Hillshire Brands (NYSE:HSH) could face an activist investor this year as it has failed miserably to become a growth story in an already stagnant sector.
The Illinois based deli meat producer, previously known as Sara Lee, attracted a buyout interest in 2011 from the largest Brazilian multinational food processor JBS (OTCQX:JBSAY) and private equity firms, prior to spinning off its tea and coffee unit into D.E. Master Blenders (OTC:DEMBF) in June 2012.
Sara Lee pitched that breakup as a growth strategy, but so far Hillshire has not met expectations. That makes the situation ripe for an activist investor to prod the company to focus on returning cash to shareholders and consider other strategic changes.
Activist Investor ?
Corvex Management recently pushed for Ralcorp Holdings to reach a deal with ConAgra Foods (NYSE:CAG) in November after the private label food company rebuffed ConAgra's previous approaches in 2011. Ralcorp spun off its cereals business in early 2012.
Elliott Management also wants the oil and gas company Hess (NYSE:HES) to be split into three parts to unlock shareholder value. The activist investor which took up a 4% stake in Hess this week, making it the company's largest independent investor, said in its letter to shareholders that it
"strongly advocates for Hess to conduct a full strategic and operational review to consider all pathways to maximize shareholder value."
It also said that the oil and gas companies' share price could surge to $126 per share if it were managed well. Shares rallied significantly this week on Elliot management move.
Activist investor Carl Icahn also recently increased his stake in Transocean (NYSE:RIG) to 5.6% and urged the company to declare a $4 per share dividend, saying he believes the company's shares are undervalued.
Similarly, an activist investor can force Hillshire to put itself for sale. The case for a sale of Hillshire is that the deli meat sector is a slow growth category, and consolidation in the packaged protein industry could help offset high costs and help raise capital to increase growth.
Where Is The Promised Growth ?
Though the newly independent management team may need more time to season in the market before actual results from the spin become clear, Hillshire's initial results are disappointing with no signs of any growth.
The company had told investors it expects to deliver 4.5% annual revenue growth by 2015 through innovation and increased support for its brands. Executives have since downplayed the near-term prospects for fiscal 2013.
CFO Henry said on the November earnings call:
We're encouraged by our performance in the first quarter, but we expect year-over-year performance for the rest of the fiscal year to be more challenging, particularly in the second half.
With its product profile of processed packaged meats, Hillshire has a higher margin than companies like Tyson Foods (NYSE:TSN), which offer commodity packaged meats. Hillshire reported a 10.5% adjusted operating margin for the fiscal quarter ending 29 September and is targeting a long-term margin of 10%. Tyson reported a 4% margin for its most recent quarter.
Consequently, to achieve a growth necessary to support the trading multiple of a regular food company, Hillshire spends a huge amount of cash generated from its boosted margins on marketing. That's what makes the company's growth artificial at best.
Rather than working on pricing and how to effectively price its products to assume inflation costs while maintaining volume growth, the new management seems to be more focused on its marketing agenda. Hillshire should improve top line sales growth by working on additional household penetration, rather than relying on high profit margins.
Hillshire could also attract a bid for the whole of the company as revenue has largely been flat since the spin. JBS could still be interested in pursuing Hillshire, though CEO Wesley Batista did tell Bloomberg News in November that he had not looked at Hillshire and was "not interested". The Brazilian company was previously unable to line up enough financing in order to make a formal offer for all of the Sara Lee. But post the D.E. Master Blenders spin-off, JBS' financing hurdles are now significantly reduced because Hillshire is much smaller, with a $3.7 billion market cap and $947m in debt. Other potential suitors for Hillshire include Hormel Foods (NYSE:HRL) and Tyson Foods.
With Standard & Poor's 500 on track to post its best January since 1997 as investors poured $55 billion in new cash into stock, mutual funds and ETFs, and the Dow flirting with 14,000, a level it has not seen since October 2007, Hillshire shares are basically flat for the year to date.
Flat. Just like its growth.
In my view, Hillshire is mismanaged, has fake growth, lacks focus, undervalued as a result of operational deficiencies and could be run more profitably.
Therefore, I believe it's a high time that an activist investor or an existing minority shareholder, should seek to influence decision making at the company by voicing concerns and engaging in a meaningful dialogue with the management. The demand could relate to changes in management, representation on the board, acquisitions or divestitures, salaries, bonus payments and improvement in the Hillshire's overall strategic approach.