We initiated positions in TreeHouse Foods, Inc. (NYSE:THS) during the third quarter. TreeHouse is the largest private label food manufacturer and distributor in North America. An aphorism in the private label industry is that “a grocer is only as good as their private label.” As such, private label food has been growing its share of the North American food industry over the past several years, as consumers have sought value in comparison with branded food, and as grocery retailers and other food vendors have pursued the greater profitability to themselves of private label products. This trend primarily began in national-brand equivalents, in which TreeHouse and other private label manufacturers offer products of comparable quality to brand names but at better prices. However, much of TreeHouse’s growth in recent years has come from premium products, which often might be natural/organic/healthy choices and possibly of even greater quality or featuring greater innovation (flavors/recipes) than competing branded products. Having evolved from simply offering retail customers a "good/better/best" option of national brand equivalents, the Company has begun to offer deeper category segmentation and insights, while developing and manufacturing multi-tiered pricing assortments, so their retail customers can better compete under the pricing umbrella typically created by higher priced national brands. Many of TreeHouse’s best customers, including large, growing retailers such as Trader Joe’s, Aldi’s, Amazon, and Kroger, have embraced this more complete portfolio strategy of private label products, which offers the retailers not only improved profitability but also better sales opportunities, as well. In addition, TreeHouse’s scale and presence in over 20 food categories, enhances its value proposition, which is to help grocery customers hone in on this secular trend towards customized store brands.
The Company has been growing successfully through acquisition since its formation in 2005. TreeHouse has driven value in its acquired businesses by bringing to bear greater operational capabilities and expertise, greater resources behind innovation and customer research, much greater scale and buying power, and an extensive existing customer list into which the acquired businesses could sell. In early 2016, TreeHouse completed the transformational acquisition of the Private Brands business of ConAgra Foods, effectively doubling TreeHouse’s revenue base and operating footprint while removing its only private label competitor of any meaningful size, all at what we view as an attractive purchase price. The acquired business had struggled under the ownership of ConAgra, which historically had been a branded player and which had not understood the different skill set required to operate a private label business. We believe that TreeHouse comprehensively understands these operational issues and already has begun to remedy them. Better execution at the acquired business, which will drive improving revenue growth and margins, combined with significant cost savings opportunities as a result of the combined companies’ greatly enhanced scale, will allow TreeHouse to deliver roughly 70% earnings growth from the time of the acquisition to the completion of its integration in 2018. During this integration, we likely will see smaller tuck-in acquisitions, as the company’s capital structure still allows it to be active in consolidating the industry. We estimate that the company has less than 10% market share in North America, with plenty of room to expand organically and through acquisition, both within its current 20+ product categories and in adjacent and new categories. Continue Reading »