For the second time in a row, TreeHouse (THS, Financial) has disappointed its investors. The company was hit by lower and weak coffee sales, and it lowered the guidance for the full year, further driving the negativity around the stock. The company posted first-quarter fiscal 2015 results, and it was a case of mixed bag as it beat earnings but missed on revenues. Let’s recap the quarter and see what the future holds.
Looking at first quarter
Coffee margins have declined due to excess capacity, and snacks growth has declined. Also, organic sales declined 2.6% year-over-year and it was the acquisitions that made the results look less gloomy. Over the years, TreeHouse has grown through acquisitions, like its peer B&G Foods (BGS, Financial), from $700 million in 2005 to $3.5 billion in 2014. During the reported quarter, sales jumped 26.5% year-over-year, primarily on the back of acquisitions which added around 29% to sales. However, currency translations hurt negatively by 1.7%. Despite the jump, TreeHouse failed to impress the analysts’ who were expecting revenues to be $56.97 million more.
The top-line got a boost from around 30% year-over-year sales increase in the North American category. But, excluding the impact of acquisitions, organic sales were down 5.7% year over year. Negative impact of currency translations hit the numbers by 2%, while sales volume and pricing was down by 2.6% and 1.1%, respectively.
One positive takeaway in the reported quarter has been the robust performance of the industrial and export segment, despite the strengthening of the U.S. dollar. The segment revenue soared by a whopping 31.6% year over year, with acquisitions contributing 18.9% and balance coming from sales volume and mix component.
Another positive from the reported quarter is that TreeHouse reported earnings per share of $0.59, which was ahead of analysts’ expectations of $0.58.
So, the company beat on earnings but missed on revenue.
What caused the problems?
Company’s margins have taken a beating too. Gross margin declined 2% year over year to 19.5% as a result of acquiring low margin businesses accounting for 1% and balance 1% decline coming from strong dollar, pricing pressures and product mix. In fact, the acquisitions in coffee businesses more than wiped off the good performance in other segments. In addition, expansion of operating costs by 10 basis points, or bps, further added to margin woes.
The company was quick to blame the single-serve hot beverages market for its troubles in the quarter, which is expected to hurt for next few quarters. Growth in brewer sales have declined sharply as mentioned in my piece on Keurig Green Mountain (GMCR, Financial) here, which made the use of unlicensed pods impossible due to technological lockout. However, GMCR is expected to do away with this lockout, so how this impacts the overall market and TreeHouse is yet to be seen.
Growth driver
TreeHouse’s premium organic natural and better-for-you formulations continue to show year-over-year increases, with pricing being 30% above average for typical national brand equivalent products. This shows that customers are willing to pay premium for healthy options and this leaves good margin for both TreeHouse and private label retailers. This can be a growth driver in the long term also.
TreeHouse has grown rapidly on the back of acquiring businesses and integrating them into its operations.
"We continue to be pleased with the integration progress of our recent acquisitions. Protenergy Natural Foods continues to deliver results above our initial expectations, and we expect Flagstone Foods' growth to ramp up meaningfully in the back half of 2015," Reed concluded. “Flagstone Foods remains the cornerstone of a multi-billion dollar better-for-you snacks platform in the making."
So, ramping up Flagstone Foods' growth will be one of the growth drivers in the back half of fiscal 2015. Over the years, TreeHouse has kept all the cash generated to itself and has allocated it wisely toward acquisitions and driving growth. TreeHouse has a natural appetite for acquiring mid-sized businesses and effectively integrating them into its business, and it is on the back of these moves that the company has grown from $700 million in 2005 to $3.5 billion in 2014. Further acquisitions cannot be ruled out.
Final words
TreeHouse disappointed the investors for second time in a row. The company has lowered full year guidance and this will spook investors and drive down the share prices. With trailing P/E of 32.29 and forward P/E of 18.51, growth in earnings is expected. However, currently it is already trading at a premium and I see a correction in coming as weakness will prevail. Hence, I would rather watch this stock from sidelines for the time being.
