KANSAS CITY — Following an extraordinarily difficult year in 2018, market conditions for grain-based foods companies improved in 2019, said a group of Wall Street analysts interviewed by Milling & Baking News. For 2020, no consensus emerged among the analysts about prospects for consumer-packaged foods companies.

With the exception of Kraft Heinz Co., which struggled throughout the year, most major consumer packaged foods companies outperformed leading stock market indexes in 2019, said Robert Moskow, senior equity analyst, Credit Suisse, New York. Over a two-year period, though, most have lagged the overall market, Mr. Moskow said.

 “I think a lot of these companies have made the necessary portfolio changes to improve the growth profile of their business, that included divestitures like Kellogg exiting Keebler and buying faster growing ones like RxBar,” Mr. Moskow said. “Conagra divested a bunch of small brands. Hershey bought a brand called One. They’re trying to build a snack portfolio. There are a lot of these. General Mills buying Blue Buffalo.”

Also an important realization has been the need for food companies to spend meaningfully on e-commerce, Mr. Moskow said.

“That’s a big deal,” he said. “I think it took a while for these companies to recognize the whole landscape for distribution channels, marketing tactics had changed radically, especially with the onset of Amazon into the grocery channel. That forced all the brick and mortar stores to become much more sophisticated in what they could provide in an omnimarketing environment.”

Diminished pricing pressure from retailers and stepped-up investments by a number of food companies are causes for optimism, Mr. Moskow said. Large retailers, such as Walmart Stores, Inc. and Kroger Co. had been aggressively “defending their turf from hard discounters and Amazon,” he said.

“Both kind of signaled they were at the tail end of those investments in 2019,” he added. “Second, food companies recognized they had cut back too far on new product innovation, advertising, overhead investment, new talent, you name it. They got caught up in a zero-based budgeting vortex in prior years.”

That trend reversed in 2019, a move appreciated both by retailers and consumers, Mr. Moskow said. A number of large food companies have enjoyed sales growth for the first time in three years.

As a result, Mr. Moskow has been selectively recommending investment in food companies that are seeing their investments generating returns in the form of sales growth.

“Going forward, I’m no longer painting these stocks all with the same negative brush,” he said.

While conditions for many of the largest companies have improved, growth expectations remain modest. Mr. Moskow said sales growth of 1% to 2% could be characterized as success, and margin expansion also may be expected from certain companies.

While positive about the food sector, Mitchell B. Pinheiro, director of equity research at Sturdivant and Co., Philadelphia, said a defensive mindset underpins his recommendations. Packaged foods companies have struggled in the face of sluggish top-line growth and have focused on margin improvement in recent years, but still offer value to the investment community. He said top-line growth will remain difficult in 2020.

“I think the entire channel shift to the discounters, whether it’s mass merch, club stores or even e-commerce, has really disrupted the industry,” he said. “Everyone is trying to see where things settle out.  We do know this shift, where a lot of the growth has been, is definitely going to pressure margins. So if you look in 2020, it does look like more of the same.”

Despite the challenges he sees ahead, Mr. Pinheiro said a positive investment thesis for the sector remains tenable.

“It’s really a growth and income sector for investors,” he said. “Some of these dividends are near 4%, and with a little bit of inflation and a little bit of growth, over time you can get a nice 8% total return in a very strong investment grade type of company that can easily support the dividend and that has growth of the dividends.”

In as strong a growth-driven market as prevailed in 2019, underperformance by consumer-packaged foods companies is to be expected, Mr. Pinheiro said.

“It’s not sexy but there is in a period of slowing returns,” he said. “I think there definitely are some good ideas in the sector that we ought to own.”

Additionally, Mr. Pinheiro said sophisticated modeling approaches project a broad market return in the low-single digits going forward, even with 10% earnings growth in the S.&P.500 in 2020, based on current price-to-earnings ratios. Given that more than half the total return of stocks over time derives from dividends, and staples generate yields of 3% to 4%, the sector looks attractive. At the same time, Mr. Pinheiro recognized that certain analysts are very bullish about the broader market, predicting a “melt up” moving forward.

