TWNK - 2 Reasons to Like the Smucker-Hostess Deal One Reason to Hate It
2023-09-20 10:10:29 ET
InvestorPlace - Stock Market News, Stock Advice & Trading Tips
On Sept. 11, J.M. Smucker (NYSE: SJM ) announced that it would acquire Hostess Brands (NASDAQ: TWNK ), the maker of snack food favorites such as Twinkies and HoHos, for $5.6 billion in cash and stock. The Smucker-Hostess deal is the Ohi0-based company’s largest acquisition in its history.
“We are excited to announce the acquisition of Hostess Brands, which represents a compelling expansion of our family of brands and a unique opportunity to accelerate our focus on delighting consumers with convenient solutions across different meal and snacking occasions,” said Mark Smucker, Chair of the Board, President and Chief Executive Officer.
Since Smucker announced the deal, SJM stock has lost more than 10% of its value, a sign investors disagree with the acquisition.
While it’s way too early to declare the transaction a success or failure, it’s not too early to chime in on some of the pros and cons of Smucker’s making this deal.
Here are two reasons to like it and one reason to hate it.
The Convenience Store Market Is Huge
The number of suitors for Hostess is said to have been significant. Smucker’s beat out some heavyweight snack businesses such as Mondelez International (NASDAQ: MDLZ ), PepsiCo (NASDAQ: PEP ), and Hershey (NYSE: HSY ).
All three of those businesses have excellent CEOs, so Smucker’s CEO, Mark Smucker, can smile knowing he was the one that secured the iconic snack maker less than two decades removed from its first of two bankruptcies in 2004 .
Despite the move to healthier snacks in recent years, it’s clear from the battle to buy Hostess that there remains a market for sweet snacks with little nutritional value, but lots of tasty enjoyment.
Ultimately, Smucker’s understood how vital Hostess’ convenience store market was to its future growth.
For example, the company acquired its Uncrustables brand in 1999 for $1 million. It has done little advertising since then because it couldn’t produce enough. It now has a factory that can blow them out of the water. More importantly, it has figured out how to make a product with bread that can thaw from frozen and remain fresh for five days in a convenience store refrigerator.
Combining the new bread and convenience store distribution should increase Uncrustable sales from $650 million today to $1 billion soon.
Hostess Has Strong Brand Awareness
There is no question that Twinkies and HoHos are very popular with the average American. However, the company’s newer products could help Smucker’s expand its snacking business beyond Uncrustables.
CEO Andy Callahan appeared in an April 2023 Associated Press article discussing Hostess Brands’ focus on innovation .
“It’s the way that brands become contemporary. It’s a way that they stay relevant and it’s the way they create a bridge to a new generation,” Callahan stated.
“When I took over Hostess five years ago, we had stopped that process. We’d stopped talking to consumers, we’d stopped innovating. We became more relevant in the business press than we became in the consumer press.”
For example, in February, Hostess launched a new product called the Kazbar , which the company describes as “layers of soft chocolate cake, crème, candy crunch and melt-in-your-mouth caramel or smooth chocolate fudge,” stated its press release.
Relevant to the purchase by Smucker’s is the fact that Kazbars are sold in 1.25-ounce and 2.75-ounce packages in convenience stores and grocery stores. With shelf space next to all the other Hostess products, Uncrustables should continue to gain market share.
However, it all starts with the strong brand awareness of the Twinkie. Even through two bankruptcies, Americans knew and loved the sweet snack.
The Smucker-Hostess Deal Means Too Much Debt and Not Enough Growth
The deal to buy Hostess, while 12% in stock , will add considerable debt to Smucker’s balance sheet. For example, it’s assuming $900 million in net debt from Hostess. Then, it has to finance approximately 88% of the remaining $4.7 billion in equity. So, let’s call it an even $5 billion in financing.
As of July 31, 2023, Smucker’s had $4.32 billion in long-term debt. The Hostess acquisition will double its debt to approximately $9.32 billion. Based on $32.1 million in interest expenses in the latest quarter, its annualized cost on its debt would be $128 million.
So, more than doubling its debt increases its annual interest payments to more than a quarter of a billion dollars. That’s not chump change. Further, it has $1 billion in 3.5% senior notes due in March 2025. If interest rates remain elevated until then (a possibility), Smucker’s interest costs on its biggest debt go way up.
That doesn’t consider what rate it will pay on the $5 billion in new financing. It should be higher than the rates it’s paying on its existing debt.
As for growth, Hostess adds $1.5 billion in annual revenue with mid-single-digit growth. Smucker’s revenues are expected to increase by 9.0% at the midpoint of its guidance for the year.
While that sounds good for a packaged foods company, the fact that it’s doubling its debt means it needs to generate significantly more cash flow from operations to pay down the debt in a reasonable amount of time.
The company will take more than a year to integrate the Hostess business into its own. History has shown that projected benefits from significant Smucker’s acquisitions in the past — think Big Heart Pet Brands (Milk-Bone, Meow Mix, etc.) — have not produced the results necessary to drive its share price higher.
There is a significant risk that Hostess Brands will be another value detractor for the company’s share price. Up just 15% throughout the past five years, Smucker’s shareholders ought to think carefully before holding for another five years.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines .
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia.
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