Will This Company Bite Off More Than It Can Chew?

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When most investors think of the packaged foods industry, they tend to think of it as a mature, slow-growth sector dominated by conglomerates such as General Mills and Kraft Foods. Yet they should pay attention to a new kid on the block, Pinnacle Foods (NYSE: PF), which went public in March at $20 per share and has since risen 20%.

Pinnacle Foods, which sells Vlasic Pickles, Duncan Hines, Mrs. Butterworth’s and Swanson TV dinners, is now looking to expand by acquiring two more key brands - Unilever’s (NYSE: UL) Wish-Bone salad dressing and Del Monte Foods’ canned food business.

If Pinnacle is successful at adding those two businesses to its portfolio, it could seriously boost its long-term growth. However, those acquisitions would be extremely costly for the company, which has fairly low cash reserves and high debt. Let’s take a look at the facts and figures behind these two possible acquisitions to better understand Pinnacle’s future.

A bit of history and fundamentals

Many of Pinnacle’s brands, such as Vlasic and Mrs. Butterworth’s, hold first or second place market share positions across North America. According to the company, 85% of households across the nation own products made by Pinnacle. The company was founded in 1998 as Vlasic Foods International, and grew quickly after acquiring the Swanson TV dinners, Open Pit and Vlasic Pickles brands from the Campbell Soup Company. In 2003, Vlasic acquired Aurora Foods, a former subsidiary of ConAgra, and in 2009 it acquired Birds Eye Foods, becoming the fifth largest frozen food manufacturer in America.

Pinnacle has also invested heavily in improving its acquired products. Through its R&D investments, the company created customized frostings with Duncan Hines Frosting Creations, higher quality pickles from Vlasic Farmer’s Garden, and family-sized frozen bagged meals at Bird’s Eye. The company’s annual gross sales from products launched within the past three years have risen 9.4% since 2009, suggesting that its dedication to constant innovation has paid off. Between fiscal 2008 and 2012, the company’s revenue rose 59% to $2.5 billion as adjusted EBITDA surged 91% to $426.1 million.

Although Pinnacle’s cash flow was most recently reported at $236.7 million, it only has $132.09 million in cash and equivalents. On top of that, it is still shouldering $2.61 billion in debt. Those figures bring us to the central question of this article - can Pinnacle afford to continue expanding through acquisitions?

Breaking the wishbone

The first brand Pinnacle is interested in acquiring is Unilever’s Wish-Bone salad dressing. Over the past several years, Unilever has been selling off its packaged food brands to focus on selling personal care products to emerging markets. Unilever’s well-known products include Dove, Vaseline, Lipton, Hellmann’s and Ben & Jerry’s. The company currently generates 56% of its global revenue from emerging markets, where it competes against other Western consumer staple giants like Procter & Gamble and Colgate-Palmolive.

To stay focused on these high growth areas, Unilever sold its North American frozen foods segment, Bertolli, to ConAgra last year. It also sold Skippy peanut butter to Hormel earlier this year, further decreasing its dependence on the North American packaged foods market. Now, Unilever is looking to sell Wish-Bone, which it acquired in 1972 as part of Lipton. Goldman Sachs, which is overseeing the sale, estimates that the brand is worth $400 to $500 million.

However, Pinnacle Foods isn’t the only company interested in Wish-Bone. B&G Foods (NYSE: BGS), a smaller rival that has also been rapidly expanding through acquisitions, has emerged as a second interested party. B&G is best known for its Ortega shelf-stable Mexican food products, Mrs. Dash salt-free seasonings, and Maple Grove Farms syrups and salad dressings. However, B&G has even less cash, at $16.15 million, and reported $631.1 million in debt last quarter.

Therefore, both parties would have to take on significant debt to finance an acquisition. However, Pinnacle and B&G appear to believe that Wish-Bone’s growth potential outweighs its cost. Although Unilever reported a disappointing 0.5% sales decline in its Foods segment last quarter, its Dressings segment reported a positive gain, fueled by strong sales in Latin America, North America and Europe. However, not everyone believes that Wish-Bone is worth the price - Clorox and Post Holdings notably passed on the deal after expressing initial interest.

Shelf-stable profits from canned food

Pinnacle has also expressed interest in purchasing privately-held Del Monte Food’s canned food business segment. That purchase, which is worth an estimated $1.5 billion, would expand Pinnacle’s reach into canned fruit and vegetables, which complements its business of frozen foods.

Del Monte Foods, the former parent company of publicly-traded Fresh Del Monte Produce (NYSE: FDP), operates two main businesses - consumer goods (including canned food) and pet food products, which include Milk-Bone, 9 Lives and Kibbles n’ Bits. Last quarter, sales of Del Monte’s consumer goods only rose 0.7% year-on-year, but sales of its pet product sales surged 8%. This means that it makes a lot of sense for Del Monte to sell off its canned foods segment to concentrate on its higher growth pet products.

Yet if Pinnacle decides to pursue the hefty acquisition, it will have to contend with Fresh Del Monte, which is also interested in absorbing its former parent company’s canned food business. Fresh Del Monte struggled last quarter with balancing its expenses, after the high cost of bananas hit its bottom line. As a result, Fresh Del Monte’s earnings slid 34.2% year-on-year as revenue only rose 2.3%. Therefore, purchasing Del Monte Foods’ shelf-stable canned products could help stabilize its top and bottom line growth.

However, Fresh Del Monte also has a fairly weak cash position of $25.9 million and has $151.2 million in debt, which means that a $1.5 billion acquisition, which would nearly double its market cap, could be a risky, all-in deal.

The Foolish Bottom Line

In closing, I believe that Pinnacle Foods is an ambitious company that has room to grow. Although it appears that it could be biting off more than it can chew by eyeing Wish-Bone and Del Monte’s canned food business, investors should remember that high debt is fairly common in the packaged foods industry, which tend to grow through acquisitions, rather than organically.

<table> <tbody> <tr> <td> <p><span><span><span><em>Company</em></span></span></span></p> </td> <td> <p><span><span><span><strong>Kraft Foods</strong></span></span></span></p> </td> <td> <p><span><span><span><strong>General Mills</strong></span></span></span></p> </td> <td> <p><span><span><span><strong>Pinnacle Foods</strong></span></span></span></p> </td> <td> <p><span><span><span><strong>B&G Foods</strong></span></span></span></p> </td> </tr> <tr> <td> <p><span><span><span><em>Debt to Equity</em></span></span></span></p> </td> <td> <p><span><span><span>266.41</span></span></span></p> </td> <td> <p><span><span><span>98.43</span></span></span></p> </td> <td> <p><span><span><span>284.88</span></span></span></p> </td> <td> <p><span><span><span>173.47</span></span></span></p> </td> </tr> </tbody> </table>

Source: Yahoo Finance, 7/15/2013

However, Pinnacle Foods still has a very high debt-to-equity ratio, which will only soar higher if it goes through with the Wish-Bone and Del Monte acquisitions. Therefore, I believe that it would be prudent for investors to wait for the company’s second quarter earnings release on August 2 to decide if Pinnacle’s growth potential can justify these big purchases, or if the company should hang back and reduce its debt before growing further.

Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Unilever. 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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