The Investment Column: Food sector may be on the turn

Is the UK food manufacturing sector finally on the turn? Yesterday's 21 per cent increase in half-year underlying profits at Hazlewood Foods, following decent figures from Northern Foods and Geest, suggests it is.

If so, it won't be before time. Shares in UK food producing companies have underperformed the market by some 15 per cent over the last five years. Dismal performances from individual stocks such as Dalgety and United Biscuits have hardly helped, while the BSE crisis has hammered those into red meat. There have also been tough issues affecting the whole sector - pressure on margins from the cost-cutting supermarkets, rising raw material prices and restrained consumer spending.

Many of these problems have waned. And exchange rate factors have made the defensive qualities of the domestic food producers much more attractive. But the improvements do not end there. The trading environment is more benign, with all the big supermarkets, bar Safeway, enjoying decent sales growth. Consumers are spending more freely and food manufacturers have put their houses in order by offloading excess capacity, improving sales mixes towards higher margin lines and rationalising their bases. With raw material prices now more stable, food stock share prices have already started to turn up.

Companies including Geest, Albert Fisher and Hazlewood have been moving out of commodity sectors into higher margin added-value products such as convenience foods where market growth is buoyant and barriers to entry are high. Hazlewood impressed the market with a 10 per cent increase in underlying sales in the year to September and an improvement in margins.

To add to the rosier outlook, the dairy groups, particularly Unigate and Northern Foods are beginning to benefit from the rationalisation of their declining doorstep milk businesses. Less attractive are companies with overseas earnings affected by the strength of sterling, such as Tate & Lyle and Cadbury Schweppes, while Unilever and Associated British Foods are already highly rated.

Its recent underperformance is likely to cast a cloud over the sector until strong trading results become a more frequent feature. And the deterioration in trading at Safeway could destabilise the supermarket groups and affect margins. But, as the graph illustrates, the sector has been edging up in recent months. While perennial underperformers such as United Biscuits, Dalgety and Albert Fisher should be avoided, stocks such as Unigate, Dairy Crest, Northern Foods, Hazlewood and Geest are still on relatively low ratings. They look good value.