Summary
- Carryover impact from price increases, distribution gains, higher advertising and promotional activities, and new product innovation should help sales growth in the 2023.
- Margins should also see a slight benefit from price increases along with moderating inflation.
- However, the stock is fairly valued.
Investment Thesis
Hostess Brands, Inc. ( TWNK ) is expected to see its revenue growth normalize in 2023 as demand for snacking products moderates from the peak levels of the last couple of years. However, the company should still be able to deliver revenue growth due to carryover benefit from price increases in the back half of 2022, distribution gains for Voortman cookies, increasing investments in advertising and promotional activities, and new product innovations. The margin should also see some slight improvement as inflation moderates and the company sees Y/Y price increases in FY23 versus prior year levels. Overall, I am optimistic about the company's growth prospects. However, the company is fairly valued at the current levels, and these growth prospects are already reflected in its valuation. Therefore, I have a neutral rating on the stock.
Q4’22 Earnings
Hostess Brands, Inc. announced better-than-expected results for the fourth quarter of 2022. Revenue was $339.5 million, up 14.2% YoY and above the consensus estimate of $331.3 million. Adjusted EPS was $0.25, unchanged from the prior year's quarter and above the consensus estimate of $0.24. However, adjusted gross margin declined 90 basis points YoY to 36.3%, while adjusted EBITDA margin declined 250 basis points YoY to 22.1%. The increase in revenue was driven by price increases and distribution gains in Voortman brand. The decline in adjusted margins was due to inflationary costs and higher brand investments.
Revenue Analysis and Outlook
Hostess Brands has experienced strong revenue growth over the past couple of years, benefitting from increased demand for snacks during the pandemic. This trend towards snacking continued throughout 2021 and 2022.
In the fourth quarter of 2022, TWNK's sales growth was primarily due to price increases and increased distribution of the Voortman brand sugar-free cookies and wafers. This resulted in a 14.2% YoY increase in sales to $339.5 million. Organic growth reflected a 20.5 percentage point benefit from favorable price/mix and a 6.3 percentage point headwind from volume decline.
TWNK’s Historical Revenue (Company Data, GS Analytics Research)
Looking ahead, although demand is expected to normalize following a very strong last couple of years, the company should still be able to achieve good revenue growth due to price increases, distribution gains, and investments in advertising and promotions.
Hostess Brands has increased its prices multiple times over the last year, as shown in the chart below. The carryover impact from price increases in the latter half of last year should support TWNK's sales growth in the first half of 2023 as price comparisons become easier.
TWNK’s Y/Y average Price Increases (Company Data, GS Analytics Research)
In addition, Hostess Brands' Voortman brand (acquired in January 2020), which offers sugar-free cookies and wafers, is gaining distribution. The Voortman brand is benefiting from the increasing demand for healthy snacking options, and its distribution gains over the last couple of years have led to strong point-of-sale ((POS)) growth for the brand. I anticipate that these distribution gains and growing demand for sugar-free products will continue in 2023 and contribute to TWNK's sales growth.
TWNK’s Voortman Brands Point-of-Sales growth (Company Data, GS Analytics Research)
Furthermore, Hostess Brands is increasing its investment in advertising and promotional (A&P) activities, particularly in its impulse-driven sweet baked goods category, which accounts for ~90% of its total sales. The company reports over 90% consumer awareness, with top-of-mind awareness of more than 40%. Therefore, increasing A&P investment is likely to increase top-of-mind awareness and drive impulse purchases of its products. A&P investments have increased by double digits over the last three years, with a 20% increase in 2022. Hostess Brands plans to continue increasing A&P investments to lift sales growth.
The company is also expected to benefit from continuous investments in new product innovations. Hostess Brands launched Bouncers last fall, a reimagined version of its core products under the Twinkies, Ding Dong, and Donettes brands, which is gaining traction from consumers in initial trial phases. The company has had a good vitality rate over the last couple of years, within its targeted range of 15%-17%. The vitality rate measures the percentage of revenue contribution from new products launched over the last three years, demonstrating the consistency of the company's innovation pipeline. Overall, I expect product innovations to continue supporting Hostess Brands' sales growth in the longer term.
Hostess Brands Vitality Score (CAGNY Consumer Conference February 2023- Presentation Slide)
Management has guided for net sales growth in the range of 4%-6% in 2023, which, although lower than the past few years, still reflects a healthy growth rate and suggests a return to normal patterns of growth and consumer demand. I believe this guidance is attainable, and the company should be able to maintain its longer-term sales growth algorithm of mid-single digits beyond 2023.
Margin Analysis and Outlook
In FY2022, Hostess Brands' adjusted gross and EBITDA margins were adversely impacted by higher raw material costs, increased advertising and promotion spend, and investments in distribution. Despite implementing price increases, the company was only partially able to offset these headwinds. In the fourth quarter of 2022, the gross margin declined by 90 bps Y/Y to 36.3%, while the adjusted EBITDA margin declined by 250 bps Y/Y to 22.1%.
TWNK’s Historical Annual Adjusted Gross and Adjusted EBITDA Margin (Company Data, GS Analytics Research)
TWNK’s Quarterly Adjusted Gross Margin and Adjusted EBITDA Margin (Company Data, GS Analytics Research)
Looking ahead, although brand investments are expected to remain elevated and the company anticipates incurring ~$5 million of start-up costs related to its new distribution center in Arkadelphia, inflationary pressures are easing, and pricing is expected to increase YoY in 2023. This suggests that margins may improve slightly in FY2023. In the medium to longer term, TWNK’s margins should improve as inflationary pressures subside, distribution investments normalize, and the company benefits from operating leverage resulting from revenue growth. Therefore, I am optimistic about the company's prospects for longer-term margin growth.
Valuation and Conclusion
Hostess Brands is currently trading at around 22.42x the FY2023 consensus EPS estimate of $1.10 and around 20.39x the FY2024 consensus EPS estimate of $1.20. Over the last five years, the stock has traded at a historical average forward P/E of 20.75x. However, the last five years included the post-Covid period when the company witnessed exceptionally strong growth. Now, with growth moderating and returning to a more normalized level, it's difficult to justify a higher than historical P/E multiple on FY23 EPS. Therefore, it's best to wait on the sidelines for a better entry point. Hence, I have a neutral rating on the stock despite its good growth prospects.
For further details see:
Hostess Brands: Good Growth Prospects But Fairly Valued