A signal to be cautious about investing in the food industry is what Brian Holland views as a slowing pace of mergers and acquisitions in the sector. A senior vice-president and senior research analyst at D.A. Davidson Companies, Portland, Ore., Mr. Holland said increasing sensitivity to balance sheet leverage and fears of potential credit rating downgrades have contributed to the slowdown.

“Multiples have been high,” Mr. Holland said. “Folks have paid big multiples for assets. Some of them may have worked okay, but some of them really haven’t. Investors are stepping back and reevaluating. I think some of these larger players would rather be sellers than buyers right now. I think they’d like to shed some assets and refocus on the maybe let’s call it three, four, five categories where they think they have an edge.”

A greatly underappreciated grain-based foods investment is Hostess Brands, Inc., Kansas City, Mr. Holland said.

 “I think it’s the most misunderstood company that I cover,” he said. “I think that they have better organic growth than the market appreciates and have better growth organic growth potential going forward than the market appreciates.”

Mr. Holland believes Hostess is dismissed as being part of an “off-trend sweet baked good category” that produces products people shun.

“They say, ‘People don’t eat this way anymore,’” he said. “Well they are still eating this way. It’s generally a flattish category, but you don’t map out Hostess’ growth trajectory by looking at the category. You look at the holes in the portfolio. Basically, Hostess has existed as this iconic brand that has never innovated. They were a D.S.D. (direct-store delivery) model, and that’s where the focus was. It was about execution at the point of sale. By repositioning themselves post-bankruptcy, it allows them to focus more on R.&D., innovation and really take a look at several categories where they very much make sense and they have a right to play in, but they just haven’t gotten into before. So, whether that’s breakfast and you get the Cloverhill acquisition; more recently with Voortman, I’ve been saying for a long time you know cookies would be a great category for Hostess. They said they would do that in due time. This isn’t a distribution or velocity story, it’s really a share story. Take the pie that is sweet baked goods and look at the categories where Hostess doesn’t participate in, and then moving into those categories. For instance brownie — three years ago they had never made a brownie before. If you would have asked me, ‘Does Hostess make a brownie?’ I would have said, ‘Yes, I’m sure they do.’ But they never did. Same with cookies. Same thing with some of these breakfast items. I think people just assume they play there. So I think there is significant runway as they continue to innovate, continue to penetrate categories where they have the right to play but have had no exposure historically. I’m very bullish the Voortman acquisition. Hostess is a name I expect to continue to outperform.”

Of seven analysts currently covering Flowers Foods, Inc., Thomasville, Ga., Mr. Pinheiro is the only one currently rating the company a buy.

He said the company has been “stuck in the mud” the last few years with scant earnings growth.

“Every quarter volumes have been down and just started to turn around,” he said. “I think it’s really a negative that a lot of sort of investors had trouble getting their heads around.

“The other negative is they really haven’t been able to get much in the way of pricing. I mean they’ve started to, but they really haven’t been compensated fully for the inflation in transportation in freight.

“You can kind of get it when wheat goes up and some obvious things, maybe natural gas and some commodities go up. It’s harder to get if your wage costs are going up. So they’ve had this inflationary pressure and just haven't been able to get away from it.”

On the plus side, in Mr. Pinheiro’s view, is a company with the ability to reach 85% of the U.S. population and national brands that are not nationally distributed.

“Their market shares are vastly different in different markets,” he said. “They have nearly a 30 share in their core South and Midsouth regions and as little as a 7 or 8 share in the Northeast.

“So I see no reason why brands that are run on a national basis can’t begin to grab share in the territories where they are underrepresented. I think rather than being a staples company where they grow in line with population Flowers can grow in line with population plus they get the sort of geographic expansion or household penetration piece to it, and I think they can grow faster than the sector average.”

Also drawing Mr. Pinheiro to Flowers is the expectation Project Centennial, a multi-year corporate restructuring initiative, will begin delivering meaningful supply-chain cost savings.

