Treehouse: Challenging Outlook Offsets Decent Q2
Ashish is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Recently, Treehouse Foods Inc (NYSE: THS) reported 2Q12 adjusted EPS of $0.60 beating the consensus estimate of $0.58 cents. The EPS beat was primarily due to a lower than expected tax rate, as operations were modestly lower than expectations. However, the news came with management’s significant reduction in F12 EPS guidance, which was cut by 8% or $0.25. The new range resides at $2.75-$2.90 as compared to prior consensus estimates of $3.08. Management has attributed the reduction in guidance to soft soup sales. While the company reported a decent quarter, the outlook over the remainder of the year seems to be challenging due to headwinds in some of the firm’s key businesses.
More facility closures
Due to declining sales in the retail soup category over the last five years the company decided to close its Mendota, IL soup plant. In addition the company is also closing its Seaforth, Ontario salad dressing plant. On the top line, the lost revenue will be replaced by the contribution of Naturally Fresh, which THS acquired on 13th April but on the bottom line such an offset does not appear available. After the discontinuation of some of its baby food business and ending some low margin pickle sales, the soup restructuring is the third product line in three years that will slow the top line growth for Treehouse.
Mix Shift Weighing on Margins
Since consumers are significantly shifting purchases to alternative channels compared to more traditional ones, Treehouse is experiencing a mix shift in volumes that is weighted toward its lower margin "value" private label brands. As a result, the company’s margins have come under pressure. Management expects the mix shift to continue over the back half of the year and the 2H12 gross margin structure in the N.A. Retail Grocery segment is also expected to be similar to 2Q.
4Q likely to be Tough
The company got undercut on price with a major grocer customer and is walking away from two co-packing arrangements. Although gross profit dollars will be up versus one of Treehouse’ worst quarters in 4Q11 but operating income is expected to be down in high-single digit to double digit due to the timing of executive compensation comparisons in G&A.
The company has a major competitor in Ralcorp Holdings Inc (NYSE: RAH). Though Ralcorp is trading at a 10% premium to Treehouse, we continue to favor Ralcorp on a relative basis because it is poised for a bigger step-up in FY13 earnings. Ralcorp’s expected EPS growth of 26.5% in FY13 is about double Treehouse’ 13.6%. Also there is an underlying bid for the business from ConAgra Foods Inc (NYSE: CAG) if management doesn't execute. Thus, Ralcorp clearly appears to be a better bet.
Moreover, given the company’s track record of lower guidance revisions over the last 18 months, there have been increasing doubts over management’s credibility. Thus, we believe the company will need to show consistent earnings growth before the stock regains its historical multiple. Although, we believe the near term concerns are mostly accounted for in the stock's price with a 12.5% drop in a week after the earnings announcement, we don’t see a positive catalyst for stock appreciation in the remainder of the year. Thus, we suggest the investors to remain on the sidelines and avoid this stock.
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