Snack on the small-cap morsels

London’s listed food producers have proved more resistant to the effects of the downturn than companies across other sectors, since to state the obvious, people will always prioritise their need to eat while paring spending in other discretionary areas.

In the main, since they operate in such a defensive space, food producers tend to be good cash generators, and dependable dividend payers to boot. In spite of these attractions, the food production sector accounts for a relatively small portion of the overall AIM market. Yet among them are a number of attractive investment morsels, and there is a good degree of diversity on offer, too.

AIM businesses offering the prospect of salivating returns range from the world’s oldest fruit brand to a Chinese orange grower and a Liberian palm oil producer. However, it would be remiss not to mention that the sector does contain its fair share of highly speculative shells, and even some companies with rather questionable business practices. As ever, it is essential for investors to do their homework.

A fruitful investment
Irish tropical fruit firm Fyffes may be best known for its bananas, but the AIM- and IEX-traded company also imports other tropical fruit such as melons and pineapples into Europe, sources fruit from countries including Colombia, Cost Rica and Guatemala, and boasts a ripening facility in the UK.

2009 was a disappointing period in its hundred-year-plus history, with Fyffes reporting losses for the first time in five years of €11.2 million (£9.27 million), on sales down 1.4 per cent to €598 million, with one-off costs, exceptionally cold weather and a decline in demand all at play.

Though last year’s financials appear to have worried investors – the shares have surrendered around 30 per cent of their value since March – broker Davy sees Fyffes cooking up profits of €14.1 million for 2010 on €574 million of sales, giving earnings of 3.4 cents and a dividend of 1.245p.

Trading on 10.5 times forward earnings and offering a forward yield of more than 4 per cent, the shares represent good value, with Fyffes having put recent issues behind it, sporting a strong name and boasting high recurring revenues. They are worth a nibble for the generous dividend alone.

Another counter that could prove a lucrative treat is Scottish sweets and cake maker Lees Foods, which grew revenue by 13 per cent to £18.2 million in 2009 and pre-tax profits by more than 60 per cent to £612,000 – earnings per share fattened up by 68 per cent to almost 18p.

AIM-quoted Lees has a broad range of products, being behind the ‘Macaroon Bar’, a chocolate-covered coconut confectionery, as well as a series of seasonal products for Easter and Halloween.

Its robust recent growth reflects the breadth of its range, as well as the fact that cash-strapped consumers continue to purchase cheap and cheerful edible luxuries during the economic doom and gloom.

Expanding its brand and exporting products to the US, France, Australia, Kuwait and elsewhere, analysts at Shore Capital see Lees growing profits by 28 per cent to £780,000 and earnings by 31 per cent to 23.6p this year. Debt free, Lees should also serve up a 6.7p dividend, which means the 149.5p shares offer a forecast yield of 4.5 per cent.

For investors looking for exposure to more natural treats, there is always China-based Asian Citrus, the orange grower and seller that grew sales by 36 per cent to  RMB 398 million (£40.2 million) in the six months to December and pre-tax profits by 65 per cent to RMB 248 million. This is a business with formidable growth prospects, selling to China’s ever-expanding middle class, which is increasingly consuming items that were once considered luxuries, such as oranges and bananas. Significantly, orange consumption in China rose by 13 per cent to 5.8 million tonnes last year, driven by an increase in disposable income for millions of Chinese as well as the spread of supermarkets across the People’s Republic and into more remote locations.

For the current year to June, analysts will be looking for Asian Citrus to harvest RMB 330.4 million of pre-tax profit, producing earnings of circa 4.2p and placing the 51.5p shares on a palatable prospective multiple of 12.3. While the Chinese orange market is likely to prove highly lucrative, Asian Citrus is a business that should be treated with at least a degree of caution. In November last year it courted some controversy with its admission to the Hong Kong Stock Exchange, reporting a net asset value that failed to take into account an earlier share split. This angered a number of investors who had purchased shares under the assumption that the company boasted ten times more asset backing than it really had, a rumpus that resulted in temporary suspension of the shares in Hong Kong.

PureCircle – phenomenal possibilities
PureCircle, the specialist developer and refiner of products made from a plant called stevia rebaudiana, also known as ‘sugarleaf’ and native to South and Central America, could prove another sweet punt. Sugarleaf has attracted a great deal of attention, since it can be used as a substitute for sugar, being very sweet, but without any of the calories associated with sugar intake.

