"Functional food" -- described as natural, organic or just plain healthy and "good for you" -- is fast coming into vogue. And Wall Street is taking notice.

An increasing number of food companies have come out with wholesome products enhanced with vitamins and other nutrients that supposedly deliver health wonders, such as reducing cholesterol levels or helping build strong bones -- without sacrificing taste. The profit margins from these food categories are high, analysts note.


A newcomer in the field that's dominated by some of the giant food companies is Smart Balance (SMBL), a relatively tiny but high-growth marketer of functional foods. Among the products with the Smart Balance brand are margarine, buttery spreads and butter-blend sticks; peanut butter; cooking oil, sprays and shortening; mayonnaise; popcorn; cheese and cream cheese; sour cream; and milk.

"Based on the tremendous success of its heart-healthy margarine spreads, Smart Balance has become one of the fastest-growing consumer food companies, with average yearly sales growth of 30%," notes Jon Anderson, analyst at investment firm William Blair, which owns shares. In these tough economic times, that's impressive.

High-Octane Milk

Compared to the giant food outfits, Smart Balance has a limited number of products, but one of its newest could become a blockbuster, say some investors: milk. Smart Balance just started to market milk nationally in December. But it's milk with a twist: It's a no-fat milk enhanced with vitamins E and D, high omega-3 content and loaded with up to 30% more calcium and protein than ordinary whole milk.

Yet it tastes just like your old-fashioned whole milk, says Robert S. Gluck, the company's vice chairman and chief operating officer. Among the four top makers of enhanced milk, Smart Balance has the biggest market share with 38%, followed by Simply Smart's 36%, Fairland Special Request's 22%, and Over the Moon's 4%. Smart Balance's milk sales in dollars jumped 47% in 2009 vs. Simply Smart's 19%, according to Gluck.

Smart Balance's milk "has the potential to grab solid share of the $12 billion U.S. milk category," says Mark Argento, analyst at Craig-Hallum Capital Group. He rates the a stock, now trading at $6 a share, a buy with a 12-month target of $10. He estimates Smart Balance will post $40 million to $50 million in gross milk sales for 2010, or about $25 million in net sales, plus about $7 million in sales for a new sour cream product. "The long-term story continues to play out, as the company builds a national 'healthy for you' brand in the dairy aisle," says Argento.

Aiming for $1 Billion in Annual Sales


In the third quarter, ended Sept. 30, Smart Balance's gross margin jumped to 49% from 43.5% a year ago. Operating earnings shot up 34%, to $3.5 million, on sales growth of 4%, to $59.8 million. For 2010, the company is aiming for net sales growth of 15%, based on increasing volume of new products and expansion of its national distribution of milk.

The company is certainly not at the top of the food chain in functional foods, but it surely aims to be. Its target is to increase total sales to $500 million in 2012, from an estimated $242 million in 2009. Its ultimate goal is to ramp up sales to $1 billion in several years, says Gluck.

Smart Balance is surely on an aggressive path. It "has risen to the No. 2 player in the margarine category and is becoming a leading brand in the broader functional foods arena through a robust product lineup beyond margarine spreads," says Scott Van Winkle, analyst at Canaccord Capital, who rates the stock a buy. The company, he says, should generate significant free cash flow given the limited capital requirements of its business model.

Analysts like the fact that Smart Balance doesn't have its own manufacturing facilities. It outsources everything needed to make its various products, so it has no astronomical manufacturing costs. Explains Gluck: "We own no productive assets, but our internal expertise is about managing that external supply chain and developing new products."

Wall Street Is Still Tentative

In another potential growth-booster, on Nov. 17 Smart Balance gained entry into Oprah Winfrey's world by signing an exclusive global licensing agreement with BestLife Healthy Lifestyle Program, which is owned by Robert Greene, widely known as Oprah's fitness trainer and nutrition expert. Often featured in Oprah's TV show and O Magazine, Greene's BestLife has its own "seal of approval" for food and beverage products. Gluck expects this partnership to further widen its market share.

To what extent do consumers care for functional food? Colin Guheen, vice president at investment firm Cowen, figures that some 34% of American consumers give top priority to healthy living. He's forecasting that such consumers will increase the share of natural and organic healthy-living products they purchase to 31% in 2020 from 17% in 2008.

Wall Street hasn't totally embraced Smart Balance yet, however. Of the 11 major analysts who track it, seven recommend buying the stock and four rate it a hold. At $6, the stock is down from its 52-week high of $8.73, hit on May 7, 2009. But some of the large institutional investors have accumulated major stakes in it, including Adage Capital Partners, which owns an 11% stake, Barclays Global Investors, which holds 5.2%, and BlackRock with 4.8%.

If their bets on functional food and Smart Balance work out, the shares could be a healthy long-term investment play.

Meet Gene Marcial at the World Money Show Orlando, Feb. 3-6, 2010, at The Gaylord Palms Resort

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