- The acquisition of Canada Bread by Grupo Bimbo makes Flowers Foods the next likely target in the fresh baked goods category.
- Even without a buyout, Flowers Foods is attractive after growing sales 23.1% and earnings 31.9% in 2013 compared to 2012.
- Expansion into California and the western part of the U.S. will boost the top- and bottom-lines going forward.
- Recent insider buying and a P/E multiple similar to Canada Bread suggests a target price of $25.88, or upside of 25%.
With the news that Grupo Bimbo is acquiring Canada Bread, I think Flowers Foods (FLO) could be the next company to get acquired in the space. Shareholders of Canada Bread are receiving a 31% premium prior to Canada Bread's announcement last October that it was exploring a sale. Shares of Flowers Foods are starting to bid up since the deal was announced and rightly so. Any deal for Flowers Foods would be for north of $25.
After the acquisition, Flowers Foods remains the second-largest manufacturer of fresh baked goods in the U.S. I like the fact that Flowers Foods did not try and make an offer for Canada Bread itself. Flowers Foods already has $923 million in debt and the company's balance sheet could not support a $1.83 billion acquisition.
Q4 and full year results
For the full year, Flowers Foods recorded record sales and earnings. Volume increased 6.3% in Q4 and 16.8% for the year. Sales increased 12.6% in Q4 and 23.1% for the full year. The company reintroduced Hostess bread brands Wonder, HomePride, Merita and Butternut, which contributed $22.8 million in sales in the quarter.
Fiscal 2013 was a banner year for Flowers Foods in several ways. Sales were the highest-ever for the company and rose to $3.751 billion, or 23.1% higher than fiscal 2012. EPS for the full year was $0.91, an increase of 31.9%. EBITDA margin for the full year was 11.2% and the company generated $270.5 million in cash flow from operations.
In terms of its core brands, the Nature's Own brand reached $1.1 billion in retail sales. This marked a gain of 17.2% over 2012. The Tastykake brand recorded sales growth of 46.2% for the year and reached $425 million in retail sales.
Investing in its core business
I liked the moves the company made last year to its core business. Flowers Foods was active in continuing to increase its footprint in the baked goods market. The company now owns the rights to Sara Lee brand breads, rolls, and buns in California. The brands Wonder, HomePride, Merita, Butternut were added from Hostess and the company also added the brand Nature's Pride. In terms of capex, Flowers Foods bought 20 closed bakeries, one operating bakery and 36 depots to meet increased demand.
The growth opportunity
The company's fresh baked goods now reach 79% of the U.S. population, and I see that number increasing as the company continues to ramp up production in its recently acquired bakeries and expand into additional markets. The Sara Lee and Hostess assets have tremendous brand recognition and I see those assets helping to drive sales and earnings growth. The newly acquired bakeries and depots give Flowers Foods the production capacity and distribution to achieve these sales gains. I like what management did in that they complemented the additional brands with additional capacity.
As you can see from this map, there is still plenty of room for Flowers Foods to capture market share in both its existing markets and expanding into new markets. The company lacks a presence in the northern part of the U.S.
Source: Company presentation
As a result, I see the company earning $1.05 a share this year and $1.25 next year. Sales should rise $300 million this year and the following year. I see the company posting sales of $4.05 billion this year and $4.35 billion next year. These estimates are actually conservative, as the company continues to expand westward, particularly in California where many consumers are still not aware of the company's brands.
Flowers Foods will also benefit in this expansion in capturing the business of east coast transplants. For instance, its Tastykake remains an east coast brand that was previously not available in many west coast markets. I see the company's core brands as valuable assets with plenty of sales gains ahead as new markets are penetrated.
Market share growth set to continue
Since the middle of 2012, Flowers Foods has grown its market share from 10% to 14% today. During this time, sales grew over $700 million, or 23%. The driver behind this is the company continues to exceed its own internal goals. The original goal was for the company's products to be available in 75% of the U.S.
The company exceeded this goal by three years and is now in 79% of the U.S. In the last year alone, 20 million people now have access to the company's products that previously did not. I see the company's market share rising from 14% as more customers become aware that the company's products are now available in their markets.
The best example of this is in the California market. At the end of 2012, the company had only a 2% market share in California. Today, it has 12% of the market. Flowers Foods will also see margin enhancement in this market after two bakeries came online to serve the California market. One in Henderson, Nevada and the other in Modesto, California. This will allow the company to exit supply agreements with outside bakeries.
Bringing plants online will boost margins
With all the expansion activity last year, Flowers Foods is still working to integrate all of its operations. The Hostess assets are still being integrated and the company will have $27 million of carrying costs related to the facilities that are not yet operational. The company is also having to work and integrate all of its facilities onto its SAP platform. This resulted in a charge of $5.5 million to Q4 earnings. This caused the gross margin to drop to 46.9% from 47.9% in Q4 of last year.
Strong cash flow makes the debt manageable
For the full year, Flowers Foods generated $270.5 million in cash flow. While the company does have over $923 million in debt, it's leverage ratio is still only 2.3 times EBITDA. The company has been a buyer of its shares and spent $5 million to repurchase 231k shares in Q4. I much prefer the company focus on debt reduction rather than share buybacks. However, the company does still have 9 million shares remaining on its current program. The company also pays a 2.2% dividend yield, which is only a 37% payout of earnings.
I'm also encouraged by the fact that over 70% of its debt isn't due until 2017 and thereafter. What's more is that the largest part of its debt profile is a $400 million note that doesn't mature until 2022, and its coupon is only 4.375%.
Flowers Foods as a takeover target
Worth noting is that in 2000, the U.S. fresh-baked goods market had eight key players. Today, there are only three. Grupo Bimbo is the largest player, followed by Flowers Foods and then Pepperidge Farm.
If we use the acquisition of Canada Bread as a guide, we see that Grupo Bimbo is purchasing Canada Bread at 24.3x this year's earnings and 20.7x next year's earnings. Flowers Foods is currently trading at 18.8x this year's earnings and 17.4x next year's earnings.
Using my estimates for the company to earn $1.25 a share next year, and assigning a 20.7 multiple, we get a share price of $25.88. That would be a fair price for shareholders and represents 25% upside from current prices.
Worth noting is that this month two insiders purchased $221k in stock. This marked the first direct insider purchases in Flowers Foods in more than six months.
I see Flowers Foods as a takeover candidate with minimal downside risk. Even if the company does not get bought out, it is growing market share, and its top- and bottom-lines. While the company's strong hold is in the southern part of the U.S., its westward expansion represents a tremendous growth opportunity. The company has the brands and the capacity to meet market demand in over three fourths of the U.S. Either way, Flowers Foods is a compelling opportunity in today's market.