The ICR conference is not a big conference for the consumer staples space, but we find it useful to see what these smaller companies are saying and how it can affect others in the industry. Big topics of conversation during the presentations yesterday were inflation/deflation, implications of tax reform and border tax adjustment, continued challenges in the center aisles and the pervasive labor inflation impact.
Freshpet (FRPT)
FRPT for those who are not familiar, is a fresh refrigerated pet food manufacturer with sales of roughly $133 million in 2016, growing at a 28% CAGR since 2013. The key focus of their presentation was to express the abundant growth opportunities they have through increased household and retailer penetration. Their big differentiator is a Freshpet fridge which they install into retailer aisles to store their goods.
FRPT is focused on further penetrating existing customers as some of the top retailers only have them in half of their stores. They occasionally run into trouble with retailers that have smaller pet aisles because convincing them to allow FRPT to steal shelf space and install a fridge is not always an easy sell.
They just went through a big capex spending period and are now capable of producing $400 million in revenue at their new facility. Management plans to spend all margin improvement on additional marketing spend in order to grow awareness of the brand.
Notably, towards the end of the call, management stated that the pet specialty business has continued to struggle. In our opinion this will continue to negatively affect other pet food brands such as Blue Buffalo (BUFF).
United Natural Foods (UNFI)
UNFI is a natural and organic food distributor, servicing major retailers throughout the United States with roughly $9.4 billion in sales. UNFI has a strategy of acquiring good regional businesses and then expanding them methodically throughout the country as they build out existing customer relationships and work to obtain more.
One of the biggest threats to UNFI’s business is captive distribution, where companies bring the distribution in-house and do it themselves. This is where UNFI’s margins can get squeezed further as their customers don’t see all the value in working with a distributor. The threat we think about is as smaller companies such as Boulder Brands or WhiteWave get acquired and get folded into larger corporations there is risk that UNFI loses that business.
The reflation trade is one of our major macro themes for 2017 in the staples space, and getting a read from every company is critical. UNFI currently has guidance for the full year of deflation of 25bps to inflation of 75bps, after finishing last quarter with 13bps of deflation (first time in their records they had a deflationary quarter). Breaking down the deflation, a majority of their business was actually inflationary but was dragged down by 7% deflation across their produce business in Q1.
Nearly all companies were asked a question about the impending tax reform with the new administration. Mike Zechmeister thinks the possibility of the government denying deductibility of COGS on imported goods seems less likely, because it is rather severe, and the denial “defaults it to an impact of your corporate tax rate, which seems rather punitive.” Additionally on the tariff, UNFI imports just about 2% of their portfolio so there are no major implications for them on that front.
B&G Foods (BGS)
BGS is an acquisition driven company that has grown from $600 million in 2012 to $1.6 billion in 2017 as a result of this. BGS has made two major acquisitions over the last 2 years, the first being Green Giant (GG) which they bought from GIS for $765 million in November 2015 and then more recently a spice business called ACH Foods for $365 million in November 2016. GG added a new frozen platform with new capabilities to BGS and will allow them to tack future acquisitions onto the business.
GG had many challenges when they acquired it as it was being managed for cash flow and not very much top line growth at GIS. BGS thinks they have the right innovation and consumer plan in order to turn it around in 2017. And although it is not the strongest category, we tend to believe putting some capital behind this brand that hasn’t seen much in a while could pay dividends for the company.
GIS not only dropped some deadweight on BGS by selling them GG, but they are also putting a brand like Ortega under pressure with their Old El Paso (OEP) line of products. GIS has the benefit of producing many of their OEP shells in Mexico which allows them to charge the consumer much less.
When asked about tax implications, Bob Cantwell, BGS CEO stated, “we don’t pay much in cash taxes because we buy assets and we get the benefit of those asset purchases for tax purposes. So corporate tax rate coming down doesn’t affect us in a big way.” Bob went on to say, “I find it hard to believe – but who knows – that there’s going to be taxes on vegetables coming out of south of the border…the U.S. doesn’t have the ability to make enough of that product to support its population over the course of 12 months.”
Hostess Brands (TWNK)
This company may have been the highlight of our day in the staples space. Dean Metropoulos, Executive Chairman of Hostess, pulled the company out of Chapter 7 in order to resurrect the iconic American brand. The biggest change in the company under new management is their adoption of a warehouse distribution model versus their previous DSD model. This is a big differentiator versus their big competitors Bimbo and Flowers Foods (FLO), as TWNK does not own its own trucks or have to deal with labor issues associated with a DSD model.
The primary reason that TWNK was able to make the switch is due to their shelf life of 65 days, which far exceeds the shelf life of bread which is under 10, FLO is stuck in the DSD model because they are anchored in bread. As you can see in the below chart Hostess products are a big driver of category growth and have already returned to a 16% market share, they were 22% before exiting the marketplace.
(Source: Company Filings)
With a 65 day shelf life, Hostess’ products are not the healthiest, but they aren’t trying to be. However, they do recognize changing consumer preferences and are focusing in 2017 on removing unwanted ingredients such as trans fats and artificial colors and flavors.
When asked about corporate tax reform management stated that interest deductibility is a risk to them, while they would obviously welcome a lower corporate tax rate. And in regard to the border tax, all of their products are made in the US, so no risk there for them.
Listening to this presentation we couldn’t help but think what a resurging Hostess will do to FLO’s TastyKake brand. We believe that Hostess will continue to steal share and TastyKake will be meaningfully impacted in the process. Although it seems that FLO may be able to get out from under the pile of lawsuits regarding misclassification of their distributors, their business is still set to struggle which will pose a threat to financial performance.
The Chef’s Warehouse (CHEF)
CHEF distributes specialty foods to top restaurants, with a focus on the independents. Major items affecting this business as we see it are potential struggles for independent restaurant operators with the impending hike in minimum wage across different states and the increased competition from bigger players such as US Foods (USFD) and Sysco (SYY) as they work to break further in with the independents.
CHEF is working with their customers in order to take labor hours out of the kitchen, providing sous-vide meat, more frozen items and items that are closer to final state. What we found shocking was that they stated they have yet to see material impact to their business from competitive activity.
USFD is the second largest broadline food service distributor and undoubtedly has CHEF restaurants in its crosshairs as they continue to grow their business. For example CHEF is just now working on an ecommerce platform implementation, while USFD is already up to a 50% penetration rate with independents. We lean negative on CHEF but have to dig deeper before making an official call, M&A may be a point of contention on this one.
Inventure Foods (SNAK)
This is a small company and a likely takeout candidate as the company is currently going through a strategic review with the help of Rothchild given the exorbitant amount of debt on their balance sheet. SNAK has a brand called Boulder Canyon, which is a chip brand with a big focus on Kettle, which they have been growing rapidly. SNAK just recently put four new kettle lines into their Indiana plant in order for them to more efficiently service the east coast. We believe this brand whether under the Inventure umbrella or someone else’s, poses a meaningful threat to LNCE’s kettle business under both ‘Cape Cod’ and ‘Kettle’ brands. Nothing is set in stone yet and the team at SNAK still needs to execute the strategy, but this is added pressure that LNCE does not need right now on their core North East market.
Please call or e-mail with any questions.
Howard Penney
Managing Director
Shayne Laidlaw
Analyst
