B&G Foods (BGS) was on a roll. A string of snack food acquisitions over the past year had driven an increase in revenues and led to a series of dividend increases. The most recent dividend increase was announced on October 15th, and increased the quarterly dividend 3.1% from $0.32 to $0.33. Heading into earnings last Thursday, the shares hit an all-time intra-day high of $37.66, before closing at $37.15 - a record closing price. After the close, the announced results were much less appetizing than many of its food products.
On the surface, results looked quite good. Net sales increased 17.6%, and although reported earnings were down 9.2%, this was due to a pair of onetime charges. These charges were for a loss on extinguishment of debt and costs related to its recent acquisitions. The loss on the extinguishment of debt was tied to the company extending a tender offer and consent solicitation for its 7.625% notes due 2018 after it had raised new money with 4.625% notes due 2021.
Replacing old high interest debt with new debt with a longer maturity, while reducing the interest rate by 300 basis points, is certainly a positive. And, without these onetime charges, the company would have had earnings increase by $1.8 million from $16.9 million in Q2 2012 to $18.7 million in Q3 2013. So, why did the market send the shares lower by nearly 8% to $34.26 since Thursday?
Several factors. First, as I noted after the Q2 results were posted, acquisitions by the company are masking the negative organic growth of its non-snack products. On that conference call, CFO Bob Cantwell told investors:
Net sales for our base business decreased $1.8 million or 1.2%, of which $0.6 million was attributable to a net price decrease and $1.2 million was attributable to a unit volume decrease.
This quarter was similar, only worse, as Cantwelll reported:
Net sales for our base business decreased $6.1 million or 3.9%, of which $3.5 million was attributable to a net price decrease and $2.6 million was attributable to a unit volume decrease. Net sales decreased by $1.7 million for Ortega, $1.6 million for Mrs. Dash, $1.3 million for B&M and $1 million for Las Palmas. All other brands decreased $0.5 million in the aggregate.
While net prices can be affected by couponing or promotions in order for the company to defend market share, a decline in unit volumes is an ominous sign. B&G had been quite successful growing its business using a three step process. The company would use leverage to acquire orphan brands from larger food companies. Next, B&G would rejuvenate and grow those brands by introducing new flavors, new packaging, new distribution channels, etc. The EBITDA from the accretive acquisitions would then be used to reduce the leverage. This process had been working extremely well and led to the dividend increases.
The series of snack food acquisitions included at least two of the four that were also accretive in terms of EBITDA (no information was released about the other two - Rickland Orchards and True North). And, since beginning these acquisitions, the company has also announced three dividend increases. From that perspective, investors have benefited. However, the company has also had two recent share offerings, and that not only requires more cash to fund the dividends on those extra shares, but also dilutes EPS.
Dilution and EPS
The press release on earnings noted:
The Company's reported net income under U.S. generally accepted accounting principles (GAAP) was $15.4 million, or $0.29 per diluted share, for the third quarter of 2013, as compared to reported net income of $16.9 million, or $0.35 per diluted share, for the third quarter of 2012. The Company's adjusted net income for the third quarter of 2013, which excludes the impact of acquisition-related transaction costs and loss on extinguishment of debt, was $18.7 million, or $0.35 per adjusted diluted share.
Note that even after excluding the onetime charges, EPS was flat year over year as a result of dilution from an equity offering. CEO David Wenner also addressed this on the conference call:
Adjusted diluted earnings per share were flat at $0.35 per share. But I will remind everyone that at quarter end, we had over 9% more shares outstanding than at the end of the third quarter of last year due to our stock offering last October.
After the close of Q3, shareholders were further diluted as a result of the Rickland acquisition. That acquisition was made with a combination of cash and stock. In a recent article, I discussed this:
Once again, a snack foods acquisition resulted in the dilution of the current shareholders. The $20.1 million of stock at the recent price of about $35/share translates to an additional 575 thousand shares - or an increase of 1.1% to the 52.6 million shares previously outstanding.
It's not only about dilution and flat adjusted EPS that should be a cause for concern. At the start of the year, B&G issued guidance:
2013 will see us continue to execute the model. In that vein, we have issued adjusted EBITDA guidance of $178 million to $182 million reflecting the benefit of an additional 10 months of the New York Style and Old London brands and modest growth in our base business.
At the end of the first quarter, guidance was increased to "a range of approximately $180.0 million to $184.0 million." And, after the second quarter ended, and following the Pirates and True North acquisitions, guidance was again increased "to $187 million to $191 million for the full year." The recent Rickland acquisition at the start of Q4 is apparently not enough to overcome a weakening base business and warrant another increase in guidance. At the end of Wenner's prepared remarks last week, he concluded:
Moreover, our most recent transactions are consistent with the free cash flow metrics we expect from acquisitions. For those reasons, we have reaffirmed the increased guidance that we published last quarter, and our Board of Directors earlier this week increased our dividend by $0.01 per share per quarter, a reflection of the increased free cash flow expected from our latest activity.
While guidance was reaffirmed, it was not increased. Also, the dividend increase of just $0.01 was the smallest in the company's history. (The company did have a dividend cut in 2008.)
B&G Foods had been a key holding in a portion of my portfolio reserved for dividend stocks for a number of years. The growing dividend and attractive yield were key factors, as was the company's disciplined approach to making timely acquisitions. The recent increase in the share price - prior to the 8% drop in the past week - had made the dividend yield less attractive despite all the dividend increases since the end of 2010. As a result, I have reduced my position.
Even with the 8% drop in share price, the new dividend currently yields 3.7%. While attractive compared to other companies in the food sector, it may not be high enough to satisfy investors looking for yield.
The less attractive yield should not be the only issue for investors to consider. The weakness in the company's base business and its entry into snack foods represent new challenges for the company and increased risks for investors.
Wenner had been very successful sticking with a model that was based on acquiring orphan brands with flat to declining sales and turning them around. Has he lost his touch? Are declining base business sales and the fact that the company did not increase guidance following the Rickland acquisition canaries in the coal mine? Whether it was flat EPS, flat guidance or inflated expectations, the market has decided that B&G is a bit less attractive than it was a week ago.
Wenner has been one of the most forthright CEOs of the companies that I follow closely. Perhaps he will eventually be able to demonstrate that B&G can grow both its base business and its snack food business. Until then, I will continue to follow him, but will do so with a reduced holding in B&G stock.