This Bakery is Getting Expensive

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Beaten down companies can create investment opportunities. That is why I am interested in stocks approaching their 52 week lows, or stocks which have plunged recently. I have noticed a decent bakery that has consistently delivered a double-digit return on equity since 2005. It is Flowers Foods (NYSE: FLO). The stock has experienced quite a few ups and downs, but in a narrow range. That is why it is considered a less volatile stock, with the beta of only 0.16. This stock decreased in price gradually, from $23.80 in June to $18.87 in October, a market value loss of 20.7%. However, the stock just jumped more than 10% to $22.32 within just a day after the company was thought to be a most likely buyer of Twinkie maker Hostess' assets when it is liquidated. Is the price increased justified fundamentally? Let’s find out.

Flowers Foods has a history dating as far back as 1919, and has two main business segments: direct store and warehouse store delivery. The first segment operates 32 bakeries for customers in several regions in the US, whereas the warehouse delivery segment operates 10 bakeries sold to customers' warehouses. It is the business with customer concentration. The top 10 customers accounted for more than 45% of total sales in 2011, and Wal-Mart was the largest one with 21.6% of sales.

Over the last 10 years, Flowers Food has managed to grow its revenue and operating income consistently. In 2002, its revenue was $1.65 billion, with $27 million in operating income. Ten years later, the revenue was $2.77 billion, with $189 million in operating income. The annualized growth rate for revenue and operating is 5.3% and 21.5% respectively. Its EPS has grown from $0.09 in 2003 to $0.90 in 2011, marking a spectacular annualized growth of nearly 29.2%. Furthermore, Flowers Foods is a constant positive cash flow generator. For the trailing twelve months, it generated $222 million in operating cash flow and $159 million in free cash flow.

However, the balance sheet does not look quite exciting. As of September, it had $864 million in stockholders’ equity, $14 million in cash and nearly $400 million in long-term debt. Furthermore, it had $134 million in pensions and other benefits, and $667 million in goodwill and intangibles. So Flower Foods had only a $2.90 tangible book value per share. It also had more than $300 million in contractual cash obligations due in 2012, and $138 million due in 2013-2014.

In addition, investors might look at the history and see the consistently increasing dividends over the last 10 years, from $0.01 per share to $0.53 per share. However, the payout ratio has risen accordingly, from only 25% in 2002 to more than 59% in 2011. If we look closely at the cash flow statement, we might find that the consistently positive free cash flow is only if we don’t include acquisition cash flow. If we include that, the free cash flow of 2008 and 2011 would be negative $162 million and negative $114 million, respectively.

Currently, Flowers Foods is trading at $22.32 per share, with the total market capitalization of $3.08 billion. The market is valuing the company at 19.4x forward P/E and 3.6x P/E. The firm is paying a dividend yield of 2.8%. Flowers Foods is at richer valuations compared to its peers. The forward earnings of Campbell Soup (NYSE: CPB) and Hillshire Brands (NYSE: HSH) were 12.9x and 17.4x respectively. Hillshire is paying the highest dividend yield with 4.8%, but in 2011, it paid out more than 84% of its earnings in dividends. Campbell Soup is the most conservative, paying a 3.2% dividend, with only a 48% payout ratio. Among the three, the free cash flow of Campbell Soup is the most stable with no big acquisition for the last 5 years. Campbell Soup is trading for $36.64 per share, with the total market capitalization of $11.49 billion, whereas Hillshire Brands is trading for $26.78 per share, with $3.27 billion in market cap.

Foolish Bottom Line

Flowers Foods own several great bakery brands, such as Bluebird and Tastykake with a 70% penetration in the US. However, it seems to grow the business via acquisitions. It would take time to figure whether the acquisition brings along synergies and profitability. With a not so strong balance sheet, high payout dividend ratio, fluctuating free cash flow after adjusting for acquisition costs, and high valuations, I would not purchase this company.








hoangquocanh has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Flowers Foods. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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