FLO - Flower Foods: Baked After A Tough Quarter

2023-06-15 13:13:18 ET

Summary

• Flowers Foods, Inc. has long paid out compelling dividends to investors.
• Other than the yield and modest dividend hikes, there is no strong growth seen on a per-share basis.
• Given the higher interest rate environment, I fail to see the appeal, even after a recent pullback.

In the fall of 2018, I concluded that shares of Flowers Foods, Inc. ( FLO ) were a wrong bake. Earnings reported at the time disappointed investors again, as a focus on innovation (through M&A) has not delivered on structural growth, nor revamped lackluster margins.

The appeal was alluring with share trading in the higher teens, although I required a bit of a higher earnings yield before getting involved. That earnings yield never revealed itself in a rising interest rate environment, making me very cautious, despite a setback in the shares at the time.

A Recast

Back in 2018, Flower Foods was a near-$4 billion bread business, with very large brand awareness across the U.S. The business was under pressure, with consumers having shifted away from traditional bread and baked goods.

The company sold (and still sells) these breads (and some cakes) through the branded retail channel, supplied by nearly 50 bakeries across the U.S., employing some 10,000 workers. Flower Foods held an impressive 15% share in the $25 billion retail fresh baker business, which performed rather flattish in terms of sales at the time.

In 2017, Flower Foods reported $450 million in EBITDA on a $3.9 billion revenue base, with adjusted earnings reported at $0.89 per share, although that 2018 earnings should improve above the dollar mark on the back of tax reform. With net debt equal to $775 million, a resulting 1.8 times leverage ratio was rather modest, allowing for some bolt-on dealmaking, all while the company commanded a $4.0 billion equity valuation at $19 per share.

With the company paying out close to all its earnings, a 4% dividend yield was the key attraction to the shares, with little growth seen, as expensive deals in the organic part of the business has not resulted in structural growth either. As Flower Foods targeted some margin expansion, appeal was seen if the company would execute, which was the big if, and something which I openly doubted. To see appeal, higher earnings and dividend yield would be required, although we have not seen my desired entry level around $15 per share ever since.

Stagnation

Moving from 2018 until today, about five years later, shares of Flower Foods have actually done quite alright. In fact, FLO shares have risen in a very steady fashion to the $30 mark late last year, before selling off to the $25 mark in recent weeks.

Fast forwarding to February of this year, We have seen Flower Foods increase sales to $4.8 billion, coming in some 20% ahead of 2018. Revenues rose 11% last year, with inflationary pressures providing an uplift to the reported sales numbers.

That is about the good news, as the same cannot be said for margins, with EBITDA margins down 90 basis points to 10.4%, with adjusted EBITDA up a mere 2% to $502 million, marking hardly any progress on that front for the last couple of years. Adjusted earnings improved three pennies to $1.27 per share, with GAAP earnings of $1.07 per share (traditionally) coming in softer than the adjusted numbers. Net debt of $725 million was quite stable, with leverage ratios being modest, all while the share count has been rather flat, and the dividend has steadily ticked up to $0.88 per share.

The 2023 guidance was largely in line with what could be expected in this inflationary environment, with sales seen up 8-9% to $5.2 billion, adjusted EBITDA seen at a midpoint of $528 million, and adjusted earnings seen flattish between $1.20 and $1.30 per share. Needless to say, certainly in a higher interest rate environment, valuations were demanding at $30, for a roughly 24 times earnings multiple. After all, a 4% earnings yield (which showed no growth) trailed risk-free rates by a substantial margin.

A Bombshell Quarter

The first quarter earnings report, as released in May, revealed a modest 7% increase in first quarter sales to more than $1.5 billion, in what seasonally is a stronger quarter. EBITDA margins of 9.8% were down 170 basis points, with adjusted earnings down six cents to $0.38 per share.

The company subsequently cut the full year earnings guidance by five pennies, while trimming the sales outlook to $5.1 billion, with adjusted EBITDA seen at $511 million. Moreover, net debt ticked up to just above the billion mark, a dismal outlook, as quite frankly I feel that the risks to the full year guidance are now clearly seen to the downside.

With the shares having fallen to the $25 mark, the earnings yield has improved to nearly 5%, but given the lack of earnings growth seen this year, and really for years, it is still hard to see appeal just yet with risk-free rates trading at similar levels.

After all, the appeal of Flowers Foods, Inc. stock is the dividend yield of 3.5% here, but outside the dividend, there is just very modest earnings growth to be expected, with no reduction in the share count to deliver on stronger growth on a per-share basis on that front.

Given this background, I continue to be cautious about Flowers Foods, Inc. stock, even as the company hiked the quarterly payout by a penny per quarter to $0.92 per share late in May, pushing up the yield to 3.7%, still lagging risk-free rates by a substantial margin. Given all this, still see no reason to get involved, even if shares are down a sixth from the 2022 highs, requiring a further pullback to the twenty mark before potentially seeing any appeal in Flowers Foods.

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