The Long Case for B&G Foods - A Stock/Bond Hybrid

Oct.12.06 | About: B&G Foods (BGF)

By Carla Pasternak

Imagine a security designed exclusively for the long-term income investor. On top of a close to double-digit yield, it would come from a safe industry -- say, foods -- that's pretty much immune to interest rate changes. You could count on its income stream, which is as reliable as, say, a CD. And yet, this ideal security would have the upside growth potential of a stock.

The security I have in mind is also on the fast track, as it is poised to deliver double-digit earnings growth over the next two years. I'm talking about snack food maker B&G Foods (BGF). This maker of pickles, seasoning, and salsa could add some spice to your portfolio.

No ordinary stock, BGF is a stock/bond hybrid wrapped in one. It's one of a handful of Income Deposit Securities designed to appeal to income investors, and its 9.5% yield is just one of its many attractive features. To get the full plate of goods on this security, please read on.

The maker of B&G pickles, Ortega tacos and sauces, and Grandma's Molasses, B&G Foods sells condiments and spices to grocery chains and food service outlets. Wal-Mart is its biggest customer and celebrity chef Emeril Lagasse's line of seasonings is its top-selling brand. The snack food maker has manufacturing plants across the U.S. from Maine to Wisconsin, and sells its products throughout North America.

Formed in 1996, BGF went public in October 2004. It was the second Income Deposit Security to hit the market, after only food caterer Centerplate (CVP). Laundry equipment provider Coinmach (DRY) and rural telecom Otelco (OTT) have since joined the list.

BGF has delivered dividends of 42.7 cents per security every quarter for the past year. That gives the shares an annual payout of $1.71 and a current yield of 9.0%.

As an Income Deposit Security [IDS], each security comprises one share of common stock, plus a bond with a 10-year term. In 2005, the cash payment comprised 81 cents in common share dividends and 90 cents in interest income from the bond.

Keep in mind that the dividend portion may rise and fall with the company's cash flow. Last year, most of BGF's dividend was treated as a return of capital, which is generally taxed at the 15% capital gains rate when you sell the shares.

The interest income part of the security's distribution is fixed at 12% of a bond. It's taxed as ordinary income, making the shares suitable for tax-advantaged accounts. As of right now, the company has no dividend reinvestment plan in place.

Growth Drivers
After a series of acquisitions, B&G has grown since its start in 1996 from about $100 million in sales to roughly $400 million today. It has made eight acquisitions in as many years, including the $30 million purchase this February of the Grandma's Molasses brand from Cadbury Schweppes.

Brand recognition is the name of the game in the food industry, and the company has leveraged the success of its top brands by developing a bevy of products under such popular labels as Emeril, Ortega, and Polaner. Since acquiring the Polaner line of preserves in 1999, B&G has transformed it into North America's leading brand of low calorie fruit preserves. It has captured nearly a 50% share of the sugar-free preserve market by targeting the rapidly growing diabetic population and appealing to widespread concerns about obesity and nutrition.

Like other food makers, B&G is facing rising food and packaging costs. In an effort to improve profit margins, the company has started shuttering low-margin production facilities. In July 2005, for instance, it closed its large Trappey's hot sauce plant in Louisiana.

To keep profit margins strong, B&G is also trying to implement price increases on its products. Its retail clients are facing competitive pressures of their own, so the price increases are a tough sell, according to CEO David Wenner. Despite these headwinds, the company was able to boost its per-share earnings by +32% -- and that's on just a +9% increase in sales -- over the last three years.

B&G has put together an extremely attractive portfolio of popular food brands that have been around for years and are well recognized by consumers. Acquiring new labels will continue to be an important part of management's growth strategy. However, even more important to the company's long-term success is its ability to adapt its products and packaging to ever-evolving consumer tastes.

Cost pressures are a headwind, but the steps the company is taking to raise prices and cut costs should continue to boost the bottom line. Over the next two years, per share earnings are forecast to climb about +17% to an estimated 62 cents per share in 2007.

With some 55% of the shares in the hands of large institutional shareholders, BGF's share price doesn't typically make huge moves up or down. Trading at a P/E of about 30 times this year's projected earnings, the shares are selling at somewhat of a premium to the overall market. Still, when you consider BGF's monster dividend yield, the shares deserve to trade at a premium.

As more investors learn about income deposit securities, I expect this security to increase its price by leaps and bounds.

Disclosure: Author has no position in BGF