Wal-Mart’s (WMT) “growing leverage” over food manufacturers could cause it to pay them less for their products while the market share of private label food makers is increasing, warned Morgan Stanley. Responding to these trends, the firm downgraded J.M. Smucker (SJM) to Underweight, its equivalent of a sell rating, Conversely, Morgan upgraded Pinnacle Foods (PF) to Overweight from Equal Weight, citing what it sees as the resilience of the company in the face of these negative trends.
WAL-MART LEVERAGE: Wal-Mart accounts for about 22% of sales to the food manufacturers covered by Morgan Stanley, according to Matthew Grainger, an analyst at the firm. That proportion has risen in recent years, the analyst reported. Wal-Mart’s increased leverage in price negotiations poses the biggest risk to J.M. Smucker, Dean Foods (DF), and General Mills (GIS), according to Grainger, who kept an Underweight rating on Dean Foods and an Equal Weight rating on General Mills.
PRIVATE LABEL GROWTH: Based on recent scanner data, the market share of private labels has reached a positive turning point, as the data indicates that it has risen 0.3 percentage points in the last 12 weeks “across a range of center-store categories,” the analyst reported. That trend could intensify as the grocery category become more competitive, Granger believes.
J.M.SMUCKER: As reasons for the downgrade of J.M. Smucker to Underweight, Grainger cited what he sees as its “high and increasing” exposure to Wal-Mart and increased private label market share in its largest categories, including coffee and pet treats. Furthermore, the company may have to invest more in its pet food business, Grainger warned. He says that his estimates for the company are about 2% below consensus levels, and he trimmed his price target on the stock to $126 from $132.
PINNACLE: Pinnacle’s ability to “identify and revitalize” badly managed brands has enabled it to withstand the negative pressures affecting the U.S. food sector, Grainger believes. The company has outpaced the trends of the categories to which it was exposed for five consecutive years, and in the past 12 weeks its sales fell 1.4%, versus a 5.2% decline for “large-cap food sales,” the analyst reported. He expects the company’s margins to rise going forward, driven by productivity initiatives and price increases. Grainger adds that the company has “consistent market share momentum at Wal-Mart and other retailers,” and he raised his price target on the name to $63 from $58.
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