Food stocks have been hit hard this year—and we contrarian dividend shoppers can no longer ignore the bargains on offer!
Investors’ overly negative take on these “essential” dividend plays makes zero sense because:
- They’re partly the result of low fertilizer prices, which can’t last because …
- The world needs more food: according to the UN Food and Agricultural Organization, global food demand will soar 70% by 2050, and …
- Food supply is tight, no thanks to droughts and Putin’s disastrous war (Russia and Ukraine are the world’s No. 3 and No. 10 wheat producers).
The result? Grocery bills that drain our wallets faster than we can fill our carts!
These conditions are worrying, to be sure. But they also create opportunities for companies that process crops, help farmers boost their yields, and sell food through stores here in the US, where the economy is still strong.
That strength, by the way, is despite the Fed raising rates—and the cost of pretty well everything with them. (We’re betting Jay Powell doesn’t do his own grocery shopping.)
Let’s take a look at three different food stocks, from different areas of the supply chain: fertilizer maker CF Industries Holdings (CF), crop processor Archer Daniels Midland (ADM), and packaged-food maker ConAgra Brands (CAG).
All three are well-run companies, with growing payouts and price gains to match. But not all three are equally strong buys now. Let’s rattle through them in reverse order, from worst to first, and see which are most ripe (sorry, I couldn’t resist!) for buying.
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Food-Stock Pick No. 3: ConAgra Brands (CAG)
ConAgra yields 3.6% and owns household-name food brands like Slim Jim, Duncan Hines, PAM and Hunt’s—in other words, affordable staples. This gives CAG an edge as inflation pushes consumers to downgrade from pricier brands.
You can see that in CAG’s revenue, which jumped 8.6% in its fiscal second quarter, ended November 27. And the stock has nicely tracked the payout higher in the last decade!
If you’ve been reading my columns on Contrarian Outlook for a while, you know about the “Dividend Magnet.” It’s the tendency for a company’s share price to track its dividend growth. You can see this in action with ConAgra’s payout (in purple above), which has gained 32% in the last decade, pacing its share price (in orange) higher.
There are three things that give us pause, though, and you can see both in the chart above.
The first is that, I think you’ll agree, 32% dividend growth over a decade is pretty lame. Second, ConAgra has cut its payout in the past: a 20% reduction as part of its spinoff of Lamb Weston Holdings (LW) in 2016. (Though it should be noted that LW’s dividend more than made up for the cut, for investors who held on to the stock. CAG did increase buybacks following the split, only to reverse that by issuing shares later: CAG’s share count is actually up 14.4% in the last decade).
Third, you’ll see on the right side that the company’s dividend growth has been slowing. That’s because ConAgra pays 74% of its free cash flow as dividends, well up from 30% two years ago and north of the 50% “safety limit” we demand. Given the positive outlook for food companies, I have no doubt CAG can turn that around. But in the interim, I don’t expect any major dividend hikes.
Food-Stock Pick No. 2: Archer Daniels Midland (ADM)
ADM operates 400 crop-procurement facilities and 270 processing plants across the globe, turning crops into supplements and ingredients for food makers. It also produces animal feed and runs a commodity-trading business.
The stock is flashing two signals I look for when I seek out buys to recommend in my Hidden Yields dividend-growth advisory:
- A payout whose growth is accelerating—unlike what we’re seeing from ConAgra, and …
- Smartly timed share buybacks.
Let’s take those two points at once because they’re tied together.
ADM’s Dividend Magnet is working perfectly, and its payout hikes are actually getting bigger. That alone is more than enough to offset its ho-hum 2.2% yield. Meanwhile, the company’s buybacks (in blue) reduce its share count, boosting earnings per share, which, in turn, lifts the share price.
So why is ADM in second spot? It comes back to the Dividend Magnet. As you can see above, the payout has gotten ahead of ADM’s share-price gains (though not by much). We want a price that tracks, or even trails, payout growth, because a Dividend Magnet can also work in reverse—dragging down a share price that’s gotten ahead of the dividend.
Food-Stock Pick No. 1: CF Industries (CF)
Sitting in top spot is CF, a US fertilizer producer that dominates its market. CF sees fertilizer demand rising as early as this spring, as farmers look to boost their yields to take advantage of still-high crop prices. And that’s before we look at the need to replenish depleted global wheat stocks (no thanks to Putin).
Meantime, CF is one of the cheapest stocks out there, with a price-to-earnings (P/E) ratio of five. Single-digit P/Es are unheard of these days, especially for companies with CF’s growth potential.
And then there’s the massive amount of capital CF is handing shareholders. Its dividend recently “Rip Van Winkle’d.” After being parked at $0.30 per share quarterly since 2015, management popped it to $0.40—a 33% increase!
It’s also directing more cash into share buybacks. Over the past year, the company has repurchased nearly 10% of its shares. And in November 2022, management approved another $3-billion buyback program that would cut the outstanding-share count by a further 18%.
Put it all together and you’ve got a dividend just starting its ascent, along with a share price that’s only just begun to respond. That’s the opposite of the situation we have with ADM, and the gap below is a key driver of our upside:
Throw in the smartly timed buyback program (which feeds our dividend growth, as fewer shares outstanding leaves the company with fewer on which to pay out), and you get a hearty gain (and dividend) play that’s just starting to sprout.
Brett Owens is chief investment strategist for Contrarian Outlook. For more great income ideas, get your free copy his latest special report: Your Early Retirement Portfolio: Huge Dividends—Every Month—Forever.