Where does the food on your plate come from? It’s a question that many of us don’t ask. Aside from the health aspects, there are good reasons why we as investors should examine the supply chains associated with food production.
In 2016, profits at Chipotle Mexican Grill, an S&P 500 company based in Denver, Colorado plunged a startling 95%. This followed an outbreak of E. coli bacteria in the company’s restaurants that left almost 500 people with food poisoning.
Unfortunately, the Chipotle incident was not an isolated one. Overall, foodborne illnesses in the US cost more than $15.6 billion each year, according to the United States Department of Agriculture (USDA). Worryingly, a subsequent investigation into the Chipotle food issue by the Centers for Disease Control and Prevention (CDC) ended without its being able to pinpoint the exact ingredients that led to the outbreak. The CDC cited difficulty in determining the source when a restaurant serves or cooks multiple ingredients together. Lacking the ability to trace and contain the spread of foodborne diseases can put lives at risk.
More than 200 diseases are spread through food, according to the World Health Organisation (WHO). And the CDC reports that one in six people get sick each year from eating contaminated food. As a result, food safety is perhaps the most important consideration when evaluating food and agriculture companies within an environmental, social and governance (ESG) framework.
Global plate of rules
Food rarely comes from one place today, and the globalisation of our food supply means it can be difficult to track the original source of contamination. About 15% of US food is imported, including 80% of seafood, 50% of fresh fruits and 20% of fresh vegetables, according to the US Department of Health and Human Services. In the UK, 30% of food consumed in 2016 was imported from the European Union (EU), according to the UK Department for Environment, Food & Rural Affairs.
While the trading of food across countries has obvious benefits, governments are increasingly aware of the safety risks it can pose. Many governments have created rules to ensure the safety of food that is imported and exported.
Ten years ago, the US Food and Drug Administration (FDA) expanded its overseas presence by opening offices in China and India to facilitate access for FDA inspections and engagement with foreign industries and agencies. Vietnam introduced 54 regulations in 2011 through its Food Safety Law, forcing food companies to sharpen up their production and supply chain processes.
Although governments are taking extra steps to boost food safety, regulation and inspection, each operates according to its own laws. This can be a challenge as rising global populations and diminishing food supplies will require some countries to import food in even larger volumes. For instance, the UK National Farmers’ Union reported in 2015 that more than half of the nation’s food will need to come from overseas within a generation.
But government regulations alone are not enough to protect the safety of the food people consume.
The responsibility of food companies
But government regulations alone are insufficient to guarantee food safety. In fact, US government inspectors did not take action this year in 20% of serious food-safety risks found in manufacturing facilities, according to the US Office of Inspector General at the Department of Health and Human Services. A Washington Post report noted that funding for the agency had decreased.
However, the onus should not be on the government alone. Food companies are responsible for protecting the safety of their consumers. Furthermore, food safety scandals are bad for business. Chipotle is arguably still recovering from its E.coli scare from over a year ago. On October 13, 2015, sometime before the outbreak, Chipotle’s stock traded at about $757 per share. As of December 18, 2017, Chipotle’s stock closed closer to $312(see chart below).
Chipotle Mexican Grill’s (CMG) historical stock price at close during October 13, 2015 to December 18, 2017
Source: Yahoo Finance/Chart IQ
Food safety issues do occur, but it’s up to the companies themselves to ensure that proper governance structures are in place to deal with them effectively, and ideally prevent them altogether.
Our take on food safety
When we think of food safety and how it can affect companies, we consider the following issues:
- Fines and the immediate impact of on the company and its share price, as evidenced in the Chipotle example;
- reputational damage;
- the inter-connectivity of global food supply and the difficulty of tracing contamination sources;
- food safety issues arising from the increase in consumption of processed foods;
- potential for food safety issues that grow out of poor business practices, bribery or corruption;
- possible fines, penalties and lawsuits. In the UK, for example, the magistrates’ courts can impose fines and even prison sentences on sellers of unsafe food.
Food safety issues can have significant negative consequences on food and agriculture companies. By properly evaluating companies and incorporating ESG factors into the analysis, any gaps in a company’s process can be exposed before issues occur.
Case study: A tale of two food companies
In 2013, Danone had to recall its Dumex infant nutrition formula products in China because of a series of suspected food quality issues with the supplier, Fonterra. Although the quality issue turned out to be a false alarm, the reputational damage had already been done. Danone ordered recalls, but trust among consumers had declined.
A similar case in the US illustrated a contrasting approach. Infant formula company, Mead Johnson was blamed after the death of a baby. Immediately after the incident, the company released information on quality checks it had conducted and was quick to release the results of retests that showed the company was not at fault. Strong corporate communications, an emergency hub and proper public dissemination of information helped Mead Johnson maintain its reputation in what could have been a much worse situation. Because of the company’s speedy and effective response, it was not as severely affected as Danone.
Food safety procedures under the microscope
Food and agriculture companies can avoid potentially damaging business consequences with comprehensive processes that minimise food safety issues and control the spread of disease. We believe suitable steps for prevention include:
- Strong oversight of the supply chain. This includes standardised supplier policies, third-party assessments of suppliers, oversight at the board level and board remuneration aligned to performance targets;
- An aim to abide by the highest standards globally;.
- Full transparency on all food safety issues, fines and mitigation techniques;
- Emergency procedures in place for dealing with food safety problems; for example, taking active steps to avoid a food safety scandal such as using sell-by dates on food packaging and modernising operational processes by making sure they are as up-to-date as possible.
These are only some of the details investors should consider when evaluating a food company for ESG factors. There are many nuances to consider when it comes to the food industry. Food safety can have potentially detrimental effects on both the company and consumer. Those companies that take responsibility for managing these risks will stand out.