(Published Feb. 15 by Nick McCullum)
Flowers Foods (FLO, Financial) reported earnings for fourth-quarter and fiscal year 2016 on Feb. 14.
Despite it being Valentine’s Day, investors did not love the stock after the company’s earnings announcement.
Flowers Foods stock dropped 8.8% that day.
Source: Yahoo! Finance
This is not necessarily a bad thing for the long-term investor however.
When companies experience (or are perceived to experience) short-term trouble, it can be a great opportunity to pick up shares at a discounted price.
“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.” – Warren Buffett (Trades, Portfolio)
We will discuss why Flowers Foods current stock price presents a buying opportunity rather than a reason to be fearful.
Business overview
The predecessor of Flowers Foods was founded in 1919 by two brothers in Thomasville, Georgia. The company became known for its high production volumes, state-of-the-art technology and great sanitary standards.
The company first went public in 1968 as Flowers Industries and introduced its famous Nature’s Own bread in 1977. The company was renamed Flowers Foods in 2001 and has gone by that name ever since.
Flowers Foods is now the second-largest bakery business in the United States. With four product mixes, two distribution networks and three sales channels, it has become a force to be reckoned with in the bread industry.
Source: Flowers Foods Investor Presentation, slide 5
Flowers Foods has a distinct competitive advantage that comes from its many brands of popular bread. Most notably, Flowers Foods owns Nature’s Own, Dave’s Killer Bread and Wonder, among others.
Source: Flowers Foods Investor Presentation, slide 8
Financial performance overview
As mentioned previously, Flowers Foods reported earnings recently.
In its press release, Flowers Foods announced the following financial results for full-year fiscal 2016, with comparisons being made to fiscal 2015:
- Sales increased 3.9% to $3.927 billion. The acquisitions of Dave’s Killer Bread and Alpine Valley Bread contributed 4% to the sales increase.
- Diluted GAAP EPS decreased 12.4% to 78 cents.
- Adjusted EPS decreased 1.1% to 91 cents.
- Costs associated with Project Centennial were $6.3 million, which translates to two cents per share.
There are three main things to note from Flowers Foods’ full-year figures.
The first is that sales increased 3.9%, but 4.0% was contributed from the company’s two major acquisitions during the year. This means that the company’s top line growth was driven entirely by acquisitions. Flowers Foods would have seen a minor 0.1% contraction in revenues ex-acquisitions, and this may have contributed to the stock’s drop after the earnings announcement.
Secondly, GAAP EPS decreased 12.4%, but adjusted EPS decreased only 1.1%. This is a large difference, and the company cited the following reasons for the lack of comparability:
- Trademark and Asset Impairments of $24.9 million.
- Legal Settlements and Related Tax Liabilities of $10.5 million.
- Pension Plan Settlement Losses of $6.6 million.
- Loss of Extinguishment of Debt of $1.9 million.
With the exclusion of the last two items, the majority of these costs were incurred in the fourth quarter. So, this substantial difference between GAAP and adjusted EPS will also be seen in the company’s fourth-quarter results.
Lastly, the company reported costs from Project Centennial of two cents per share, which is 2.6% of GAAP EPS and 2.2% of adjusted EPS. Project Centennial is Flowers Foods initiative to return growth to the company, which will be discussed in more detail later. I mentioned it here to show the company is investing a significant amount of capital into the initiative.
Flowers Foods also announced the following financial results for the final quarter of fiscal 2016. Each of the comparisons is being made to the same quarter one year ago.
- Sales increased 1.2% to $868.7 million.
- Diluted EPS decreased 60% to six cents.
- Adjusted EPS remained unchanged at 16 cents.
The 60% decrease in diluted EPS was likely on the back of the substantial legal impairment incurred in the fourth quarter.
In December, we published an article describing how Flowers Foods recently settled a class action lawsuit with respect to the company classifying some of its drivers as independent contractors rather than employees.
Here is what Flowers Foods said in the Dec. 9 press release surrounding the settlement:
“On Dec. 9, 2016, Flowers Foods Inc. and Flowers Baking Co. of Jamestown LLC, reached an agreement to settle Rehberg et al. v. Flowers Foods Inc. and Flowers Baking Co. of Jamestown LLC , a class action lawsuit that was filed in March 2013 in the U.S. District Court for the Western District of North Carolina (Charlotte Division). 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.”
Investors were generally expecting the settlement to be much worse, so when the settlement was announced, the stock price shot up accordingly.
Looking ahead
One of the main growth prospects for Flowers Foods in the immediate future is Project Centennial. This is an initiative that is aimed at cutting costs and restoring EPS growth. Project Centennial has gone through two stages so far.
The first stage consisted of a comprehensive diagnostic evaluation of the company’s opportunities to drive growth, reduce costs and invest internally. The goal of identifying these opportunities was to boost Flowers Foods’ competitive positions and improve the operating margins. The company announced the first stage had been completed on Nov. 9.
Flowers Foods also said the second stage of Project Centennial began in mid-October. Management is now developing and executing on the opportunities that were identified in the first stage of the initiative.
In the company’s most recent press release, here is what was noted about Project Centennial:
“With Project Centennial, we are taking decisive action to pivot towards the consumer and remove complexity and costs from our business. In fiscal 2017, we are moving forward with urgency to reinvigorate our core business, reduce costs and build capabilities to efficiently grow our brands.” – Allen Shiver, Flowers Foods CEO
Project Centennial is expected to seriously ramp-up in fiscal 2017, with the company expecting costs from the program to be in the range of seven cents to nine cents per share.
I am confident in the project’s ability to return Flowers Foods to growth.
Secondly, fiscal 2016 saw Flowers Foods close two significant acquisitions – Dave’s Killer Bread and Alpine Valley bread. With these assets still fresh on the books, the company should still be capable of realizing cost synergies that will translate to the company’s bottom line. Further, I am sure Flowers Foods will continue to complete acquisitions it deems attractive.
All in all, Flowers Foods still has good growth prospects over the long run.
Final thoughts
Without a doubt, Flowers Foods stock price is at a depressed level. The company is currently trading at its lowest point in calendar 2017.
It is important to keep in mind that this company just reported flat fourth quarter adjusted earnings, a 1.1% decrease in full-year adjusted earnings and 3.9% sales growth for fiscal 2016. The company’s stock dropped 8.8% – but has its value dropped 8.8%?
I would argue it has not. Flowers Foods is trading at more of a bargain than at any other time in 2017.
“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” – Buffett
Value-oriented investors may benefit from picking up shares of Flowers Foods before the stock returns to a more normalized level. Flowers Foods is currently the tenth-highest ranked stock in the United States using The 8 Rules of Dividend Investing due to the recent price decline.
Disclosure: I am not long any of the stocks mentioned in this article.
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