Whenever it comes to consumer goods industry, I got very excited. Because industry-wide, it seems to be more predictable than other industries such as defense, technology where the future of the company depends on the technology innovation or unstable policy changes. There are two filters for the consumer goods candidates to hold for the long-run, the first is the long term appreciation in the stock price (in 10 years period), and second, it should fit for income investors where it kept paying dividends for existing shareholders out of its profits.
Then I found one producer and marketer of bakery products in the US. Since the beginning of 2001, the stock was around $2.5 per share, and the stock price has been continuously on the rise to $21 in the middle of 2008, with not much fluctuation even with the global economic depression, and now it is staying at $18.5 per share. For the 12 year period since 2001, not taking into a lot of dividends paid out, the capital gains have made this company’s investors the consistent compounded annualized return of 18.15% per year. That bakery producer is Flowers Foods (FLO).
(source: Google Finance)
FLO has the long history dated back 1919 when two brothers, William Howard and Joseph Hampton Flowers, opened the Flowers Banking Company in Thomasville, Ga. It has been the public company since 1969 in the American Stock Exchange, began to trade in NYSE since 1982. The business got two main segments: direct-store-delivery (DSD) and warehouse delivery. The DSD focuses on the production and marketing of bakery products to US customers in Atlantic, Mid-Atlantic, southwest as well as in California and Nevada. The warehouse delivery involves in producing snack cakes for sale to co-pack, retail and vending customers nationwide as well as frozen bread, rolls, buns and tortillas for sale to national retail and foodservice customers through warehouse distribution. Several familiar brands includes Nature’s own, Whitewheat, Country Heart, Sunbeam, Roman Meal and Aunt Hattie. The top 10 customers in fiscal 2010 has accounted for significant 46.5% of total revenues, and the largest customer is Wal-Mart/Sam’s Club, accounted for 21.8% of company’s sales. So FLO depends very much on the widespread of Wal-Mart stores.
Even though it was not fast growing business, FLO seems quite stable and predictable. We can see it very clearly in terms of revenue, operating income and net income. Overtime, all three items have been growing gradually, step by step, slow but seems to be firm.
For the two year 2001, 2002, the operating income was positive, yet the net income turned negative. It was due to the large interest expense it incurred for the two years. And from that time on, the interest expense was not that significance, and increasingly lower percentage compared to the operating income. For the last 10 years, the annualized revenue growth is around 4.7%, but the operating income growth is 42.4% and the growth in net income since 2003 is nearly 32% per year. For that, we can see that the operating margin and the net margin are on the rise over time. Indeed, let say in 2003, the operating margin stayed at 5.3%, in 2010 it was already nearly 8%. And the net income was around 1% dated back then; in 2010 it was more than 5 times higher, at 5.3%.
The financial structure of FLO is ample, with the equal division between Equity and Liabilities in the total assets. In the liabilities side, the main item is the long-term debt and capital leases, at the recording amount of $305 million, whereas $230 million is from unsecured credit facility, within the $229.0 million in outstanding borrowings under the new credit facility at October 2011, approximately $166.7 million of which was utilized for the Tasty acquisition in May the same year. This credit facility is new, with the term of five-year, $500 million senior unsecured revolving loan facility with two, one-year extension options. Further, FLO may request to increase its borrowings under the new credit facility up to an aggregate of $700.0 million upon the satisfaction of certain conditions. In addition, FLO kept purchasing its own stocks over year, pushing up the outstanding balance of treasury stocks from $22 million in 2003 to $221 million in the quarter ended September 2011. That has lowered the amount of equity figures, making it sounds less prudent than it is in the financial statements.
FLO is considered to be consistent cash flow generator over time. Over the last 10 years, it kept generating positive operating cash flow as well as the free cash flow. The two set back years were 2008 and 2009 with the decrease in account payable and accrued liabilities combined with the increase in account payable and inventories.
Currently, with the debt of more than $300 million, the cash flow ratio is very prudent, at more than 100%, more than enough to cover the outstanding debts FLO is bearing.
For management, I would love to the see the significant holdings of all key insiders including directors, managements. As a group, FLO directors, managements are holding more than 17% of the total outstanding shares, the number which I found satisfactory.
(source: SEC filings)
However, in terms of insider trading, I am not very happy to see the consistent large sell-outs of CEO, CFO, Chief Accounting and Chief Information Officer of FLO, only two buy from two directors but that was very insignificant comparing the massive sell outs in the first half the year.
Discounted Free cash flow
With the consistent and somehow predictable free cash flow over time of FLO, the discounted free cash flow might be the good way to judge the intrinsic value of the company. First historically, the free cash flow of FLO grew from $30 million to $208 million in 10 years, making the annualized growth of nice 21.4%. Now in order to conservative, we estimated the next 05 years with the growth of only 15%, and then it would grow to infinity at the rate of 2%. The discount rate is at 10%.
|USD million||1||2||3||4||5||Terminal value|
With the somehow conservative estimation listed above, the calculated intrinsic value of FLO ranged around $4.2 billion. With the recent market capitalization of $2.52 billion, with the same discount rate, it would set the growth for the next 05 years of FLO at only 5%, and the infinity growth after that at 1%.
Following Morningstar figure, we can see that FLO valuation is quite comparable to the industry average in terms of P/E, P/S and P/CF, only the Price to book is a little bit higher, indicating the return on equity is much higher for FLO compared to the industry average, and it was quite comparable to the company’s 05 year average valuation in all measures.
FLO is quite fairly valued in terms of relative valuation, but it was quite undervalued when it comes to conservative estimation of the discounted free cash flow method. It was definitely not the screamingly cheap buy. But with the historical consistent dividend payment, yielding nearly 3% now, combined with the predictable business, it can be considered to fit well for the income investors as well as value investors to hold for the long-run.
This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.