“To date they’ve realigned how they manage the business on sort of big strategy,” he said. “The next step will be supply chain and improving their fixed cost leverage, which essentially means improving the bakery assets and getting higher capacity in their bakeries. It might mean shutting a bakery (they just closed a plant in Alabama – Opelika).”

He said if the company were able to raise EBITDA margins to 13% or 14% from 11% or 12%, the company’s appeal would be considerable.

“Investors who think they can get there own the stock,” he said. “Investors who don’t, who think they're going to struggle to expand the margins ought not to own it.”

Drilling into specific aspects of the Flowers business adds to its appeal in Mr. Pinheiro’s view. He said the company “lost some momentum” in the food service business in 2018 and dealt with the repercussions of product quality issues resulting from faulty yeast.

“They will get some of that business back,” he said. “Additionally, Tastykake and Mrs. Freshley's had an off year in 2019. I think they’re going to rationalize and then throw some new products on top of that, bringing some excitement to the brands. That’s going to happen in the next 12 months. Meanwhile probably the most important thing is that they have a stable of brands that is strong as any out there. They have the No. 1 soft variety bread with Nature’s Own; the historically No. 1 white bread in Wonder bread; the No. 1 organic bread with Dave’s Killer Bread; and the No. 1 gluten-free bread with Canyon Bakehouse. They also have the No. 1 snack cake brand, Tastykake, in the six or seven mid-Atlantic states. So they have a great stable of brands. The brands have high awareness levels. They just need greater distribution, and that's where the geographic expansion story comes in.”

Mr. Pinheiro, who has covered Flowers Foods intermittently for decades and has known each of the last four chief executives, said he is positive about the most recent leadership transition.

“Ryals is a really sharp guy,” he said of A. Ryals McMullian, who became c.e.o. in 2019. “I've had numerous conversations with him, and I have to agree that Project Centennial, the whole strategy behind it, is spot on. This is a Ryals initiative.”

Mr. McMullian’s father Amos McMullian led Flowers through the late 1900s, and Mr. Pinheiro said the “familial culture” of the company is a plus.

“They have realigned their management structure, but I do think a lot of what made Flowers really special will continue to be there,” he said.

A cautious view of Flowers was offered by Mr. Holland, who rates the company a neutral.

“I think that there’s work to be done there,” he said. “We keep waiting for some of the operating initiatives that they put in place to really flow through. They just haven’t yet. Maybe 2020 is an inflection point, but we were hoping 2019.”

Mr. Holland acknowledged that some of the difficulty faced by Flowers represents forces beyond the company’s control, citing freight and a tight labor market.

“That’s not really going to go away, so that makes it harder for the operating initiatives they’ve had to generate some margin expansion,” he said. “I think the next step is for them to optimize their bakery manufacturing footprint and/or rationalize it. If and when they can do that they could increase, grow their earnings power.  But we understand from speaking with the company, that’s a pretty complex process. So we continue to wait for updates.”

Among Mr. Moskow’s list of food companies with a promising outlook, Mondelez International stands out, mostly because of the company’s impressive international footprint, he said.

“I also think they are doing well with Nabisco domestically,” he said. “It’s Oreos mostly. They just continue to come up with new flavor varieties, limited editions, new packaging formats. They’ve really pushed that brand in a positive way.

“They’ve also integrated Tates well. Tates is growing and has been a way to learn the specialty segment a little better. I think they gained a little bit at Keebler’s expense as Kellogg prepared that business for divestiture.”

Kellogg Co., Battle Creek, Mich., was upgraded by Mr. Moskow during 2019 because he has been increasingly impressed by the growth generated by the companies snack brands, such as Pringles, Cheez-It and Pop Tarts. Investments in new packaging formats, flavor varieties and expansion into new channels have been successful, he said.

“The thing that’s missing is North American cereal,” he said. “Now that that category has stabilized, I feel like they have a pretty good opportunity to fix that part of the portfolio as well.”

The upside for ready-to-eat cereal going forward has been undercut by a trend Mr. Moskow has emphasized for a number of years — consumers’ preference to increase intake of protein. Tyson Foods, Inc., Springdale, Ark., has been a beneficiary of this shift.

