Investors are increasingly looking for “healthier” investments in healthcare companies, leisure and fitness firms and specialist food products. Forward-thinking food and beverage companies adapt, with healthier product offerings. While the risk to consumer companies of not adapting to these trends is accepted as a headwind by the market, we believe the risk is not fully understood.

As the trend towards healthier, more nutritious food is gaining momentum, what does it mean in terms of both risks and the potential opportunities?

Increasing pressure from policymakers

There has been a notable shift towards greater government regulation in the last 18 months. The key areas of focus for policymakers have been labelling and restrictions on marketing to children.

The US Food and Drug Administration (FDA) has proposed changes to the nutritional facts label for all food and beverage products. These will include a mandatory requirement to declare the percentage daily value for sugars, as well as disclosing the value of added sugars.

In addition, there are increasing restrictions on advertising, with some countries (such as Mexico and France) banning TV advertising of unhealthy products to children.

Sugar tax

A sugar tax was introduced in Mexico in 2014. So far, it has raised 18bn pesos (approximately £700m), although it is thought to have had only a temporary impact on consumption.

A tax on sugary drinks has also been passed in Berkley California. Some 33 other cities in the US have tried and failed to implement a sugar tax. There have been discussions of a sugar tax being introduced in other countries, including Ireland and France.

Litigation

Litigation is the biggest potential “black swan” for the sector. Our view is that companies with sales exposure to the US face the greatest risk of litigation, owing to a highly advanced litigation culture, and higher sugar content than in the same branded products sold elsewhere

Litigation already poses a risk. Cases have been brought against individual products and brands. There has not been a case that has reached a jury yet; all have been settled out of court for figures in the low millions. However, we believe if a case reaches a jury, it may increase the probability of large settlements.

Science

The publication of independent scientific evidence proving causation between sugar and metabolic syndrome is yet to materialise. However if and when it does, it will move litigation focus away from marketing and towards product liability, where the biggest settlements were made in Big Tobacco cases.

If this product liability is scientifically proven and can stand up in court, current false marketing claims will only be the tip of the iceberg. Not only are current product portfolios dominated by sugar, there is significant legacy risk for Big Food. Sugar content dating back to low-fat trends seen in the 1970s, when a rise in calorie-counting prompted Big Food to develop “low fat” products in which sugar was added to maintain product taste.

There are an increasing number of independent studies being conducted. The evidence proving sugar is the primary cause of metabolic syndrome is increasing.

Opportunities

Changing consumer trends also provide investment opportunities. Certain firms, who have already implemented nutritional profiling across their product portfolio and those who have heavily invested in R&D, are better placed to increase market share and become market leaders.

The opportunities are evident from the growth rates seen at “healthier” companies. For example, WhiteWave, the US-listed company producing healthier, plant-based food products is the fastest growing company in the US food and beverage sector over the past four years.

Hershey, the second fastest, may not seem aligned with this healthier product trend. However, we believe its growth is a result of its strategic move to diversify its reliance on confectionary with its acquisition of Krave.

The Hershey example is relevant for the broader sector. There are opportunities to create healthier product portfolios by acquiring smaller, private, health food companies.

To date, it does not appear that litigation risk and lower sales are material to the investment case, but we believe there is a high probability that this may change with a medium-term investment horizon.

Looking forward

In the next few years we believe there will be lower growth rates and pressure on profit margins, through increased research and development (R&D) spend across the sector. These effects have a high probability of occurring owing to consumer and public health awareness, and rising healthcare costs.

If the third catalyst materialises, there is an additional variable to factor in: the cost of litigation and further brand damage leading to possible write downs (or a reduction in the value of an asset).

Conclusion

The demand for processed food and fizzy drinks is not going to disappear overnight. However, consumer behaviour is changing and tastes are evolving, with a better understanding of the health implications of high sugar, carbohydrate-heavy diets.

Big Food has been slow to adapt, reliant on strong lobbying efforts. The similarities with Big Tobacco are now becoming clearer and the increasing pressure from consumers, public health bodies and governments are changing the way investors need to think about the sector. We believe future growth rates for the sector should reflect these headwinds.

Investors will need to consider both regional exposure and the product portfolio when assessing the potential financial impacts to stocks. Our research has highlighted that companies with significant exposure to developed markets and a weak nutritional product profile face the greatest risk in terms of lower growth rates and higher R&D requirements.

Elly Irving is an environmental, social and governance analyst at Schroders.

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