This Stock is Cheap and Ready to Take-Off!

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After spinning off from Sara Lee Corporation, Hillshire Brands (NYSE: HSH) has underperformed the broader markets and its shares have seen a 9% downfall whereas the S&P500 has risen more than 7%. As a result, the company is now trading at a forward PE of 17.94 and looks undervalued on a PEG basis. The following table shows company’s valuation multiple and growth rate with respect to its competitors including Tyson Foods (NYSE: TSN), Hormel Foods Corporation (NYSE: HRL) and Kraft Foods (NASDAQ: KRFT).

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Tyson</p> </td> <td> <p>Hormel</p> </td> <td> <p>Kraft</p> </td> <td> <p>Hillshire</p> </td> </tr> <tr> <td> <p>Forward PE</p> </td> <td> <p>10.83</p> </td> <td> <p>14.94</p> </td> <td> <p>15.30</p> </td> <td> <p>17.91</p> </td> </tr> <tr> <td> <p>EV/EBITDA (ttm)</p> </td> <td> <p>4.81</p> </td> <td> <p>8.71</p> </td> <td> <p>10.88</p> </td> <td> <p>2.31</p> </td> </tr> <tr> <td> <p>P/S (ttm)</p> </td> <td> <p>0.18</p> </td> <td> <p>0.93</p> </td> <td> <p>1.30</p> </td> <td> <p>0.35</p> </td> </tr> <tr> <td> <p>Next 5 Year Growth</p> </td> <td> <p>7.33%</p> </td> <td> <p>9.00%</p> </td> <td> <p>10.75%</p> </td> <td> <p>20.20%</p> </td> </tr> <tr> <td> <p>PEG Ratio (5 year Expected)</p> </td> <td> <p>1.27</p> </td> <td> <p>1.74</p> </td> <td> <p>1.51</p> </td> <td> <p>0.84</p> </td> </tr> </tbody> </table>

We can see from the above chart that Hillshire Brands is looking cheap on several metrics. Though the company has the highest forward P/E ratio, it has the lowest EV/EBITDA and second lowest PEG ratio. The company also offers the “best-in-class” growth rate over the next five years. I think Kraft foods is also worth looking at, as in addition to a double-digit growth rate, the company also provides an attractive dividend yield of 2.90%. Hillshire Brands (beta=0.37) and Kraft foods (beta=0.30) are also low beta companies and thus, provide a good protection from an economic downturn. Hillshire also appears to be a potential take-out candidate as the company has an attractive sizeable downstream business and its acquisition will result in significant cost synergies. I think Tyson and Hormel are the potential acquires. Hillshire’s market cap of $3.2 billion is about half the size of Tyson’s $5.9 billion and Hormel’s $7.7 billion. Moreover, both Tyson and Hormel have the balance sheet strength to do such an acquisition.

Although, I believe Hillshire Brands is a potential takeout candidate, but my primary reason for being optimistic about the company is not the potential takeout story, but rather, my belief that Hillshire’s earnings will grow by a greater rate than the group average over the next few years as the company enjoys a strong pricing power and is investing for the future.

Strong Pricing Power

Hillshire has successfully passed on price increased to consumers in the past whereas protein companies like Smithfield Foods, Tyson Foods and Sanderson Farms cannot raise prices immediately because most of their products are commodity meats. It is important to note that, Hillshire is a packaged food company, not a protein company. It sells branded products that are less commoditized, and thus can raise pricing when necessary without waiting for competitors to cut supply or shedding too much volume.

Investing for the Future

It is encouraging to see that the company is investing for the long term and is commitment to its FY2015 target without propping up near-term performance. In contrast to the old Sara Lee, Hillshire Brands is not seeking to provide a “Pyrrhic victory” with near-term earnings upside by sacrificing future investments. I favor packaged food companies like Hillshire Brands that are investing in R&D and marketing off a low spending base, as well as those that have above average cost saving opportunities.

To conclude, Hillshire Brands potential take-out story should provide it attain a premium valuation. In addition, the company has strong growth prospects and looks highly undervalued on several metrics. Being a branded packed foods company, the company enjoys a strong pricing power and can take prices when necessary. Thus, I am bullish on this stock and recommend buying it.

GayatriSharma has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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