As investors, it is prudent to purchase shares in businesses that have long-term staying power. This provides the sleep-well-at-night level of comfort that comes from knowing your stock will still be doing well five,10 or even 20 years from now.
Flowers Foods (FLO, Financial) definitely fits this bill. A bakery business with a market capitalization of ~$4 billion, this company is a darling for dividend growth investors.
It is not hard to see why – with a dividend yield of greater than 3% and 29 years of steady or increasing dividends, this company has a proven track record of growing income for shareholders.
Flowers Foods is a member of the Dividend Achievers Index, a group of elite companies with at least 10 years of consecutive dividend increases. You can see all 273 Dividend Achievers here.
On Nov. 9, Flower Foods reported earnings for the 12-week period ending Oct. 8. This article will cover that earnings release in detail and discuss the investment prospects of this company.
On Dec. 9, Flowers Foods also announced some very favorable news for investors. Namely, they have settled a class-action lawsuit filed in 2013 in North Carolina that has had investors worried for years. The settlement was much smaller than expected and the favorable economic conditions that led to this lawsuit are permitted to stay intact. This announcement will also be discussed.
Business overview
Key Stats:
- Stock Price: $19.30
- Market Capitalization: $4.12 billion
- Price-Earnings Ratio: 23.0 using adjusted earnings
- Dividend Yield: 3.3%
The origin of Flowers Foods can be traced back to 1919 when two brothers, William Howard and Joseph Hampton Flowers, opened the Flowers Baking Company in Thomasville, Georgia. The company grew rapidly through serial acquisitions until, in 1968, the company went public as Flowers Industries.
After a 10-year transformational period starting in the mid-1990s, Flowers Industries became Flowers Foods and is now a force to be reckoned with in the baked goods industry. Their flagship product, Nature’s Own, is the number one bread brand in the U.S.
Flowers Foods does a fantastic job outlining their business operations with the following summary from their 2016 investor fact sheet.
Source: Flowers Foods Investor Fact Sheet
One of the major selling points of Flowers Foods is the brand equity that their company owns. Their portfolio of products contains many household names, as illustrated in the following picture.
Source: Flowers Foods Investor Fact Sheet
Historically speaking, Flowers Foods has allocated a lot of their capital towards financing acquisitions. Similar to Alimentation Couche-Tard, Flowers operates in an extremely fragmented industry that lends itself very well to acquisition-based growth.
Source: Flowers Foods Investor Fact Sheet
Now that we have a sense of the operations of this company, let’s dive into their third quarter financial performance.
Financial performance
As already mentioned, Ă‚ Flowers Foods reported third quarter financial results on Nov. 9 for the 12-week period ending Oct. 8. Here are a few financial performance metrics highlighted in their press release.
- Sales increased 3.8% to $918.8 million. Acquisitions of Dave’s Killer and Alpine Valley Bread contributed 4.4% to the overall sales increase.
- Diluted EPS decreased 9.5% to 19 cents.
- Adjusted diluted EPS decreased 8.7% to 21 cents.
- Net income decreased 8.2% to $40.2 million, adjusted net income decreased 10.0% to $43.3 million.
- Adjusted EBITDA decreased 3.0% to $101.7 million.
- The company continues to expect for the year ending Dec. 31, 2016:
- Sales range of $3.930 billion to $3.986 billion.
- Diluted EPS range of 88 cents to 93 cents.
- Adjusted diluted EPS range of 90 cents to 95 cents.
- Continued execution of Project Centennial, a comprehensive business and operational review.
- Recorded a legal settlement charge of $1.25 million related to an agreement that was entered into subsequent to quarter end to settle a class-action misclassification lawsuit in Connecticut.
Source: Flowers Foods Press Release
As you can see, the company experienced declines in essentially every major financial metric. The company’s stock reacted accordingly, opening much lower than the previous close – though it recovered quickly through the course of the week.
The financial results of this company for the third quarter are concerning because diluted EPS declined (by 9.5%) even though sales actually increased (by 3.8%, though acquisitions actually boosted that number by 4.4%, suggesting that sales declined on a pre-acquisition basis). Since EPS declined while sales increased, this suggests poor cost management – something I will be watching closely moving forward.
CEO’s remarks and ongoing litigation problems
Flowers Foods President and CEO Allen Shiver said the following about the quarter’s financial performance:
“... our results in the third quarter were affected by challenging category dynamics and elevated marketing and legal costs.We remain acutely focused on driving growth and increasing efficiencies, including our Project Centennial efforts. The initial diagnostic phase is complete, and we are now finalizing our plans to implement strategies intended to grow sales and improve margins."
I have included this quote to point out one thing. The company was affected by increased legal costs – this is largely due to various class-action lawsuits that challenged the classification of the distributors of Flowers Foods as “independent contractors.”
The company was being sued by 190 of its 5,100 independent distributors for being classified as independent contractors rather than employees. The company settled the lawsuit. The settlement is very small for a company as large as Flowers – only $9 million dollars.
