There’s lots to like about Annie’s, even with a rich valuation. Highlights include:
- Q1 results were disappointing, but typically Q1 is its weakest quarter of the year; management reaffirmed its FY revenue growth guidance of 18-20% and adjusted diluted EPS range of $0.97 to $1.01
- We believe that BNNY’s premium valuation is justified by higher growth rates across organic offerings, of which Annie’s is a leader, especially as it increasingly moves its products to the mainstream aisle from the organic aisle
- BNNY is in a bullish breakout, with the stock price trading above our immediate term TRADE and intermediate term TREND levels (see chart directly below)
- The company remains ahead of health and wellness trends in its product offerings
- BNNY’s innovation is focused on taking everyday foods that people like to eat (ex. mac & cheese and cheddar snacks) and making healthier and better tasting products than its competitors; we think this strategy should be advantageous and sustain long-term growth versus traditional CPG innovation focused on new and “different” SKUs that may miss consumer interest
- The company caters to a higher income client who can afford or trade up to the premium pricing of organic, despite swings in the macroeconomic landscape
- It is poised to take a greater share across mac & cheese, crackers and fruit snacks; the introduction of frozen pizza early in the year and last month’s release of four new frozen meals offer excitement to the category. It is yet to be seen if BNNY can buck the trend of low profitability in the frozen section
Performance Outlook
Annie’s reported Q1 pro forma EPS of $0.13 on (8/8), one cent below Bloomberg consensus and revenues underperformed expectations (13.8% versus consensus 17.1%). Despite the softness in the top-line, management reiterated its FY guidance and we expect with its increased advertising spend slated for 2H (especially on pizza), a rebound in top-line in the coming quarters. Note too that Q1 is typically its lowest revenue quarter of the year.
We continue to state that despite the lofty valuation of Annie’s (P/E of 37.4x vs food peer group average of 18.0x), organic food companies are deserving of a premium over the group due to their outperforming growth profile. BNNY enjoyed revenue growth greater than 20% over the last three years and has grown revenues at an average rate of 17.5% over the last 5 years. These figures are simply not anywhere near the much lower rates of growth for its peers in the food category, most of whom have recorded average revenue growth south of 10% over the past five years.
For a company that is virtually debt free, investing in cap-ex to grow the business, and increasing its work force, while maintaining a leading position in organic foods as it expands to the mainstream aisle to meet consumer demand for organic, we think BNNY rightly deserves to trade at a premium multiple.
For reference, below we show how BNNY stacks up against its competitors in the food category. Admittedly we are comparing BNNY, a small cap, to large cap non-organic companies, yet this snapshot serves as a reference point.
While gross margins slipped -190 bps to 37.8% in Q1, and we expect Q2 to be down slightly less (~100-150bps) versus the year ago comp of 38.3%, we expect a slow rebound towards 40% in the back half of the year.
On the Annie’s Brand
What’s not to love about a company that has been able to get ahead of the biggest consumer trend of customers better understanding what they’re eating and how what they eat may affect their overall health?
Health and wellness is the industry’s buzzword and has been the focus of all consumer companies over the last 3-4 years. While some portfolios have been challenged to meet this trend (think: PEP, KO, CEE), BNNY is now enjoying the movement of its products from the natural and organic aisle to the mainstream (center of the store) aisle and the opportunity to take share from traditional branded players, especially those without organic offerings.
With 47% of its sales from Meals, 39% from Snacks, and 14% from Dressing, Contaminants, and Other, Annie’s sales growth has come from its strategy to take everyday products that consumers love to eat and improve the taste while using all natural and organic ingredients. We see this as a huge competitive advantage as its innovation is focused on improving what the consumer already likes, rather than innovation for the sake of creating something “new” that may fail with the customer. We think this innovation should equate to increased household penetration.
And the movement of its products to the mainstream aisle (Mac & Cheese was first to do so in 2011) has not only met consumer demand for organic but also benefitted retailers (offering in most cases a higher margin structure). Annie’s now enjoys number one share position in national organic products in mac & cheese, snack crackers, gram crackers and fruit snacks.
Annie’s has over 135 products in 26,500 stores in the U.S., with initial inroads into Canada, across all major retailers (mass and grocery) and natural and organic stores. Given its nationwide distribution, its focus is on adding SKUs to existing channels and driving products to the mainstream aisle.
We like Annie’s ability to maintain and grow its market share as it caters to a higher income customer (typically better educated and more health conscious) that has the discretionary dollars to pay up for the price premium of organic. Broader U.S. economic trends, with the unemployment rate at 7.6% and record highs in food stamps, suggest that lower income earners remain very price constrained since the economic downturn. Therefore, BNNY is in less competition with its branded rivals that cater to a lower income demographic. (Note: Annie’s products are sold on average at a 25-30% premium to more traditional brands across categories).
New Product Inroads
In January 2013 Annie’s launched frozen pizza in Whole Foods. In the same month it issued a voluntary recall of its frozen pizza after small metal fragments were identified in the pizza dough from a third-party flour mill it sourced. Despite the challenges of its launch, frozen pizza is making strides (with build-out in Target and natural retails in particular), and a strong repeat rate of 70% according to the company. The one great challenge for BNNY will remain the value perception within the frozen pizza case, but the company is optimistic that television advertising slated for 2H 2013 will help to drive sales.
The company also just launched four varieties of family sized frozen meals, intended for parents who need a quick dinner option, but still want a “healthy” meal. We acknowledge that BNNY may be competing for a different (higher income) consumer with its frozen meal offerings versus traditional frozen offerings, but we are well aware of how challenged frozen has been for the industry. We’ll have to wait and see how performance plays out.
Finally, the company is reporting strong results in snacks, in particular Cheddar Squares, launched two months ago, that target an older aged customer (versus the success of Cheddar Bunnies for kids).
Matthew Hedrick
Senior Analyst