Overhill Farms' New Business Will Drive Growth

Singular Research is initiating coverage on Overhill Farms (OFI), citing that new business with current and new customers will drive revenue and earnings growth in 2009 and beyond. Key excerpts follow.

Investment Thesis

The food supply business provides attractive investment opportunities in both times of economic weakness and strength. When the economy is expanding, overall consumption and spending by consumers is strong, enabling companies to expand margins while also making expansion attractive. On the other hand, when economic growth is poor, value-oriented names in the food supply industry remain attractive due to the relatively inelastic demand for food on an aggregate basis.

Suppliers of premium products and national brands may also feel a pinch as consumers opt for cheaper substitutes. We feel Overhill Farms (OFI) offers an attractive way to play all aspects of the economic cycle due to its role as both a retail and food service supplier and its defensible position in the wholesale food supply industry. Other, larger suppliers such as H.J. Heinz (HNZ), despite being competitors, continue to work with OFI to fulfill their needs for smaller production runs that are not cost effective for their own production facilities. Private label products are no longer viewed as inferior goods as they were years ago, resulting in continued demand for products that OFI supplies to many grocery chains. Furthermore, with consumer budgets strained by rising prices, store brand items see increased consumption due to their inverse elasticity of demand.

When the economy regains its footing, OFI will also be well-positioned to benefit due to its relationships with customers such as Jenny Craig and Panda Restaurant Group, which should see growth in their businesses at that time. OFI's airline supply business, which is currently declining although profitable, is still a positive as it does not required differentiated manufacturing or otherwise. As a result, the business line contributes positively to overall utilization.

We feel OFI shares represent an attractive investment opportunity. Additional business which is contracted for FY:09 will lead to revenue growth, with private-brand product lines for the Better Living Brands Alliance such as O Organic and Eating Right offering potential upside as Safeway (SWY) works to expand distribution. When possible, OFI negotiates both the cost and sales side of its contracts concurrently, so that the cost of an input, such as chicken, for the life of a production run is known and priced into OFI's contract with its customer. This provides some, but not absolute, margin protection.

At the macro-economic level, several factors exist that represent positive drivers for OFI. The structure of the food supply industry is such that smaller suppliers play an important role in aiding new product introduction which larger suppliers are not as able to do on a cost-effective basis. A weak economy and strained household budgets also represent a positive driver as consumers are more apt to purchase store brands and frozen items, which are typically less costly. Lastly, OFI has proven to be a key partner for customers such as Jenny Craig and Panda Restaurant Group, with room for growth with each.

Risks

• OFI has 4 customers which each account for over 10% of revenues – Jenny Craig, HJ Heinz, Panda Restaurant Group, and Safeway.
• Food-borne contaminants such as salmonella could result in widespread product recalls and loss of business.
• Recent trends favoring locally-produced foods could present a long-term, secular change in food industry operations.

Comments

[doydoy:]

Overhill Farms OFI is an excellent small cap company with a great management.
They are very undervalued based on their growth and PE ratio of 13 in comparison with Tyson Food TSN PE ratio of 25.
Their risks of Salmonella are very low since they produce frozen food that requires high heat before consumption.
Also they just expanded their facility with modern efficient equipment. They also hedge their food cost to limit their profit from eroding in case of price increases. They are small and nimble they adjust to the customers needs quickly.
They are also introducing and organic line and a healthy food line with about 30 products.
I think they will be the target of an aquisition by a larger player.
I beleive Panda restaurants wanted to diversify their food suppliers about a year ago so they used a second supplier but that did not last, Panda came back to OFI and they give OFI more business now.
OFI is 15 to 18 a share stock.
It does not have enough analyts covering it, so it practically has minimum exposure.
I own the stock.

2008 Sep 17 02:40 PM