I have been long B&G Foods (BGS) since 2007. During that time I have become a big fan of CEO David Wenner and the company's use of leverage to acquire brands that were accretive to earnings and allowed the return of capital to shareholders through attractive dividends. The acquisition of Culver Specialty Brands from Unilever (UL) late last year for $325 million followed that formula. As recently as September 6th at a Barclay's conference, Wenner said:
Its formula has worked very, very well over a good number of years now and so we really don't see any reason to change what we do in a lot of ways. It is work, it has generated the returns and it's been very, very successful.
However, over the past few months, a number of actions by the company indicate that there may be some changes taking place in the corporate strategy.
The company has historically used significant leverage - up to 5x - when making new acquisitions. Because the acquisitions were immediately accretive to earnings, profits could be used to quickly bring the debt back down to a 3x to 4x level. At that point B&G would be ready to borrow money for a new purchase. It's what I had expected to occur when B&G announced the acquisition of New York Style® and Old London® brands from Chipita America, Inc. in late September.
The acquisition was a departure from other recent acquisitions since it included a manufacturing facility (production of most of B&G's products is done with co-packers) and sells into a slightly different market segment from its other brands. In addition, instead of using debt to finance the transaction, the company issued new shares. In early October B&G announced:
...its intention to offer, subject to market and other conditions, 3,629,165 shares of our common stock, pursuant to an effective shelf registration statement previously filed with the Securities and the Exchange Commission. In connection with the offering, B&G Foods expects to grant the underwriters an option for a period of 30 days to purchase up to an additional 544,375 shares of common stock. ...
...B&G Foods expects to use the net proceeds of the offering for general corporate purposes, which may include among other things, the payment of all or a portion of the purchase price and related transaction costs for the recently announced acquisition of the New York Style and Old London brands or any future acquisitions, and the repayment or retirement of a portion of B&G Foods' long-term debt.
It is difficult to argue with the success of the offering. The underwriters took the over-allotment and the company realized $120.3 million after underwriting fees when the shares were priced at $30.25 (not far from the all time high of $32.84 reached in late September). Regardless, it represents a dilution to current shareholders and a change to the company's successful strategy. Raising cash also raised the question about whether there would be another acquisition by B&G.
In a November 12th interview on Bloomberg, Thilo Wrede, an analyst at Jefferies & Co. thought either B&G or ConAgra (CAG) might be interested in acquiring Skippy, a brand recently put up for sale by Unilever. Could that be a reason for B&G to raise cash? It seemed unlikely since it would be a rather large purchase for B&G and Skippy is not the type of neglected product that B&G typically acquires. Skippy is also in a fairly crowded space with other major brands including Jif from J M Smucker (SJM), Peter Pan from ConAgra and Planters from Kraft (KRFT), as well as private label and specialty brands. It would also seem unlikely that ConAgra would still be interested in Skippy at this time considering that they just announced a $6.8 billion acquisition of Ralcorp Holdings (RAH).
Then, earlier this week. and consistent with the press release about the stock offering, B&G made the following announcement:
[B&G] has issued a notice of partial redemption for $101.5 million principal amount of its outstanding 7.625% senior notes due 2018 at a cash redemption price of 107.625% of the principal amount of the notes being redeemed, plus accrued and unpaid interest on such amount, to, but excluding, the redemption date of December 28, 2012.
The company has apparently decided to use a large portion of the funds raised from the stock offering to pay off debt early, further reducing leverage. How bad is B&G's leverage? During the Q2 conference call, Chief Financial Officer Bob Cantwell stated:
We finished the second quarter of 2012 with $715.6 million in long-term debt. Our net leverage based on the midpoint of our full year EBITDA guidance is 4.1x.
It was remarkably similar to his statement on the Q3 conference call:
We finished the third quarter of 2012 with $713.4 million in long term debt. Our net leverage based on the midpoint of our 2012 EBITDA guidance is at 4.1 times.
Should investors be concerned that net leverage had not declined? Or, should they be concerned that a portion of the cash raised from the stock offering was used to retire debt rather than more acquisitions? B&G continues to use its increasing free cash flow to raise the quarterly dividend. On October 16th the dividend was increased 7.4% from $0.27 to $0.29, the fourth increase in the past two years. Should more of the cash be used for debt reduction and acquisitions rather than an increasing dividend?
As a shareholder, I like the increasing dividend, but I wonder why the net leverage has not declined. Was the stock offering an indication that B&G has become too aggressive with debt financed acquisitions and with returning capital to shareholders by increasing the dividend so often?
Although I will continue to hold B&G and enjoy the current 4% dividend yield, I remain concerned about the fact that the leverage has not declined. Next week B&G will be presenting at the Bank of America Merrill Lynch 2012 Leveraged Finance Conference. The conference certainly seems an appropriate forum to gain further insight into the company's leverage, and if Wenner and Cantwell don't adequately address the static net leverage issue, I will consider reducing my position.
Additional disclosure: I have written covered calls against some of my BGS holdings. I have no positions in any of the other companies mentioned in this article.