Previously, I looked at Dr. Michael Burry’s Scion Capital’s most recent 13F Filing with the Securities and Exchange Commission, which detailed the fund’s four equity positions. The smallest of the holdings, coming in at just over 9% of the investment portfolio (13Fs exclude cash), is Gores Holdings Inc. Should investors follow him into the stock?
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Time to buy Gores?
Gores is a typical Burry stock. Gores, now known as Hostess Brands Inc. (TWNK, Financial), is an under-the-radar special purpose acquisition vehicle that merged with Hostess Brands, the maker of Twinkies, last month. SPACs are generally misunderstood and avoided by the market due to their poor history and complex nature, making them the perfect hunting ground for the rigorous value investor who is prepared to put in plenty of hours of work to get to the bottom of the business.
Hostess itself is another complicated story. The company has recently risen out of the ashes of bankruptcy (the second in the past 12 years) and is still loaded with debt. Net debt to 2016 estimated EBITDA is 4.5 times – hardly the sort of ratio that inspires confidence in a serial bankruptcy.
But Hostess isn’t a total train wreck. Like all confectionery companies, Hostess, maker of the highly popular Twinkies brand, is a relatively defensive business with impressive margins. Before merging with Gores the firm reported 30%-plus EBITDA margins with revenue growth of 11% this year and free cash flow conversion of 85% by the end of 2017. What’s more, it can be argued that Hostess’ prior problems have had little to do with structural market issues but are instead a result of high legacy costs and a cost structure that makes no sense in the modern world. During its first bankruptcy the group did little to bring down costs and rebase the business, which ultimately led to a second bankruptcy several years later. But after exiting the second bankruptcy Hostess had no legacy pension liability (it was paying $100 million per year on a $2 billion underfunded pension), far fewer factories, one-eighth the head count, limited exposure to unions and an exceptional cost structure.
The second bankruptcy not only led to a more streamlined Hostess, but it also showed how valued the brand was among consumers. Hostess was essentially out of the market for over six months beginning in late 2012 through July 2013. Despite that departure, Hostess relaunched to fanfare and great success gaining a 10% share of the snack market almost immediately. Over the next few years the firm’s market share rose to 15%. Market share growth hasn’t come through discounting or sales. In fact Hostess products sell at a premium to the competition of 82% helping the business achieve EBITDA margins and free cash flow conversion above most of its peers.
Management believes there is further room for growth. The firm is planning to increase the number of products per store from 20 to 25 and enter the food service, club, frozen retail and school markets. Cost savings are continuing to flow through with a third automated oven coming online during 2017 –Â part of the company’s $130 million capacity upgrade program.
According to Gores/Hostess’ projections already filed with the SEC, the Hostess business is expected to generate EBITDA of $235 million next year with unlevered free cash flow of $121 million. By 2018, EBITDA is expected to hit $253 million with unlevered free cash flow projected at $138 million. By 2020 EBITDA is projected at $283 million and unlevered free cash flow at $157 million.
Since returning to the market the stock has gone from around $12 per share to $12.84 at the time of writing with a market capitalization of $1.23 billion and an enterprise value in excess of $2.3 billion. Based on these numbers the group is trading at a 2017 EV/EBITDA ratio of 11 and a 2017 free cash flow yield of around 10% rising to just under 13% by 2020, a highly appealing ratio in the current environment.
Maybe Burry is on to something with this maker of the iconic Twinkies brand.
Disclosure: The author does not own any share mentioned.
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