Founded in 2002 by Russian magnate Magomet Malsagov, PureCircle is tantalising the taste buds of investors, since stevia has been approved as a food ingredient in a number of countries including the USA, France and Switzerland. PureCircle has also built a refining plant in China and has already worked with PepsiCo to produce PureVia, used in drinks in PepsiCo’s flavoured water, tea and smoothies subsidiary, SoBe.

PureCircle is on a strong growth path, having generated a 74 per cent surge in sales to $37.5 million (£25.3 million) and profits up 7 per cent to the equivalent of £1.47 million in the half to December, driven by increased sales of stevia products to companies including Nestlé, Pepsi and Danone.

Mirabaud forecasts a more than doubling of PBT to $20 million for the year to June, giving increased earnings of 8.4p and leaving the shares selling for a rather pricey 33 times earnings. Having said that, this rating reflects the fact that investors are expecting such phenomenal returns from PureCircle should the stevia market become a viable global alternative to sugar.

EPO – plotting palm oil profits
Also listed under food producers is Equatorial Palm Oil (EPO), the Liberia-based palm oil play, which managed to pare losses in the year to December by 33 per cent to £943,000, with its loss per share reduced from 4.6p to 2.9p. Since the company has yet to begin producing palm oil, there was no revenue to report.

The group owns three operations in Liberia at Palm Bay, Butaw and River Cess, totalling 169,000 hectares, and plans to begin producing palm oil by the end of the year. EPO has also ordered a palm oil mill from Malaysian company Modipalm Engineering, which it expects to arrive in Liberia shortly.

Michael Frayne, EPO chairman, has ambitious plans for the business. ‘The plan is to plant 50,000 hectares worth of seeds within five years,’ he explains. ‘That would produce five tonnes of oil per hectare, or 250,000 tonnes. Palm oil consumption will continue to grow, both in the West and in Africa, and there is no one big company that currently monopolises the industry.’

Admittedly, palm oil is employed within a huge variety of products, ranging from Maltesers to Goodfellas pizzas, and can also be used in the manufacture of soaps and washing powders and a slew of foods. However, palm oil production is highly controversial, with numerous human rights and environmental groups pointing out that the process often involves destruction of the rainforests, as well as the nudging of already endangered species further towards extinction.

Frayne concedes that there is controversy, but he believes that ‘environmental concerns around palm oil are to our advantage, as we are a sustainable business that does everything by the book’. He also points out, ‘The palm oil business is an essential part of global trade, giving a livelihood to many people in the developing world. We employ 200 people in a country with 85 per cent unemployment, so you have to consider the social as well as the environmental impact.’

Though no broker estimates are as yet available, bulls argue that EPO could deliver profits in the year to December 2011 and there is no doubting that the company operates in an exciting and growing market. At the same time, there is also the risk that Liberia may experience political instabilities, so investors should proceed with due care.

A real good investment
Last but by no means least is The Real Good Food Company, which turned losses of £421,000 into profits of £1.63 million in the year to December, despite slightly lower sales of £215.6 million, in a financial about-face that reflected the success of its ingredient division.

Real Good Food has three divisions: Napier Brown, a sugar business; Renshaw, a supplier of ingredients to the baking industry; and a bakery division called Hayden’s. Profits revitalisation in 2009 was driven by the strong performance of Renshaw, which grew its sales by 8 per cent and operating profits by 37 per cent to £2.5 million on the back of the rising popularity of home baking in the USA.

The other divisions did not report the same levels of growth. Napier Brown, which accounts for 74 per cent of group sales, suffered a 24 per cent operating profits reverse to £2.73 million on a 5 per cent sales decrease. However, Hayden’s, which supplies all of Waitrose’s bakery counter goods, did manage to narrow losses from £555,000 to £394,000 during a year in which intensive restructuring took place under managing director Paul Smith.

For the current year, analysts at Shore Capital see Real Good Food growing adjusted pre-tax profits 4.5 per cent to £2.3 million, with earnings per share forecast to swell by an impressive 32 per cent to 2.5p. Trading on less than 13 times earnings, the shares could prove a nutritious snack for investors from here on in.