B&G Foods, Inc. (BGS) is a packaged foods company that is behind many well known brands that end up in your weekly shopping cart. The company pays a large dividend that yields an impressive 7.39% on the current stock price. With a dividend yield that is quite high for its sector, we reviewed the business to find if B&G Foods represents a great income opportunity, or a "yield trap" for investors. Due to a number of red flags that we outline below, we conclude that the dividend is not sustainable at current levels. We anticipate a dividend cut in the near future.
We certainly understand why B&G Foods' dividend may be grabbing the attention of investors. A company with a portfolio of well known brands and a high yielding dividend wouldn't alarm anyone at first. Food stocks are typically very stable businesses that produce steady streams of cash flow.
This rings true with B&G Foods, whose revenue and earnings have trended higher over the past 10 years with no real volatility in the business' performance.
The cracks within B&G Foods begin to show when you take a closer look at the company's management style over the years. Rather than grow organically, B&G Foods has utilized a growth through bolt-on acquisition strategy. For years, B&G Foods has purchased assets - a whopping 29 brands have been purchased over the past 10 years alone. The timeline of acquisitions can be seen here.
There are various companies that utilize acquisitions to drive growth, so this in itself isn't the issue the company faces. The issue, is that poor execution of an acquisition strategy can damage a business over time. B&G Foods has simply not been very good at executing.
Whether management has acquired the wrong assets, paid the wrong price to acquire these assets, or simply didn't integrate them properly (or a mixture of all three) - the addition of these brands has sent the company's performance into a prolonged downtrend. B&G Foods is simply not as profitable as margins and FCF conversion have both trended lower over the past decade.
The company has also generated a poor cash rate of return on invested capital. A company that is efficiently managing its resources will generate a solid CROCI (a percentage usually 13% or higher). Not only has the company's extended performance fallen short of this benchmark, it has also trended lower.
With inefficient performance, a company will struggle to organically fund repeated acquisitions. This will in turn create stress on a balance sheet as the company uses debt and other means to fund M&A.
We see how this has played out with B&G Foods, and the result is ugly. Management has stretched the balance sheet beyond a manageable figure at more than 8X EBITDA (we typically use just 2.5X as an indicator that a company is over leveraged). While the upcoming quarter will see leverage fall to around 5X as a result of proceeds from the sale of Pirate's Booty, it shows management's willingness to leverage up the company to risky levels. The company's $26 million cash position is out numbered by total debt of $2.07 billion (a ratio of almost 1:100).
Despite leaning so hard on the balance sheet, it still hasn't been enough to fund all of B&G Foods' acquisitions over the years. The company has had to repeatedly issue equity to raise funds, a strategy that simply dilutes shareholder value. The amount of outstanding shares has grown from 37 million to 66 million (almost doubling in 10 years).
If this strategy were feasible, you would at least see stabilized fundamentals over time. Instead, we see debt continuing to climb faster than earnings (causing leverage to increase). With more conservative management, maybe the company doesn't sell Pirate's Booty (a strong performing brand that the company had acquired just in 2013). The sale simply deducts a profit stream from the company. Management doesn't seem willing to reconsider its strategy, as it highlighted the potential for future acquisitions following the debt reduction from the divestiture. These actions will simply drive debt up again.
While management is running the company in this fashion, the dividend itself doesn't make sense. The payout consumes virtually all of the company's cash flow, and has exceeded a 100% payout ratio for much of the past two years.
The company responded by raising the dividend just a penny per quarter this past year (a 2.2% bump). This is a steep drop off from even its prior raise of 10.7% the year before. With the base business stagnant (3rd quarter sales for the core business were flat Y/Y), where is the financial relief going to come from? The payout ratio needs to drop to at least 80% for feasibility.
Management seems optimistic:
"We believe that we are unmatched in our ability to manage our portfolio of brands for cash, supporting our dividend, which is once again yielding nearly 7% to shareholders. And with a clean balance sheet, we are very well positioned to continue to pursue our finance-driven acquisition strategy. And as Bruce mentioned earlier on the call, we still have authorization to purchase an additional 31.5 million of common stock under our stock repurchase plan."
But the evidence just doesn't support this. The high leverage, high payout, and the last increase being a "token" raise just don't indicate strength. Ultimately, the market is also skeptical. The dividend's current yield of 7.39% is 65% higher than the stock's 10 year median dividend yield of 4.46%. A abnormally high dividend yield typically signals risk that the market sees in the company's ability to pay its dividend.
Ultimately the company needs a surge of growth, or a drastic turnaround in margins to organically raise cash flow enough to create breathing room around the dividend. We just don't see that coming for the business given its recent results.
When you piece everything together - management's poor execution of its acquisition strategy, the declining fundamentals, the stretched balance sheet, and the high payout - a dividend cut appears probable in the coming quarters.
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Author Disclaimer: Wealth Insights is an investor and investment author. His content is not geared to anyone's specific investment goals, time horizons, or risk tolerance. Content is for illustrative purposes only and is not intended to displace advice from a fee-based financial adviser. Accuracy of data is not guaranteed.
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.