Tariffs led to significant market decline and heightened recession fears, pushing investors toward defensive sectors like consumer staples. 

Lamb Weston (LW), top player in the frozen potato industry in North America, faced major setbacks in 2024 due to reduced restaurant traffic, rising food costs, and overcapacity issues. 

In response, activist investor Jana Partners, along with operational partners, has initiated a turnaround plan focused on cost-cutting and streamlining production. 

Strategic turnaround and cost-cutting measures position it to capitalize on rising domestic consumer demand for staple foods, thereby benefiting from the market’s shift toward resilient, tariff-favored companies.

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Yesterday, we spoke about an early tariff winner. Now there appears to be another group of companies that the market has supported since tariffs were levied.

When President Trump unveiled his extensive tariff plan last week, markets responded with immediate concern.

The S&P 500 fell by 4.8%, the Dow Jones Industrial Average dropped 4%, and the Nasdaq plummeted by 6% in a single trading day.

Investors moved quickly to shed stocks with international exposure as they feared potential damage to corporate profits across industries.

As recession fears grip the market, consumer staples are stepping into the spotlight as defensive plays, with Lamb Weston (LW) emerging as a particularly compelling opportunity.

Lamb Weston is a major player in the frozen potato business. For over 70 years, it’s been turning potatoes into french fries and other frozen products that restaurants and grocery stores sell worldwide.

With about 10,000 employees and 27 factories across the globe, the company is the top dog in North American frozen potatoes and the second largest globally.

Its business model is pretty straightforward. It buys potatoes from farmers, processes them in factories, and sells the finished products to restaurants and retailers.

French fries are the main product, but the company also makes specialty items like twisted potatoes, lattice cuts, and potato wedges.

Fast food restaurants are Lamb Weston’s biggest customers. It supplies major chains like McDonald’s (MCD) and Taco Bell with specially designed fries that meet each restaurant’s exact specifications.

Beyond fast food, the company sells to sit-down restaurants, food distributors, and grocery stores.

It also has a significant international business, which expanded by buying out its European joint venture partner.

The frozen potato industry is pretty concentrated, with Lamb Weston competing mainly against McCain Foods and European producers like Agristo and Clarebout.

It’s a mature industry but one that typically grows steadily alongside the restaurant business.

2024 was a tough year for Lamb Weston as it faced several major challenges.

Restaurant traffic slowed down as consumers cut back on eating out due to inflation, food costs went up, and the company had excess production capacity after expanding just as demand was weakening.

It also made a strategic misstep by dropping some lower-margin customers only to find that some of their targeted high-margin fast food clients reduced orders due to their own traffic declines.

All this led to a perfect storm. 

Lamb Weston had to write down potato inventory it couldn’t sell, its factories were running below capacity, which drove up per-unit costs, and the stock price dropped more than 27% while the broader market was up 25%.

In response, Jana Partners, an activist investor, stepped in, buying a 5% stake in the company and pushing for changes.

Jana actually has a history with Lamb Weston, they helped spin it off from Conagra Brands back in 2016.

Now, they’re working with Continental Grain to improve Lamb Weston’s operations and possibly position it as a takeover target.

The company has launched a restructuring plan that includes closing older factories, temporarily reducing production on certain lines, and cutting costs.

It’s aiming to save $55 million through these efforts while reducing capital spending by $100 million.

Mike Smith, who became CEO in January after working at the company since 2007, is leading this turnaround effort.

Recent financial results show some signs of improvement. 

Lamb Weston’s fourth-quarter earnings beat expectations, and the stock jumped nearly 10% on the news, the biggest gainer in the S&P 500 that day.

Net sales improved by 1% to $1.65 billion, and the company is projecting full-year sales between $6.35 billion and $6.45 billion for 2025.

Despite these turnaround efforts, the market expects Lamb Weston’s returns to remain in lower levels.

We can see what the market thinks through our Embedded Expectations Analysis (“EEA”) framework.

The EEA starts by looking at a company’s current stock price. From there, we can calculate what the market expects from the company’s future cash flows. We then compare that with our own cash-flow projections.

In short, it tells us how well a company has to perform in the future to be worth what the market is paying for it today.

At the current stock price, the market expects the company’s Uniform return on assets ”ROA” to decline to 12% instead of improving.

Despite challenges, Lamb Weston’s long-term fundamentals are solid. 

Its vertically integrated operations, which span potato sourcing, processing, and distribution, provide cost advantages and supply chain control.

The company also benefits from decades-long relationships with blue-chip clients, ensuring consistent demand.

The market seems worried about a potential recession, and that’s making consumer staples companies like Lamb Weston more attractive to investors.

People still need to eat during economic downturns, and fast food often does well as consumers trade down from more expensive dining options.

If management can stabilize margins and navigate near-term headwinds, the stock’s current valuation leaves room for a meaningful upside.

Best regards,

Joel Litman & Rob Spivey
Chief Investment Officer &
Director of Research
at Valens Research