What Lies Ahead For Ralcorp Holdings?

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Ralcorp Holdings, Inc. (RAH) reminds us that you can't judge food by its cover. The company is the top US maker of private-label or "store-brand" ready-to-eat and hot breakfast cereals. Ralcorp has stocked its pantry with a widening variety of private-label cookies, crackers, peanut butter, ketchup, snack nuts, and candy. The company also makes a few branded products: Ralston Hot Cereal, Ry Krisp crackers, 3 Minute Brand Oats oatmeal, and Rippin' Good cookies. The company's Carriage House Company produces private-label dressings, syrups, jellies, and sauces. Its Lofthouse and Cascade Cookie Company businesses provide frozen cookies to in-store bakeries. And for something completely different, it owns 19% of Vail Resorts, the famous ski area.

Profits have increased every year since 1997 when the company reported 33 cents a share. They've gained steadily and were $2.58 a share last year, expected to be $3.10 this year. Revenues have been improving right along with the earnings, going from $1.3 billion in 2003 to a current level of $2.025 billion expected for 2007. Over the next 5 years, look for sales to increase by 10.5% a year, on average, and earnings to average 13% growth in the same time period.

Part of the earnings story is that RAH has been able to increase prices in cereals, cookies, crackers and jams. Further help comes from cost cutting, especially in the Carriage House division as well as lower commodity costs, particularly the cost of natural gas, diesel, logistics, and tree nut prices. While other commodities have increased such as corn and wheat, margins have continued to improve.

The company has been active buying others, namely Cottage Bakery, Parco Foods, Western Waffles, and Medallion Foods. These 4 newcomers are expected to contribute 35 cents a share to the bottom line in 2007. These help offset the slower growth in the cookie, cracker and snack nut categories. Its biggest competitor, Kraft's (KFT) Nabisco, as well as Kellogg (NYSE:K) have decided to keep prices steady, limiting RAH's ability to raise prices for cookies and crackers while its volume is eroding. General Mills (NYSE:GIS), the largest cereal maker, is cutting prices in its ready to eat cereals.

Ralcorp was incorporated in 1994 as a subsidiary of the Ralston Purina Group (NYSEARCA:RPG). The sub was spun off on March 31, 1994 with shareholders getting one share of the new company for each three RPG shares owned. The brand now has Ralston Foods (24% of 2006 sales) which produces private-label cereals; Bremner, makers of private-label crackers and cookies; Nutcracker, producers of private-label and value-brand snack nuts as well as Bakery Chef and Carriage House.

The stock took a nice jump (up 8%) on Wednesday, hitting an all time high. The reason: earnings beat estimates. Even though profit fell 22%, from 32 cents to 28 cents, when an extraordinary charge from its share of Vail Resorts was excluded, the operating eps was 70 cents a share, well ahead of the 53 cents predicted by analysts. The latest improvement came from those acquisitions mentioned above and price increases, the company said. One analyst enthused about the results and rated it as an "overweight" buy. Another analyst kept his "neutral" rating on the stock due to a concern that product price increases have hurt demand for the company's Ralston and Bremner cereals as well as higher ingredient costs having a bigger impact in the second half of the fiscal year.

RAH is in that category of a defensive stock. It makes some basic staples most people have in their cupboards. With the latest bump in price, all the good news may be baked into the stock. On the other hand, with the big surprise it gave this quarter, will there be more and bigger ones ahead?

RAH 1-yr chart

Disclosure: Author has no position in RAH.

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