Hillshire Brands: Yet Another Spin-Off Success?
Soroush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
From contrarian investing to Buffetology, there are many trading strategies being used in the financial markets today. One tactic that usually flies under the radar is the spin-off play. As we originally covered in the Kraft/Mondelez split, empirical evidence has shown that spin-offs: (1) outperform the market, (2) are underrated by Wall Street, (3) are undervalued immediately following the split, and (4) have typically been directed by highly motivated leaders with a fresh take on managerial tactics. Over the past 45 years, newly formed spin-offs have beaten the market by an average of 19.4% in the first twelve months, with 24 month (24.4%) and 36 month (26.3%) alphas even more impressive; research was performed by Purdue faculty members McConnell and Ovtchinnikov. We’d like to see that duo run a hedge fund; maybe they could keep up with our Top 10.
This seems like a pipe dream, but just looking at the recent performance of Phillips 66, which spun off from ConocoPhillips in April, allows us to see the potential of this strategy. Since it’s split from Conoco, shares of PSX have returned 18.6%, beating the S&P (2.5%) quite handily. Interestingly, Hillshire Brands (NYSE: HSH) does not look like it is following this path, at least so far. Since the meat company’s split from Sara Lee in late June, shares of HSH have fallen more than 11%, while the broader markets have risen 5.3%. While it is easy to write this off as a rare spin-off failure, at least from an investment standpoint, it is worth delving into the details a little more.
Earlier this month, Hillshire announced that its fourth quarter revenue was up 3% year-over-year, as demand for hot dogs and sausages had increased from last summer. The company did, however, withhold its earnings figures after discovering a few accounting errors with its Brazilian coffee business, D.E. Master Blenders. By the end of this year, the Street is expecting HSH to report earnings of $1.56 a share, with this figure rising to $1.61 by the end of 2013.
From a valuation standpoint, shares of the company are currently trading at a price-to-earnings ratio (8.5X) below the packaged food industry’s average (20.8X), and competitors like Hormel Foods (NYSE: HRL) at 16.2X, Kraft Foods (NASDAQ: KRFT) at 20.4X, and Tyson Foods (NYSE: TSN) at 11.9X. When earnings growth is factored into the equation, this undervaluation looks to be even more prominent, as HSH sports a PEG ratio of 0.8; typically any figure below 1.0 signals that a particular stock is cheap. Moreover, this PEG is also below the likes of HRL (1.6), KFT (1.5), and TSN (1.2).
The same can conclusion can be reached when using the company’s price-to-sales ratio (0.3X), which is way below the industry norm (1.1X), HRL (0.9X), and KFT (1.3X). When compared to Sara Lee’s own 5-year (0.9X) and 10-year (0.9X) historical averages, we see a similar story. Now, obviously this isn’t the perfect comparison to make, but the vast undervaluation that we’re currently seeing is at least worth looking at. Over the past decade, Sara Lee’s revenues traded at a 34% discount to those of the S&P. This year, Hillshire’s are trading at a much lower 77% discount.
Going forward, the stock does have quite a bit of upside, assuming that its year-end earnings forecasts can be met. If consensus holds, fairly valued shares of HSH can eclipse $32 a share; they currently trade in the $25 range. By the summer of 2013, this target stretches to $35. One potential risk that Hillshire faces is a shrinking economic moat in the lunchmeat industry, which makes up around one-tenth of the company’s total top line. With the growing popularity of generic brands and the continued strength of competitors like Kraft and Hormel, this situation is worth monitoring.
Nevertheless, the stock is still undervalued by nearly every metric, and positive growth is on the horizon. WealthLift’s Sentiment Index rates Hillshire as a strong buy, with nearly all of the community’s users placing an “overperform” rating on the stock. For more trading ideas in today’s uncertain market environment, visit WealthLift INSIDER.
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