THS - TreeHouse Foods: About Time To Grab This Food Producer

2023-08-08 08:52:44 ET

Summary

• TreeHouse Foods is a leading private label food manufacturer positioned to capitalize on customers trading down to generic private label brands.
• The company has undergone a transformation, shifting to high margin profile and deepening its presence in various product categories.
• TreeHouse Foods reported strong earnings growth, raised its guidance, and trades at a discount to its peers, making it an attractive investment opportunity.

Investment Thesis

TreeHouse Foods ( THS ), spun off from Dean Foods, is a leading private label food manufacturer serving a wide range of retail grocery, foodservice, and co-pack customers. Heading into Q2, investors anticipated a beat given the company recently revised their guidance higher during the analyst day held on June 13 this year; however, it again raised its guidance after topping analyst expectations, which is a positive surprise. Also, given customers are trading down to generic private label brands at the retailers such as Costco (COST), Walmart (WMT), Amazon (AMZN), and others, THS is perfectly positioned to capitalize on the opportunity. We initiate THS as a Buy given favorable macro tailwinds, its premium positioning, and competitive moat.

Background

THS has transformed itself into a high-growth, high-margin company after a series of strategic steps. It grappled with operational issues despite a favorable macro environment since the pandemic as a result of economic uncertainty and price increases, with its share price remaining flattish since the onset of the pandemic till the end of last year, significantly underperforming the broader markets as well as its peers.

It also struggled with operational issues in its meat preparation business, which was generating low margins and forming more than 50% of the company sales. However, since last year, it has been on a transformation with management changes and the sale of its low margin meat preparation business for $950 mn to a PE firm at a juicy 13.6x EV/ EBITDA helped them to bolster its balance sheet and reinvigorate its focus on high margin categories. It has extended its presence and reach across a wide range of private label brands within snacking, coffee & RTD, Tea as well as frozen and refrigerated products which has a sizeable TAM and category growth in HSD.

We believe the lean high-margin profile with category leadership and depth across several segments makes THS perfectly positioned in an uncertain macro environment.

Earnings Corner

THS reported strong Q2 results with organic sales growing 4% YoY as a result of 11% jump in ASP partially offset by 7% decline in volumes/portfolio mix. Gross margins came in at 15.7%, an improvement of 200 bps YoY, driven by pricing actions partially offset by ongoing investment in supply chain. This came in a tad lower than consensus expectations, however, it bodes well for the company's future as demonstrated by continued improvement in service recovery over the past quarters.

SG&A expenses came down at 9% YoY as a result of lower retention bonus expenses and lower professional fees which along with strong sales and robust gross margins led the EBITDA increasing 49% YoY at $76.4 mn with margins expanding 250 bps YoY to 9.1% and Adj. EPS growing to $0.45, in line with expectations. Balance sheet flexibility remains robust with liquidity of $284 mn and no maturities until 2026 with Net Debt/EBITDA expected to be under 4.5x at the end of 2023.

THS raised its guidance further, driven by strong momentum as it now expects organic net sales to grow 7.5-9.5% (from 6-8%), and also raised its adj. EBITDA expectation to $360-$370 mn (from $355-$370 mn). We believe, given the current momentum, THS is likely to beat its estimates primarily as the high-margin sales volume from the coffee acquisition gets added to the total as well as continued improvement in gross margin primarily driven by TMOS and supply chain savings initiatives.

Valuation

THS trades at 16.3x Fwd Earnings, which is at a discount to its peers. We believe, given the recent track record of the company with robust growth and improving margins as demonstrated by improving outlook, this provides a favorable risk reward for the investors. Initiate with a Buy with a target price of $60 (at 20x 2023E PE)

Seeking Alpha's quant rating also rates it as a Buy, driven by continued momentum and upward revisions to the guidance.

Risks to Rating

Risks to rating include:

1) any improvement in the macro environment and deflation which can lead to a lesser number of consumers trading down and impact its private label brands

2) THS has lower pricing power than its peers given it sells private label products and operates on lower margins and any impact on commodity prices or food inflation could significantly affect the business.

3) THS faces intense competition from a wide range of snacking, coffee and RTD and tea products from a large host of well-capitalised competitors which can significantly affect earnings.

Conclusion

THS has been a beneficiary of consumers trading down on the back of food inflation and the retailers' focus on improving their private label brands over the years. We believe the transformed THS provides a compelling high margin and cash flow generation story. It is perfectly positioned to capitalise in the uncertain macro environment and has demonstrated a track record of operational excellence which will continue to drive earnings higher. Initiate at Buy with a target price of $60 (at 20x 2023E EPS).

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