Pinnacle Foods: Taking The Correct Measures To Address Challenges

| About: Pinnacle Foods (PF)

Summary

Company is taking the right measures to address the industry challenges and support its revenue growth.

Stock is trading at a forward P/E of 20x, versus its peers average P/E of 21x.

Shift towards premium-priced products will result in profit margin expansion.

The U.S. packaged food companies in the recent past have struggled to grow their revenues consistently due to shift in consumer preferences towards healthy food alternatives. Also, intense competition in the industry has weighed on companies performances. In the challenging industry environment, Pinnacle Foods (NYSE:PF) is taking the correct initiatives to support its long-term performance. The company has strong brands, and it is working to strengthen its product portfolio further by investing in product innovation. Also, the company is pursuing strategic acquisitions to align its product portfolio consistent with changing consumer preferences. Moreover, PF is undertaking cost reduction measures, which will fuel its near-term earnings growth and support its growth investments. As the company will continue to execute its growth initiatives, its stock valuations will expand, and the stock will trade at premium valuations to its peers; PF is trading at a forward P/E of 20x, versus its peers average forward P/E of 21x.

Financial Performance and Growth Catalysts

The company delivered healthy financial results for 2Q16, and the momentum is expected to continue in the upcoming quarters. PF posted EPS of $0.42, ahead of consensus estimate of $0.39. Also, the company management raised 2016 guidance by $0.02 to $2.10-$2.15. EPS for the quarter was positively affected by the Birds Eye brands solid performance and productivity gains. Moreover, revenues for the quarter grew by 19.4%, driven by the acquisition of Boulder Brands. An important takeaway from the recent quarter's results was the fact that the North American retail segment delivered strong results despite challenging market conditions, as the segment's sales increased by 2.3% and market share grew by 0.70% in declining categories.

The company is correctly focusing on innovation and strategic acquisitions to address the industry challenges, which will allow it to strengthen its product portfolio and market share. Also, as the company is focusing its product innovation initiatives by targeting premium priced products through improved packaging and adding premium ingredients, consistent with consumer demands, its profit margins will improve. Moreover, PF is rightly using strong cash flows generated by its foundation brands, which makes one-third of its sales, to support growth investments in high growth leadership brands. I believe the company's strategy to strengthen its product portfolio by innovation and strategic acquisitions is a correct strategy and will fuel its revenues growth in the upcoming years.

I think, the company will continue to make strategic acquisitions in the future to build scale and take advantage of low borrowing rates. And the company's merger and acquisition strategy will focus on growing its leading brands in frozen and stable shelf categories. The potential acquisition targets for PF include Ore-Ida frozen potatoes or ConAgra (NYSE:CAG)'s frozen meal brand, Healthy Choice, which will augur well for its frozen meal market share. PF has managed to increase Birds Eye Voila, a frozen meal brand, market share from 24% in 2012 to 40% in 2015. Moreover, the successful acquisition of Boulder Brands remains an important growth driver for PF. Boulder Brands will not only allow PF to grow its health and wellness platform and fuel revenue growth but also reduce costs through synergies. The acquisition will also position PF well in the gluten-free market, which is expected to double to $23 billion by 2018. The following chart shows the company's recent acquisitions.

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In addition to strengthening its product portfolio, the company is working to improve its cost structure, which will support its growth investments and margin expansion. PF is improving its cost structure by optimizing supply chain and reducing operational expenses. PF targets productivity savings of 3.5%-4% of the cost of goods sold (COGS) in 2016. If the company opts for more strategic acquisitions in the future, it will be able to improve its cost structure further through synergies, which will result in profit margin expansion.

Valuation and Summation

The company is taking the correct measures to address the industry challenges and support its revenue growth. Historically, the stock has traded at a 5%-10% premium to its peers. However, since the start of 2016, the stock is trading at a discount to its peers, mainly due to sales pressure; the stock is trading at a forward P/E of 20x, versus its peers average P/E of 21x. I think as the company is gradually shifting towards premium priced products, its profit margins will expand, which will result in the stock valuation expansion. Also, if the company opts for more strategic acquisitions, the stock will trade at premium valuations in contrast to its peers.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.