Tag: Hostess

Q3’18 Recap: Slightly disappointing print, but 2 year outlook remains solid. $TWNK $TWNKW

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Hostess reported Q3’18 adj. EBITDA of $40MM compared to street estimates of $45MM. The main driver of the miss was higher inflation (impacted GMs by 330bps) as well as the Cloverhill acquisition, which as a reminder is negative EBITDA right now (but expected to be $20-$25MM by 2020). The company has announced price increases to cover raw materials, which I think will be easily passed through, as I’ve discuss in my previous posts on pricing power (e.g. moving Twinkies price to $1.80 to $1.88 isn’t a deal killer for a buyer, but that’s a ~4.5% price increase for the company).

Cloverhill accounted for another 630bps of gross margin degradation. All in, gross profit margin, excl. transaction costs, declined form 40.8% of sales to 30.4%. Some of this was expected, but it definitely disappointed. That being said, there’s still a lot to look forward to for investors with a 2 year outlook.

One, the Cloverhill acquisition should no longer be a drag to EBITDA in 2019 and then will be a nice contributor in 2020. They bought the business for $25MM, so this is an extremely attractive purchase price multiple in an industry where things are being sold for 10-12x.

Second, the acquisition provided penetration into both new brands as well as channels the company didn’t have before. This will allow a new platform for the company to leverage the Hostess brand. For example, the company did not have much in the breakfast channel. This can now be a platform for growth.

Lastly, the company is still a FCF machine. Despite buying a business that is obviously a significant drag on EBITDA, the company has generated ~$131MM of FCF in the past 12 months. That’s ~9% of the market cap (using a fully diluted share count, adding 30MM of class B shares, which many sell side analysts don’t use due to focus on EPS).


Outlook: When you look out to 2021 when Cloverhill should be a meaningful contributor and the rest of the business has recovered profitability, I model ~$292MM of EBITDA. As such, the company is currently trading at 6.8x. Using just a 10x multiple, I have a price target of $18/share which foots to a 6% FCF yield. I think this is relative conservative compared to where other food names trade, especially those with such a strong brand power as Hostess. Over time, I think the business should move up to 12x EBITDA, which foots to $22 stock price.

I’ve written about the warrants in the past and these price targets would also foot to a $3.25 and $5.25 price compared to their current levels today at ~$1.00. I am long both today.

Hostess Model

Poor timing on TWNK… Still see the light at the end of tunnel. Q2’18 Recap

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“Better to be lucky than good…” the old adage goes… Well, I wish I had just a smidge of luck with my post and position on Hostess (and its more risky warrants). Hostess reported Q2’18 Adj. EBITDA of $47.6MM, well below my estimate of $56.8MM. Although sales were up 6.2%, partially due to the Chicago bakery they acquired, EBITDA was down from $63MM in the prior year and margins contracted from 31% of sales to 22% of sales in the current period.

Yeesh. What a mess. Run for the hills, right? Well, that is what investors did. The stock was down 17.6% today.

Before you hit sell too, I think it is important to parse out what happened.

First, over half of the margin decline was due to the Chicago bakery. As a reminder, this bakery was essentially shut down after an immigration raid. Although it was negative EBITDA at the time, Hostess looked at the business and its brands and figured there was good value to be had. They bought the business for $25MM and it had $10MM in inventory. After turning the business around, the company expects to generate $20MM-$25MM of EBITDA, which implies a solid purchase price. However, in the short term, the negative EBITDA business being added to a highly profitable Hostess core business would obviously weigh on results.  If you have a long-term view, this is still a solid opportunity.

The next part of the miss was cost inflation. Many, many companies have been calling this inflation out (oil and oil derivatives have essentially doubled) and wage and trucking freights have also been very high. Hostess is a solid brand though and if the average price of a Twinkie goes up from $1.80 to $1.88, with that impact sales? Maybe, but in this example, they would get a 10% unit price increase which falls straight to the bottom line.

Lastly, and the hardest to predict, was a customer that changed its display partnership with Hostess. From the call:

“Q2 was directly impacted by the quickly escalating inflationary costs in the supply chain and a decline in retail inventory and consumer poll due to lower promotional support from one large retail partner, as well as additional allowances with customers to drive growth….”

“We had good line of sight to increase and display support behind Hostess in third and fourth quarter at one of our largest retail partners. The corporate change in display philosophy during Q2 not only impacted Hostess, but also drove share loss for this customer. Consistently, across many examples, when Hostess performs well and is growing through merchandising and innovation, Hostess and our customers consistently grow market share together. This particular retailer has been a great partner to Hostess since the relaunch and my discussions with them had been collaborative and focused on profitably growing the category. We are pleased with the merchandising support we have secured from all of our large customers during the back-to-school period, which should help support the sequential improvement we expect to achieve in the third quarter.”

This retailer is highly likely Wal-Mart and as you can see from the commentary, it seems like they have some line of site in this improving.

Bottom line: Disappointing Q, but I am sticking with the company and the warrants. We have until Dec 9, 2021 which gives us a lot of time for the company to realize value. My price target moves to $17.3, which is based on 12x 2020 EBITDA.

Q4 Earnings Recap: TWNK

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Now that Q4 earnings season is approaching its end and Q1 will begin ramping up before we know it, I wanted to provide a recap of earnings of stocks I’ve favorably mentioned here.

