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Wait for a Price Cut on Organic-Food Stocks

Ken Perkins, CFA

Ken Perkins: Organic and natural foods have gotten a lot of attention recently, and that's primarily because sales have grown by about 10% a year for the last decade. A lot of investors are skeptical about these trends and how sustainable they are, but we actually think that these growth rates can be sustained, primarily because consumers are more focused on health and wellness now than they have been in the past and many consumers are willing to pay premium prices for the perceived quality of these products.

Of course, affordability is an issue that organic food suppliers need to think about because some consumers may not be able to afford the premium prices that they have to pay in order to have access to these products. However, we think that there is still a lot of room for organic food to grow. There are many consumers who could afford it and haven't been buying it yet, and so we see a lot of room for growth on the demand side. On the supply side, we do think that there could be some limitations in terms of keeping up with the pace of the demand. However, with less than 1% of all U.S. farmland being allocated toward organic food products, we think that there shouldn't be any problem, at least over the near to medium term, with supply keeping up with the demand.

So overall, this is a very positive opportunity for food manufacturers and retailers, but we don't think that all firms will benefit equally. We think that retailers such as Whole Foods (WFM) and Kroger (KR) could benefit disproportionately as they expand their products in the space. But we think that food manufacturers could be more challenged over time. This is primarily because most firms will use the term "organic" to try to command a price premium; but other firms can do that as well, and so that could actually dilute the value of using the term organic and, ultimately, lead to a lot more price competition in the organic space. Not to mention, there are also high valuation multiples on any stock that has these growth prospects.

So, while we're very confident that the organic-food space will remain in demand and that sales growth will be robust over the near term, we're less optimistic about the stocks. With Whole Foods, Kroger, and some of these other retailers trading at very high multiples, it's very difficult to justify buying into the space. We think that the organic growth trend may be priced in to these stocks--perhaps more than it should be.