Ascending to New Heights

by Shawn Narancich, CFA Executive Vice President of Research

Ascending to New Heights

Subsiding geopolitical tensions in Eastern Europe, tentative steps by Chinese policymakers to support slowing growth, and more deal-making domestically combined to send U.S. stock prices to new record highs this week. Investors expecting negative revisions to previously reported first quarter GDP numbers were undeterred by the latest numbers that proved surprisingly poor, buying shares of economically sensitive companies poised to benefit from a rebounding economy. The fact that benchmark U.S. equities are now up four percent for the year is less surprising to us than the observation that bonds have nearly kept pace. Until just recently, key fixed income indices were outperforming stocks, prompting no small amount of ink to be spilled by investment analysts attempting to explain why bonds have done so well at a time when economic growth domestically is accelerating.

Skating to Where the Puck Will Be

While somewhat shocking at first glance, the one percent first quarter GDP contraction reported by the U.S. Commerce Department earlier this week paints an unrealistically dour view of the US economy. By now, almost anyone who didn’t hibernate through the unusually cold and snowy winter knows what the inclement weather did to economic activity. We are encouraged by recent strength in reported payrolls, rising U.S. energy production and the health of key manufacturing indices that point to rising domestic investment. With retail activity picking up, we do not foresee inventory investment continuing to detract from GDP in the second quarter, and surprisingly low interest rates may very well end up providing a nice boost to the recently lackluster housing market. All told, we expect a strong rebound domestically, one that could produce upwards of four percent GDP growth in the second quarter.

Food Fight

We anticipated that a faster rate of economic growth, relatively low interest rates and high levels of cash on corporate balance sheets would stimulate merger and acquisition activity this year, and that is certainly what has transpired. Deal-making in the cable, telecom and drug industries that has dominated M&A headlines so far this year gave way to activity in the food aisle this week, as meat processors Tyson and Pilgrim’s Pride now find themselves in a bidding war for Jimmy Dean sausage and cold cut company Hillshire Brands. What started as an attempt by Hillshire to expand its grocery store presence by acquiring Pinnacle Foods (purveyor of Birds Eye frozen vegetables and Log Cabin syrup) has turned the hunter into prey. Pinnacle Foods, which soared 13 percent earlier this month on the Hillshire bid, has now given back almost all of its recent gains on the heels of Pilgrim’s Pride’s $45/share bid for Hillshire Farms. The presumption is that the poultry producer wouldn’t want Pinnacle in the fold, opting instead to vertically integrate with Brazil’s JBS, the 75 percent owner of Pilgrim’s Pride. Complicating matters, chicken and pork processing competitor Tyson entered the fray by offering a superior bid of $50/share for Hillshire.

How this game of chicken concludes is hard to tell, but what the frenzied deal making in the food business demonstrates is the industry’s slow growth and ultra-competitive dynamics. Key players are being incented to combine and eliminate duplicative cost structures, produce more favorable margins by vertically integrating from the meatpacking floor to the cold-cut aisle and dampen the cyclicality inherent in livestock production.

Our Takeaways from the Week

  • Contraction in the US economy early this year should give way to stronger growth in the months to come
  • M&A activity continues at a heightened pace as key players jockey for better industry positioning