Sunday, March 05, 2006

Del Monte Crippled by Cost Pressures

If you really want to hurt someone, we suggest convincing them to buy shares of canned food manufacturer Del Monte (DLM).

Today, supermarket shoppers are unable to differentiate Del Monte's brands (which include tuna good Starkist, cat food 9Lives, and Del Monte fruit cocktail) from everything else that's being pitched at them. Del Monte has been run over by commoditization, and if you're wondering who to point the finger at, look no further than Walmart (WMT).

In order to give consumers more choice, megastores have allocated plenty of shelfspace to private labels. Besides losing market share to rivals, Del Monte's done little in the way of R&D. The result has been a shoddy product portfolio that's less visible in an increasingly crowded marketplace. Naturally, it doesn't help that Del Monte operates in an unattractive industry, characterized as it is by fierce rivalry, high customer/buying power, and low margin products.

Del Monte's problems are also driven by cost pressures associated with volatile energy prices. To offset higher commodity prices, Del Monte and others are restructuring and honing in on operating efficiencies (some, like Sara Lee [SLE], are going as far as laying off personnel and cannibalizing assets just to keep the dividend afloat -- yuck!)

We think analysts are giving CEO Richard Wolford too much credit for both his past actions and current plans to get Del Monte back on its feet. After Del Monte acquired some assets from Heinz (HNZ), Del Monte's sales doubled. We believe that if Del Monte had focused more on organic revenue drivers, it'd be playing in an altogether different ballgame today.

We wonder as to why management refuses to eat its own cooking. Top execs own roughly 2% of the shares outstanding -- we like to see insiders own between 5%-10% of a firm. Considering that Del Monte has $20M in cash, but over a $1B in debt, we see little reason to get excited about this slow growth company. We believe Del Monte is close to striking out.

We remain neutral on the packaged foods category and we suspect that Del Monte's woes will continue throughout 2006, and possibly into 2007.

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