Solid Q1’19 – Maintain Buy on Hostess Stock $TWNK

Hostess reported Q1’19 EBITDA of $49MM compared to $46MM of consensus and my $45MM estimate. Sales growth was the really strong point with 6.7% growth, beating consensus by 560bps.

This is honestly the best news for Hostess stock since the acquisition of Cloverhill. Recall, Hostess bought Cloverhill out of distress (but what I view is a great deal). Cloverhill was an operation with negative ~$20MM in EBITDA (and a bulk of its employees were undocumented workers), but still had strong brands. Hostess management figured they could turn the operation around and get it to $20-$25MM of EBITDA in a couple years from purchase. Since they paid $40MM for it, they essentially bought the asset for 2x EBITDA – in a market where food / consumer companies are going for well into the double digits.

Following the acquisition of Cloverhill, however, quarters optically looked very ugly since the company was negative EBITDA. Even if I didn’t mark it, you could probably guess when the business was acquired.

Now, with this print and clear improvement in Cloverhill (given margins are improving on a quarterly basis) I think Hostess will now start to be appreciated by investors.

For one, its becoming more clear that the Cloverhill deal has synergies.

Club was a terrific growth driver for us. We talked about when we acquired the Cloverhill business of not only did it give us a platform to expand into breakfast but it also gave us some access to certain customers and channels to be able to expand that.

We’ve leveraged that in club, not only for the Cloverhill and Big Tex brands but also to expand our Hostess branded business as well as we launched Dolly in club as well as across some other channels. So the innovation of taking that platform and spreading that across multiple channels

The cadence sounds good as well. With a solid beat here, we have to ask ourselves what the outlook is for the rest of the year. Management was pretty clear:

But more importantly, we did expect merchant — the breadth of the merchandising improvements including our largest customer still improve as the year went through. We expected it to get better as we came out of Q1. Across the board we’re seeing that and I expect that to continue and to accelerate as we go through the year.

Is Hostess stock still cheap?

I think it is. Despite Cloverhill pressuring the company’s margins in the short term, Hostess still has top-tier EBITDA margins in the food space. If Cloverhill is turned around as planned, this could step-up to high 20s again. But is that what consensus is expecting? Let’s look at the estimates:

This doesn’t add up to me. Hostess did $230MM of EBITDA in 2017 before it acquired Cloverhill. They said on the acquisition call they expected Cloverhill to contribute $20-$25MM in EBITDA by 2020 (which was re-iterated on the lastest call).

This would imply to me that Hostess should be more likely to do ~$250MM of EBITDA by 2020, well ahead of $222MM expected by Wall Street analysts. Now, there has been inflation across the board impacting food companies, but even if the company did $235MM, that is well ahead of street.

Despite too low of estimates, the multiple ascribed to Hostess is ALSO too low.

Hostess stock trades at nearly a 1x discount to where the median comps trade. If I were to use $235MM-$250MM, the company trades at 10.9x-10.2x 2020 EBITDA. This seems too cheap.

What do you think Hostess is worth?

The company has top tier margins, generates strong FCF, and has great brand value. I think the Cloverhill acquisition also shows management is smart with how they allocated investor’s capital.

Therefore, I think the company should trade for 12.5x-13.0x EBITDA. This would mean the company trades in-line with General Mills, a food giant that has been struggling with organic growth.

At the low end, I think there is ~20% upside over the next 12 months and ~30% upside in a bullish scenario. This seems like a solid return to me with relatively low risk compared to other investments I see today.

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