Sector Screener: don’t chase exciting stocks, buy these instead

Dull companies in boring sectors are frequently overlooked by investors. Indeed, many stock market participants focus on firms that either sell a product or service in which they are interested or operate in a sector deemed to be relatively exciting. For example, consumer goods firms and technology stocks are usually in relatively high demand among investors for those reasons.

While this does not present a problem if such companies are fundamentally sound and offer fair value for money, in many cases they do not have either of those attributes. This can mean that investors end up with relatively disappointing returns compared with peers who prioritise company fundamentals over an interesting story.

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Indeed, there are a plethora of companies in the FTSE 350 that have solid balance sheets, clear competitive advantages and sustainable long-term growth prospects. While their business models may be somewhat lacking in excitement, their return prospects should hold the interest of investors over the long run.

Growth opportunities

The FTSE 350 Food Producers sector is an obvious example of an apparently uninteresting sector that offers significant long-term investment appeal. Over the past year, it has produced a 22.9% return, versus an 8% gain for the wider index, which places it fifth in a list of the best-performing sectors during the period.

The sector continues to offer an attractive long-term growth outlook. At its core, it is set to benefit from favourable global demographic changes, particularly a rising world population, that should provide growing demand for the variety of foods produced by its wide range of incumbents. In fact, the United Nations estimates that the world’s population will rise from 8 billion in 2022 to 8.5 billion by 2030. It then expects further growth to 9.7 billion by 2050, with the global population expected to reach 10.4 billion by the end of the century.

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Separately, several FTSE 350-listed food producers are benefiting from the impact of acquisitions. Due in part to an uncertain economic outlook, there are opportunities for larger firms to leverage their solid financial positions to buy smaller peers. This helps to bolster their top and bottom-line growth prospects, while improving their competitive position over the long run. And with many companies having scope to move into adjacent, or even new markets, sector incumbents have scope for substantial growth over the coming years.

Source SharePad. Data as at 18 June 2024. Past performance is not a guide to future performance.

Source SharePad. Data as at 18 June 2024. Past performance is not a guide to future performance.

A case-by-case basis

Food producers have historically been viewed by some investors as defensive companies due to the fact that food itself is a basic need. While their financial performance is typically less cyclical than that of many FTSE 350 members, the recent bout of rampant inflation has highlighted the difficulties that even relatively defensive firms can have in passing higher costs onto consumers. In some cases, profit margins have been squeezed over recent months, leading some investors to question the defensive merits of the wider sector.

The recent period of above-target inflation, though, provides investors with an insight into the competitive position of specific food producers. Those firms that have largely been successful in maintaining, or even increasing, profit margins over recent months are likely to enjoy significant pricing power, which is an obvious indicator of a strong competitive position. This can be a highly worthwhile asset, alongside a solid financial position, over the long run, as further economic difficulties are likely to ultimately arise.

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Investors, of course, should not anticipate that the financial performance of any food producer will be wholly detached from the economy’s outlook. Instead, they should assess each sector incumbent on a case-by-case basis. Firms that have solid fundamentals and sound long-term growth strategies are likely to generate relatively high returns. For many investors, this end result will prove to be far more exciting than buying a story stock in an apparently more interesting sector.

Source SharePad. Data as at 18 June 2024. Past performance is not a guide to future performance.

Cranswick

Shares in food producer Cranswick (LSE:CWK) have outperformed the wider sector over the past year. They have risen by 36%, with the FTSE 250-listed company’s recently released full-year results being highly encouraging.

They showed that the producer of a wide range of meat, dips and pet food generated like-for-like revenue growth of 11.6%. When combined with an 80 basis point rise in its operating profit margin, delivered partly as a result of tight cost controls, the firm’s earnings per share (EPS) rose by 15.6% year-on-year.

Return on equity in the most recent financial year stood at 13%. This highlights the company’s strong competitive position, with a double-digit figure achieved despite the firm having very low levels of debt. Its net gearing ratio stands at just 11%, with finance costs covered over 18 times by operating profits during the year.

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A strong financial position allowed Cranswick to spend £46.1 million on two acquisitions during the 12-month period to further improve its growth prospects. Annual capital expenditure of around £91 million, meanwhile, should have a positive impact on its competitive position.

Higher profits allowed the firm to raise dividends per share for the 34th year in succession. Shareholder payouts increased by 13.4%, which is substantially ahead of inflation. Although a dividend yield of 2% may be deemed too low by some income investors, the prospect of fast-paced growth in payouts means the stock nevertheless remains a worthwhile long-term income proposition.

Of course, the company’s share price rise means that it now trades on a relatively rich price-to-earnings (PE) ratio of 18.2. While this is significantly greater than the market valuations of many other large and mid-cap UK-listed shares, it nevertheless offers fair value for money when the company’s profit growth prospects are taken into account.

With sound fundamentals and an excellent market position, Cranswick is well placed to overcome potential economic challenges in the short run. It is also in a strong position to capitalise on long-term industry growth, with further share price gains likely to be ahead.

Tate & Lyle

Fellow food producer Tate & Lyle (LSE:TATE) also offers an attractive long-term investment outlook. The FTSE 250 member currently trades on a PE ratio of just 12.1 after recording a share price decline of roughly 11% over the past year. This suggests it offers good value for money, with its recently released annual results highlighting an improved overall performance.

The producer of a wide range of food ingredients, including sweeteners and texturants, generated an 18% rise in EPS due in large part to a 170 basis point increase in its EBITDA profit margin. This resulted from an ongoing focus on higher margin business, with the company’s volumes falling versus the prior year so that revenue moved 2% lower. The firm also generated £32 million in productivity savings during the year and raised its five-year target from £78 million to £118 million in total savings.

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Tate & Lyle forecasts that volumes will return to positive growth during the current financial year as consumer confidence improves. It also expects to execute a £215 million share buyback programme following the disposal of its primary products business Primient, which seems logical given the company’s relatively modest market valuation.  

With a net gearing ratio of just 12%, the firm is well placed to engage in M&A activity to further enhance growth prospects. Having made major changes to its structure and range of operations over recent years, it now expects to generate profit growth of 7-9% per annum through to 2028. Alongside its modest valuation, sound balance sheet and improving competitive position, this suggests that it offers an attractive risk/reward opportunity for the long term.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.