Means for Food Industry

Source: Thinkstock

Source: Thinkstock

Thursday morning we learned that Hillshire Brands (NYSE:HSH) received a second takeout offer from Tyson Foods (NYSE:TSN) after receiving one on Tuesday from Pilgrim’s Pride (NASDAQ:PPC). Tyson offered Hillshire shareholders $50 after Pilgrim’s Pride offered $45/share.

This bidding war has generated a lot of investor enthusiasm from traders who see the potential benefits that consolidation in the packaged food industry can bring about. As I pointed out on Monday, packaged food companies are also technology companies. They used patented techniques in order to improve farming and processing efficiencies, and it is for this reason that a company such as Hillshire is generating so much interest.

I also pointed out that as the industry consolidates there are fewer companies to compete in the space, and that means that the companies that are remaining have added pricing power. Since they also have the patented techniques necessary to improve efficiencies, this means that it is less likely that a smaller competitor, or even a larger new competitor can enter the market competitively.

It isn’t the only one. The bidding war for Hillshire comes shortly after Hillshire made an offer for Pinnacle Foods (NYSE:PF). Furthermore, about a year ago, a Chinese company — Shuanghui International — bought out America’s largest pork producer — Smithfield Foods.

What is incredible about this consolidation is that investors are expecting even more. In early trading Hillshire shares traded at $51.50/share, or 3 percent above Tyson’s $50/share offer. This suggests that there could be more to this bidding war. Furthermore, shares of Tyson Foods rose on the news by about 3 percent, and this speaks to the aforementioned benefits that consolidation in the packaged food industry can bring to shareholders.

Given this situation has developed to the point of shareholder exuberance, I would be cautious investing in this space. The shares of many of these companies have risen substantially as investors are pricing in the heightened probability of continued M&A as well as the aforementioned benefits of consolidation in the industry.

Nevertheless, there are still opportunities in the space, and the potential for further consolidation is still heightened.

First, there is Hormel Foods (NYSE:HRL), which is the maker of Spam and other low cost packaged food products. The company’s shares trade at about 22 times earnings, which is in-line with the S&P 500. However, it is below the multiples that Hillshire Brands and Pinnacle Foods trade at. Hormel is a solid company with stable earnings growth, strong profit margins, and a long history of returning capital to shareholders through ever rising dividends.

The shares are off their highs after weak first-quarter earnings, and the stock hasn’t responded to the onslaught of M&A in the packaged food space, so there could be opportunity here.

Another lesser known option is Seaboard (NYSEMKT:SEB). Seaboard owns one of the nation’s largest pork processing businesses. It also owns a sugar producing business in Latin America, as well as the Butterball brand. This is a company that is very thinly traded, and it is difficult to find quality research on it as the company is mostly owned by the secretive billionaire Bresky family. However, the shares are relatively inexpensive, and management has an impeccable track record of generating long-term shareholder value. Seaboard is not a takeover target, but it should benefit from consolidation in the industry.

Finally, investors can consider positions in larger packaged food companies such as Kraft (NYSE:KFT) or PepsiCo (NYSE:PEP). These companies won’t benefit as much from the consolidation, but they are lower risk options, and they haven’t moved higher on the recent M&A activity. Note, however, that these companies trade at premium price to earnings multiples, and so investors are encouraged to be cautious.

Disclosure: Ben Kramer-Miller has no position in the stocks mentioned in this article.

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