Are You Ashamed To Buy Into This Trend?

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

I don't know why one would be ashamed of it since 99% of Americans do it now. One per cent of us are too old fashioned to do it.

That's right, 99% of us buy private label merchandise, whether it's food, over-the-counter medicine, or pet food. The recession catalyzed 47% more Americans to start buying private label. Retailers, especially grocers and drugstores, sat up and took notice, creating their own private label brands. Even Valero, the independent oil refiner and marketer, is beginning to market its own line of snacks at its service stations/convenience stores.

Rite Aid, Safeway, Kroger, and CVS, among many others, all have very strong concentrations of private label alternatives to name brands. According to the 2012 Reversal Of Fortune retail report by Symphony IRI Group, 32% of CVS's sales growth is thanks to private label, and CVS plans to roll out up to 1,000 new private label items every year.

Don't be ashamed to buy

Two companies at the forefront of private label food manufacturing are Treehouse Foods (NYSE: THS) and Ralcorp Holdings (NYSE: RAH), which agreed to be bought by ConAgra Foods (NYSE: CAG) on November 27 and is expected to close in March 2013 for $6.8 billion.

The Ralcorp deal is particularly beneficial to ConAgra, a food manufacturer whose brands are found in 97% of American households, as it opens up new lines of cereals, pastas, crackers, sauces, and spreads from the nation's largest private label manufacturer, Ralcorp.

ConAgra reported 2013 Q2 earnings on December 20 and guided higher for 2013 with EPS up 16% on a comparable 2012 Q2 basis beating analyst expectations. However, sales declined for many of their lesser known brands: Andy Capp’s, DAVID, La Choy, Rosarita, Banquet, Egg Beater’s, Lightlife, Snack Pack, Blue Bonnet, Healthy Choice, Manwich, Van Camp’s, Chef Boyardee, Hunt’s, Parkay, Crunch ’n Munch, Kid Cuisine, and Peter Pan.

With the Ralcorp buy ConAgra faces some big new competition like Kellogg's and General Mills in addition to current competitors: Mondelez, Heinz, and Nestle. As to be expected from an Omaha, Nebraska based company, corporate governance risks are low on all factors. The company had repurchased some $170 million shares in the last year, but plans to scale that down in light of the Ralcorp acquisition. It is also shareholder friendly with a 3.40% yield at a 60% payout ratio. It currently trades at a 18.42 P/E with a 12.86 forward P/E.

The drawbacks to ConAgra include a portfolio of those brands that showed sales declines. After digesting the Ralcorp purchase CEO Gary Rodkin told CNBC they plan to further grow the company with more acquisitions down the line.  They might want to consider jettisoning some of these lesser brands to B & G Foods (NYSE: BGS) and let them have a crack at it.

Trouble in the treehouse

Analysts expect a 6.72% growth rate for ConAgra over the next five years but analysts expect faster growth at 10.63% for Treehouse Foods. It has a P/E of 20.21 and is down almost 30% from its 52 week high of $66.

When Treehouse reported Q2 earnings on November 6, they disappointed on both revenue and earnings. Margins also contracted across the board. Credit Suisse downgraded it to underperform and lowered the price target to $50 after the miss. While it beat the previous quarter its decision to close a soup plant and also a salad dressing plant and lowered guidance prompted another analyst downgrade.

Also disappointing was their foray into K-cups after the Green Mountain Coffee Roasters patent expiration, which should have been very lucrative but manufacture has been plagued with grounds problems and breaks. Citigroup had upgraded the name in August, expecting the private label K-cups to add to earnings.

Its major competitor was Ralcorp, which may be another reason for the share price decline as Ralcorp now will be part of big brand ConAgra. Some analysts theorize that those who have been buying private label have stepped down further to dollar stores, which offer the same products even cheaper than grocery private label.

Be proud to buy this

Treehouse is the largest manufacturer of pickles and many of the same products as B&G Foods. B&G is a name brand but inhabits a sort of netherworld between the big names like Kraft, Heinz, Unilever, etc. and private label brands. Its brands are purchased on the cheap from these larger companies or independent brands that are failing. Then B&G Foods makes them over and contracts with independent distributors. Many of their products are recognizable but most aren't considered big name products. For a recent and more complete takeout on B&G click here.

While B&G Foods is not a private label brand it performs very much like one with low overhead, lower price points for its brands, and it doesn't have the name recognition of the major brands. By the way, corporate governance risks are also low on all concerns.

The company has been a Wall Street darling with its low overhead (only 740 employees) and high yield of 4.20%. It has a 21.56 P/E but the name is up 17.30% in 2012. Analysts expect 14.20% growth over the next five years. Their Fairy Godmother approach to failing brands has also transformed shareholder portfolios with tenfold share price appreciation since 2009.

The final takeaway

Don't be ashamed to buy ConAgra or B&G Foods. They have yield and both continue to grow through acquisition. Both should continue to execute well in 2013, much better than Treehouse Foods is expected to perform. In a way you're getting the best of private label and name brand companies and enjoying a multi year trend that shows no sign of ending.

leglamp 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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