To the Victors Go the Spoils

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On November 27, food giant ConAgra Foods (NYSE: CAG) finally attained its business transformation goal with an agreement to purchase competitor Ralcorp Holdings (NYSE: RAH) for roughly $5.1 billion, or $90 per share in cash.  The purchase price values the company at 1.5 times FY2012 sales and 30.3 times FY2012 adjusted EPS.  ConAgra initially set its sights on Ralcorp in March 2011, with an $82 per share cash offer.  After receiving a rejection on both that offer and a subsequent higher offer, ConAgra gave up the fight as Ralcorp’s board decided on an independent strategy that included spinning off its Post business.  However, ConAgra’s management pinned its future growth on a larger presence in the private label food business, and this acquisition catapults it to the number one position in the segment.

What’s the Value?

Ralcorp is a manufacturer, distributor, and marketer of private label food products to the retail and commercial foodservice sectors.  This segment of the food business has been a growth area as retailers seek proprietary brands that will create loyalty and customers seek cheaper alternatives to national brands.  The company achieved its leading industry position primarily through acquisitions, including 27 purchases since 1997.  Its integration process has been very successful over the years, with net sales and adjusted EPS increasing 301.7% and 346.2%, respectively, between 2001 and 2011.  Despite the major divestiture of the Post business, Ralcorp has continued its acquisition strategy lately, with purchases of American Italian Pasta in 2010 and the refrigerated dough business of Sara Lee in 2011.

During 2012, Ralcorp's growth has slowed after adjusting for the company’s acquisitions and divestitures.  In its latest fiscal year, Ralcorp reported sales and adjusted EBITDA of $3.5 billion and $559.6 million, increases of 4.7% and 6.7%, respectively, over the prior year period.  While total sales rose due to the company’s acquisitions and a favorable product pricing environment, Ralcorp suffered volume declines across its major business units.  However, the company continues to generate strong cash flows and has achieved consistent, long-term growth while employing reasonable leverage.

One Plus One Equals Three, Maybe

ConAgra is hoping to exploit economies of scale with this blockbuster acquisition.  After starting as a flour milling operation in the 1860’s, it has grown primarily through acquisitions in the branded products area, including Chef Boyardee, Orville Redenbacher’s, and Healthy Choice.  While ConAgra’s sales increased 7.8% in FY2012, adjusted operating income was flat compared with the prior year, as rising input costs couldn’t be passed on to its customers.  The company is also a player in the private label food business, with annual sales of roughly $950 million, but the acquisition should enhance the combined company’s profitability as annual sales in the segment will rise to roughly $4.5 billion.

The Next Opportunity

The question for investors is whether to follow ConAgra into the private label business.  While this segment should continue to grow in the current economic climate, a better bet is to tap into the other growth area of the food business, namely organic and healthy foods.  A company that is well-positioned for future growth in this area is Smart Balance (NASDAQ: BDBD).  The company is a distributor and marketer of healthy food products through groceries, mass merchandisers, and natural food stores.  Smart Balance has grown quickly, with sales rising 147.1% between 2007 and 2011, due primarily to its purchases of Glutino in 2011 and Udi’s in 2012.  Through the first nine months of 2012, the company reported revenues and adjusted operating income of $256.6 million and $37.7 million, increases of 34.8% and 22.0%, respectively, over the prior year period.  On its third quarter conference call in November, management reiterated its expectation for 20% sales growth in FY2013 as Smart Balance’s gluten-free and natural products should continue to win market share from customers pursuing better nutrition.  This company is a healthy addition to investors’ portfolios.

rghanley owns shares of Smart Balance. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Smart Balance. 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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