“It’s especially true with breakfast,” Mr. Moskow said of the protein preference. “The cereal category is starting to stabilize. I think its growth longer term will be impaired by consumer desire for more protein in the morning. Tyson has done a great job leveraging the Jimmy Dean brand. Extending it in different convenience formats. I don’t see that stopping.”

Mr. Moskow also emphasized the powerful potential for plant-based protein.

“I’m a strong believer that these small start-up firms like Impossible Foods and Beyond Meat will have big brands in the category,” Mr. Moskow said.

He is less certain about whether traditional branded foods companies with brands that “happen to play in the space” will be successful.

“The question is how material a boost in growth those brands will have,” he said.

Despite a deep share price correction and a new leadership team, Mr. Moskow remains dubious about the outlook for Kraft Heinz, rating it an underperform.

“The stock looks cheap optically,” he said. “I just think they have an enormous amount of work ahead of them to reorganize their marketing approach. Reinvest in product innovation. Figure out how to get the price gap right versus private label and commoditized categories like cheese and meat. I think they’re still in the process of restaffing the place after the exit of Bernardo Hees and the people who he brought on board. All of that plus the strong possibility of dividend cut again, a second dividend stock, makes it a tough stock to like. I would argue that their portfolio is the most challenging portfolio to operate out of all of them.

“They are controlled by 3G, which is a private equity firm, and 3G doesn’t have a strong track record of running a business for growth. They typically make these businesses to be M.&A. rollups. The plan they had for this to be an M&A. rollup is not going to play out.”

Asked what went wrong at Kraft Heinz, Mr. Moskow said, “I think they denuded the assets of the company.”

“They implemented an overly aggressive program of overhead cost reductions,” he said. “That led to loss of talent. They put inexperienced managers in charge of the place. Some of them very smart, but I think the new c.e.o. recognizes and has said publicly we need people with more c.p.g. experience into these roles. When I downgraded the stock two years ago, I had done some work and found management changes had hurt relationships with major retailer and exacerbated distribution declines.”

Mr. Moskow tipped his cap to Miguel Patricio, the new c.e.o. at the company, calling him “the kind of c.e.o. we like to meet.” Still, the company faces a long road to recovery.

“I think he has an enormous task at hand,” Mr. Moskow said.

While cheered by stabilization in the market for ready-to-eat cereal, Mr. Moskow described himself as “a true neutral” regarding General Mills, Inc.

The company has numerous positives, including strong management, a shift toward a more promising product portfolio and greater expertise in e-commerce and revenue management, Mr. Moskow said.

“They’ve rightsized the organization and have a fast-growing pet food brand,” he said. “The two things that hold me back are the overhang on Blue Buffalo from consumer concerns about grain-free formulations. There is an F.D.A. (Food and Drug Administration) investigation into some dog deaths that include Blue Buffalo’s brand. Secondly, the core business excluding Blue Buffalo has not grown.”

Mr. Moskow is warier of J.M. Smucker Co., with concerns particularly centered on the company’s pet food business.

“I think they are ill equipped to run a pet food business,” he said. “There is some kind of structural issue here with the brands in that portfolio. Some are good, a lot are not. Secondarily, I don’t think they’ve demonstrated aptitude in this category in terms of operating it. I’m particularly concerned about the fact that the first pet food acquisition failed to meet its targets, and they had to write it down. Then they tried to solve it by buying a second pet food brand, Nutritsh. Now it now looks like it’s about to miss its targets, too.”

Also a concern at Smucker are rising costs for coffee. Recent costs have been “as good as it gets,” and an upward correction is “inevitable,” he said.

While still rating Conagra “neutral,” Mr. Moskow said a recent meeting with management was hopeful.

“Their new product efforts and relationships with retailers were better than I thought at the end of 2019,” he said. “What they demonstrated in December results is that they held distribution pretty well even though private label is gaining space at Walmart. What’s missing is retail sales trends have not turned positive yet. So I think I and others are waiting to see if the investment they made in the Birds Eye brand will help return that brand to growth.”

He said overall the company has rebounded impressively after a year of ceding market share.