Here is what was announced in the Dec. 9 press release:
“The settlement provides for payment of $9.0 million, comprised of $5.2 million in settlement funds and $3.8 million in attorneys’ fees. The settlement also contains certain non-economic terms that are intended to strengthen and enhance the independent contractor model, which remains in place. This agreement, which covers approximately 270 distributor territories, is subject to court approval.”
For investors, this is fantastic news. The stock price reflected that by jumping 13% the day of the announcement. One thing to point out is that the settlement contains “non-economic terms that are intended to strengthen the independent contractor model, which remains in place.” The continuation of this independent contractor model is a highlight from a great press release for Flowers Foods.
This was the single biggest concern investors had about Flowers Foods, so the investment prospects of this company just became even better.
An update on Project Centennial
When the company released their second quarter earnings earlier this year, they announced a new initiative called Project Centennial will run through fiscal year 2019 (marking the company’s 100th anniversary, hence the name). The project, done in conjunction with consulting firm Accenture and aimed at reducing operating costs, is seen as a key driver of future earnings growth.
In their earnings release, the company provided the following update on Project Centennial:
“During the quarter, Flowers progressed towards the completion of the first phase of Project Centennial, which included a comprehensive diagnostic evaluation of opportunities to drive growth, reduce costs and make investments intended to strengthen the company’s competitive position and improve margins over the long term.
In mid-October, Flowers began the second phase, which entails formulating and executing new strategies to capture growth opportunities. To fund these initiatives, the company is currently finalizing the specific actions necessary to achieve savings through identified operational improvements that include further use of the company’s shared services capabilities, network optimization, and better leveraging the company’s expenditures on goods and services.”
The company has admittedly been quite vague about the inner workings of Project Centennial. However, as a business that has historically driven growth through acquisitions, I suspect that Project Centennial is focused on identifying cost synergies related to recent acquisitions (like Dave’s Killer Bread and Alpine Valley Bread).
I am excited to see how Project Centennial unfolds over the next few years.
Investment thesis & valuation analysis
My investment thesis is mostly centered around the stock’s attractive valuation and great dividend.
Recent years have not been kind to the stock price of Flowers Foods, with the stock price experiencing a distinct downturn. After the announcement of the lawsuit settlement, the stock price increased noticeably but is still trading below normal levels.
Source: Yahoo! Finance
Now that investors’ largest fear has been addressed, I believe that Flowers’ prospects look better than ever. The underlying business remains quite strong and I believe this continued price downturn presents a buying opportunity rather than a reason to be fearful.
Based on this quarter’s adjusted diluted EPS of 21 cents (which corresponds to a run-rate of 81 cents), the company trades at a multiple of 23.0 times adjusted diluted earnings. This compares favorably to the overall stock market – as the S&P 500 currently trades at a price-earnings ratio of around 25. So the company is attractively valued based on earnings.
Based on assets, the same trend holds. Flowers reported $1,177.22 million of total equity on their balance sheet for the most recent quarter, with no preferred equity outstanding and total common stock outstanding of 207.63 million. This means that Flowers Foods has a book value per common share of $5.67.
Based on their current stock price of $19.30, the company is trading at a price-to-book value of 3.4. This is well below the company's historical average – for example, the company traded as high as 4.5 times book value towards the end of 2015.
Based on either earnings or assets, Flowers Foods trades at an attractive valuation.
Dividend prospects
As mentioned earlier, Flowers Foods has a incredible 29-year record of steady or rising dividends. There are very few companies that can match this kind of dividend longevity, particularly companies that are this small in size (less than $4 billion market capitalization).
The dividend growth has not been slow, either – dividend payment growth from nine cents in 2004 to 57 cents in 2015 represents a cumulative annualized growth rate of 18%.
Due to the recent price drop, the company's dividend yield is at a high level compared to historical levels. Based on their $19.30 stock price and their current annualized dividend payment of 64 cents, the company pays a forward dividend yield of 3.3%.
Lastly, Flowers’ dividend is safe. As mentioned, their adjusted diluted earnings per share this quarter was 21 cents. Given their quarterly dividend of 16 cents per share, this means the bakery company has a payout ratio of 76%. Keep in mind that this comes during a year that has seen the company’s earnings decrease – the ratio will reduce as earnings growth resumes.
Their dividend is sustainable and should continuing growing along with a recovery in earnings.
The bottom line
While I maintain that investors should not pay too much attention to quarterly results, there is no denying that the third quarter was not the most impressive quarter for Flowers Foods.
However, the underlying business remains strong. They continue to operate in a recession-resistant industry (people will always buy bread), and they are a source of consistent, reliable dividends for shareholders.
The concerns surrounding the litigation made the stock price drop to irrational levels, and though the stock still trades below historical averages, this does not worry me. Now that the litigation is over, this stock should return to a level more closely resembling fair value.
This presents a buying opportunity rather than a reason to avoid this stock. Warren Buffett said it best:
“The best thing that happens to us is when a great company gets into temporary trouble…We want to buy them when they’re on the operating table.”
Disclosure: I am long Flowers Foods.
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