Hostess reported Q4 EBITDA of $58MM, in-line with street expectations. However, sentiment on the stock was very low and ~15% of the float was sold short which resulted in a significant pop in the stock. EBITDA guidance came in slightly light of expectations, at $225MM at mid-point, but part of the reason is due to a bolt-on acquisition which bring in Big Texas and Cloverhill brands to the current portfolio. The business will be initially dilutive by ~$20MM as the former parent was having operational and recall issues. It used to do sales of $175MM and $25MM of EBITDA. Hostess expects it to contribute $65MM while they turn it around and generate at least $20MM of EBITDA by 2020. Since they only paid $25MM for this assets  and since it provides them greater access to the vending, cash & carry and independent convenience stores channels, it seems like a solid strategic buy in an expensive market.

Bottom line: The core business is doing fine, Hostess continues to generate significant FCF, and it’s allocating capital in a smart way. I still think the stock is worth >$20, which is at least 40% upside to today’s levels.

Also note, based on my estimates, by year-end 2019 the company will have >$300MM of cash on the balance sheet. It won’t just sit on that cash, it will either do more acquisitions, buy back stock, or maybe further in the future, initiate a dividend.

Hostess Model Snapshot

Stock Pitch: Hostess Brands

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“I can understand [Coca cola]… Anyone can understand [it]… It’s a simple business.”

Today’s stock pitch is a simple business. It’s easy to understand and in many ways, it is very similar to Warren Buffet’s Coke investment. And that is… Hostess Brands! That’s right – the maker of Twinkies, Ho-Hos and Ding-dongs, is making a pitch appearance.

Hostess_Comeback_IB

Food staple stocks have been under pressure recently, relatively speaking. Call it sector rotation or moving out of bond proxy stocks (i.e. those equities viewed as safe enough to move into when interest rates are too low), but the indiscriminate selling as opened up buying opportunities.

So what’s the pitch for Hostess Brands?

  • Strong brand name
  • Great return metrics (high EBITDA margins, little capex)
  • Very stable business (people don’t stop eating Twinkies in a recession)
  • The stock may be looked over due to misguided perception of healthy vs. indulgent snacking
  • Plenty of white space to drive growth

But DD – aren’t Twinkies bad for you and isn’t that segment shrinking?

Good question Reader, but the answer is yes and no. I will just note that a Twinkie is only 135 calories – that’s less than half the calories of a Twix bar. But, yes the health-conscious segment is growing, but the indulgent snack trend is still strong. In fact,  indulgent snacks have posted low single digit growth rates over the past several years, roughly in-line with healthy snacks (3.1% and 3.4% in 2014 & 2015 respectively vs. 2.5% and 3.8% for healthy snacks).

Ok, even if that’s true, didn’t Hostess declare bankruptcy? Yes! But it has emerged as a much stronger company. Hostess’ previous distribution strategy drove it into bankruptcy. Hostess declared Ch. 7 bankruptcy, which means it went into liquidation. After selling some brands (Wonderbread) and shedding liabilities (pension etc.), Apollo bought the Hostess brand name and reinvested in the business, utilizing automation and a direct distribution strategy to drive efficiency. The table below summarizes it well.

Hostess_ before and after

It should be noted that since Hostess entered Ch. 7, its products were pulled from the shelves and competitors took market share. Now that Hostess is back, one reason why it is growing well is simply that it is regaining that market share.

TWNK Oldco

Another reason why I like Hostess is simply the amount of white space available to the company. With the acquisition of Superior Cake the company entered a new space of in-bakery items. Hostess has since then launched a series of peanut butter products, deep fried Twinkies, and chocolate covered items. New product introductions like these should drive better than GDP growth over the long-run.

Superior Cake

Another way Hostess can drive growth is geographic white space. Its mostly a U.S. company today and I could easily see a launch of Hostess products moving into Mexico and South America, where Grupo Bimbo dominates.

“Coke’s moat is wider than it was thirty years ago. You can’t see the moat day by day, but every time the infrastructure gets built in some country that isn’t yet profitable for Coke, but will be twenty years from now, the moat is widening a little bit… That’s the business that I’m looking for. Now what kind of businesses am I going to find like that… I’m going to find them in simple products. Because I’m not going to be able to figure out what the moat is going to look like for Oracle, or Lotus, or Microsoft ten years from now…”

Financials & Valuation

Aside from good growth, I really like the free cash flow characteristics of Hostess’ business. With 30% EBITDA margins and capex (including growth capex) at around 5% of sales, that means a lot of earnings translate into free cash.

And given these goods cash flow characteristics, strong brand value of Hostess I would put Hostess’ valuation in the top tier of peers. But when we look at where the comps trade, there is clearly a dislocation and opportunity for investors.

TWNK comps

I think Hostess should trade at 13x EBITDA, and perhaps higher. As seen at the bottom of my model snapshot, this is pretty close to a 5% FCF yield, which I think is fair. For this point, I’d also like to highight how much cash builds on Hostess’ balance sheet. It is unlikely that they just sit on this cash – this will likely go to acquisitions, share buybacks, or even eventually, a dividend.

TWNK Model Summary

This is the time to bring up the fact that the CEO is leaving. He is well respected in the industry and I can’t say this isn’t a loss for the company. I do still like that Dean Metropoulous will remain executive chairman, a leader who has more than 30 years of experience in the food & beverage space.

What do you guys think? Let me know if you guys have any thoughts or questions.

-Diligent Dollar