Where does food come from? There are deeper reasons why investors should examine the sources and supply chain.
- Food safety issues a growing concern as more food is globally-sourced
- We consider many factors when evaluating food safety among food and agriculture companies
Profits at Denver, Colorado-based restaurant chain Chipotle plunged after an E. coli outbreak. Overall foodborne illnesses in the U.S. cost more than $15.6 billion each year, according to the United States Department of Agriculture (USDA). But just as, if not more, concerning than economics, a subsequent investigation into the Chipotle food issue by the Centers for Disease Control and Prevention (CDC) ended without 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 human lives at risk.
More than 200 diseases are spread through food, according to the World Health Organization (WHO). And one in six people get sick each year from eating contaminated food, the CDC reported. For all such reasons, food safety is one of the most important considerations, if not the most important consideration, when it comes to evaluating food and agriculture companies for environmental, social and governance (ESG) factors.
Global plate of rules
Food rarely comes from one place today, and the globalization of our food supply has contributed to the reason why it can be difficult to track the original source of contamination. Borrowing the neighbor’s sugar is a multi-country concept.
In the U.S. for example, about 15% of the country’s food supply is imported, including 80% of seafood, 50% of fresh fruits and 20% of fresh vegetables, according to the U.S. Department of Health and Human Services. In the UK, 30% of its consumed food in 2016 was imported from the European Union (EU), according to the most recent statistics from the UK Department for Environment, Food & Rural Affairs.
While the sharing of food across countries has its benefits, governments are increasingly aware of the safety risks it can pose. Many governments have created rules to ensure the safety of the food that is imported and exported.
The U.S. 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 cast a more watchful eye on their production and supply chain processes.
Although governments around the world are taking extra steps to boost food safety, regulation and inspection, each government operates according to its own laws. This can be a potential challenge as rising global populations and diminishing food supplies will require certain countries to import food in even larger volumes. For instance, the UK National Farmers’ Union reported in 2015 that more than half of the UK’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 not enough to protect the safety of the food people consume. In fact, U.S. government inspectors did not take action this year on one of every five serious food-safety risks that were found in manufacturing facilities, according to the U.S. Office of Inspector General at the Department of Health and Human Services. A Washington Post report noted that funding had decreased for the agency, which could have contributed to the issue.
However, the onus is not and should never have been on the government alone. Food companies are just as responsible for protecting the safety of their consumers. Food safety scandals are often bad for business. Chipotle is arguably still recovering from its E.Coli scare from more than 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.) Fines, penalties and lawsuits that arise from food contamination issues could be signals of what companies are doing to control or mitigate problems.
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 and prevent them.
Our take on food safety
When our firm thinks of food safety in regards to how it can affect companies, we usually consider most of the aforementioned issues. In summary, and in short, these include:
- Fines and the immediate impact of these costs on the company and share price, as evidenced in the Chipotle example. Another recent example is BRF SA, a Brazilian food processor that lost millions in revenue in 2017 as a result of a meat scandal.
- Reputational damage
- The inter-connectivity of global food supply and the difficulty of tracing contamination sources
- Development of food safety issues as people consume more 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, the Magistrates’ courts can impose fines and even prison sentences.
Food safety issues can pose 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
A few years ago, 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 had ordered recalls, and many consumers’ trust had declined. Danone was negatively impacted as a result.
In a separate story from a few years ago in the U.S., there was a widespread scare after the death of a baby. Infant formula company Mead Johnson was blamed. Immediately after the incident, the company released information on quality checks it 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’ve been a much worse situation. Because of the company’s speedy and apt response, it was not as negatively impacted as Danone had been.
Food safety procedures under the microscope
Food and agriculture companies can avoid potentially damaging business consequences with proper prevention and processes that minimize food safety issues, and control the spread of disease or fix the problem should one arise. We believe suitable steps for prevention include:
- Strong oversight of the supply chain. This includes standardized 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. There should also be transparency on global operations and the various degrees in which food safety issues can occur in different regions.
- Emergency procedures in place for dealing with food safety problems.
- Taking active steps to avoid a food safety scandal such as using sell-by dates on food packaging and modernizing 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 the company and consumer, and it will be the companies that take ownership of managing these risks that will stand out.
Companies mentioned for illustrative purposes only and should not be taken as a recommendation to buy or sell any security. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks may be enhanced in emerging markets countries.