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4 food and dairy companies for investors to consider

It seems that the winner of the Warnambool Cheese and Butter Factory Co. (ASX: WCB) takeover tug-of-war will be Canadian company Saputo, with Bega Cheese Ltd (ASX: BGA) and Murray Goulburn dropping out of any further bidding. Warnambool shares went from $4.50 to almost $9.50 in a little over four months and the price-earnings has been driven up to a whopping 69.7.

This result stresses the value and importance that companies place on sources of good, high-quality dairy and food products. This is more true in overseas markets like China, where dairy products are in very high demand. This will only grow more and extend to other products as countries like China urbanise more and a new middle class expands.

There is a possibility that other food and beverage companies could become attractive for takeovers or at least for increases in shareholding control. It’s best to investigate which companies in the industry are strong stocks, so you enjoy the gains from a quality company with the possibility of a buyout if it ever comes.

The first to consider is Bega Cheese itself. Since January 2013, its share price has gone from about $2 to $4.80, so it has had its own impressive run up. Its brand is well known, and even I buy its cheese, so one tick for stock research.

NPAT rose from $20.4 million to $25.4 million in 2013. It has manageable gearing and long-term debt is less than five times NPAT. It’s planning to sell its 18.8% stake in Warnambool in the offer from Saputo, which may be worth up to $110 million, about the same as all of its long-term debt. It will receive a great premium for its stake.

Freedom Foods Group Ltd (ASX: FNP) is a maker of cereals, organic foods, and dairy milk products. It is also the largest shareholder in the A2 Corporation, based in New Zealand, which markets dairy products and infant formula in Australia, the UK and China.

Recently, revenue has been growing, but NPAT has not been so quick to increase. Nevertheless, the share price has shot up from $0.80 in January 2013 to its current $2.68, hitting a high of about $3.50 along the way. A very high price-earnings shows you how a market can be driven upwards by sentiment, so it is best to watch that story from the sidelines.

Meat and live export companies like Australian Agricultural Company Ltd (ASX: AAC) could attract attention of overseas companies and could benefit from an increase in demand for beef from Asian countries where the main meat supply may be pork.

It has seen losses in four of the past five years, and gross gearing is around 71%, so shares haven’t been strong like the dairy companies, but with renewed interest in agricultural products that could change if earnings turn around. That’s hard to plan for, so best to wait and see what the company can pull off.

Foolish takeaway

If a takeover is announced and it looks attractive then a ‘special workout’ may be alright to attempt. However, buying a stock because it might attract M&A activity is not the best strategy if the company itself is on shaky ground or showing bad performance.

You shouldn’t alter your investment rules too much. It can lead to less than optimal decision making that could turn an investment into a gambling bet. Rule number one is “don’t lose money”, and rule number 2 is “don’t forget rule number one.”

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Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned.