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BUSINESS DESCRIPTION

J&J Snack Foods Corporation (NASDAQ:JJSF) sells a variety of branded and private label baked goods and food items. Soft pretzels made under the Super Pretzel and related brands are the company's flagship product and contributed 18% of the firm's revenues in 2012. Frozen juices are a declining (13% revenue) portion of the firm's business. Churros are an increasingly important part of the company's operations. Handheld "dough enrobed" product sales have almost tripled their sales (6%) over the last year largely due to the successful integration of Conagra Foods (NYSE:CAG) handheld food division. Baked goods including Mrs. Good Cookie and Country Home brands, in addition to private label brands, are JJ's largest single division with 32% of sales. JJ's frozen beverage sales (16%) are primarily derived from the sale of ICEE and Slush Puppy brand drinks via 87,000 machines that it also sells and maintains (7%). The company recently acquired organic pretzel maker Kim & Scotts gourmet pretzels for $7.9m and churro maker California Churro for $24 million. JJ's products are distributed via supermarkets, restaurants, and food service companies.

INVESTMENT THESIS:

Shifting product distribution mix. Increasingly the company is shifting its product mix toward higher margin churros, pretzels, and Icee sales. In addition, JJ recently to changed its sales mix to favor retail and restaurant distribution over the price sensitive food service channel which currently accounts for 62.7% of sales. The retail distribution outlet yields higher operating margins of 12.2% versus 10.4%. In addition, in its FQ2 conference call, management mentioned a more aggressive shift to restaurant sales which are currently only approximately $20m of the company's sales, but which management has stated it can double to quintuple over the next five years.

Pristine balance sheet leaves room for financial engineering. Management has recently undertaken changes to its balance sheet that should be accretive to shareholders. Currently JJ has $188m in cash and securities on its balance sheet. Management has indicated that it will seek additional income with this cash by investing in mutual funds with an average yield of 4%. In addition, the board authorized a 500k share repurchase. With a .9% dividend yield that only costs approximately $12.6m a year in cash, estimated capital spending of only $30m in 2013, a cost of repurchase of $37m at current price levels, the company will only utilize $79.6m in cash versus an estimated $55 in free cash flow in 2013.

High probability of acquisitions. JJ's management has consistently proven that it has the ability to acquire small firms, integrate them into its distribution network, and then rapidly scale them. After Hostess' bankruptcy, JJ was one of the companies mentioned as a prospective bidder. However, the company is highly methodical about its acquisitions and will only acquire firms that fit its distribution channels and that are complementary to existing goods, thereby driving synergies. Given the company's cash balance and several instances where management has indicated it wants to pursue a substantial acquisition, it should only be a matter of time before a new acquisition is announced.

International avenues for growth. At present, the company primarily operates in the U.S. with only 2.3% of sales and 2.5% of its assets located outside the U.S., primarily in Mexico and Canada. However, international sales have been growing at an annual growth rate of over 10.8% a year (2012). The company already has dedicated sales teams and distribution centers in Canada that it can utilize to further expand its negligible footprint. Churro sales in particular could benefit from international expansion as these markets already accounted for 1/3 of JJ's total churro sales in 2012.

Valuation

The company is extremely undervalued on a DCF basis and fairly valued on a comparable basis. I used an equity risk premium of 10%, a terminal growth rate of 2%, and a WACC of 6.9%. I held 2013 income at consensus earnings of $3.41 a share, increased revenues in 2014-18 by 7% a year (which is half of the firm's 14% compound annual growth rate over the last 5 years), decreased COGS by .5% to 68.5% of sales in 2014-2015 and 67% in 2016-2018, and increased SG&A by 6% a year to reflect some SG&A leverage from greater scale. I then added back the company's $188m in cash. The resulting DCF produces a $104.68 price estimate.

On a comparable basis the company is in-line with its peers on virtually every metric. The firm's closest comp Snyder's-Lance, Inc. (NASDAQ:LNCE) has approximately half the net margins but significantly higher income growth. Conversely, the firm's largest comp Kellogg (NYSE:K) has substantially more debt as a percentage of capitalization, a comparable growth rate and margins, but a lower valuation. Therefore although the company is smaller and faster growing than the majority of its peers, I believe that the company is fairly valued on a conservative interpretation of comparables. Taking an average of the company's value on a comparable basis which is approximately the current stock price of $75.91 and the DCF value of $104.68, results in a target price of $90.29.

Comps

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INVESTMENT RISKS:

JJ's customer base is highly concentrated with its top 10 customers accounting for 43% of 2012 sales and one customer account for 8% of sales. A loss or reduction in SKU allocations from a major customer could significantly diminish the firm's revenues. Increases in the price of commodities, namely fuel and flour, can have an extremely negative impact on the company's profitability. Although the company engages in some hedging activity, a prolonged rise in prices coupled with a weak retail pricing environment could result in lower earnings. The company's founder and CEO is 70 years old. The remainder of the management team also has significant experience, but the founder's death could materially impact the firm's operations.

RECOMMENDATION & PRICE TARGET: Buy as the firm is undervalued on a DCF basis. Blended Price Target: $90.59, Current Price: $75.91, Potential Upside: 18.90%

Source: J&J Snack Foods: Boring Company, Great Value