2024-01-03 23:41:44 ET
Summary
- Post Holdings faced sluggish demand in 2023 but is seeing improving margins and has an active M&A strategy.
- The company has done over $1 billion in asset portfolio management in the past three years, increasing its pet exposure.
- Despite a large debt load, Post Holdings has an attractive 8% forward free cash flow yield and is poised to continue expanding margins and generate strong cash flow.
Shares of Post Holdings ( POST ) were a meaningful underperformer in 2023 as the company faced sluggish demand, as did many manufactured food companies. However, margins are improving meaningfully, and its active M&A strategy is likely to continue to be value accretive. While its debt load is high, its 8% forward free cash flow yield is attractive.
Post Holdings is a food company with a focus on cereal, peanut butter, and pet food. It is highly active in managing its portfolio of brands, frequently acquiring, and divesting them. In 2023, it acquired J. M. Smucker’s ( SJM ) pet food business while in 2022 it divested BellRing Brands. The company has done over $1 billion in asset portfolio management over the past three years. On balance, this has increased its pet exposure, which I view positively, and we are starting to see that impact results.
In the company’s fiscal fourth quarter , it earned $1.63 in adjusted earnings, nearly doubling last year’s $0.85, thanks to recovering margins. For the full year, it earned $5.34 with $1.23 billion of adjusted EBITDA, up by 28% from 2022. In Q4, revenue rose by $366 million while cost of goods sold rose by just $207 million. As such gross margins expanded to 28.3% from 24.9%. This sales growth was entirely driven by $405 million in revenue from Pet Food with foodservice sales reduced by lower egg price pass-through and weakness in refrigerated retail.
Margin recovery was a meaningful driver of improved 2023 results as EBITDA margins rose to 17.6% from 16.5% in 2022. We have seen moderating food inflation over the past year, which one may think of as a margin headwind. However, while consumer food prices are slowing, food input costs are slowing even faster, even turning negative. In 2021-2022, raw food costs rose more quickly than they could be passed on by companies like POST. Now with consumer food prices above input costs, we are seeing Post able to recapture lost margin. This may be a headwind for revenue growth, but it should help Post continue to expand margins and cash flow, which ultimately are most important for share price performance.
Looking deeper into results, excluding pet foods, its consumer brands (US cereal and peanut butter) saw volumes fall by 6.2%. This segment has been negatively impacted by pared-back SNAP benefits, and as this unfavorable comp is lapsed in H1 2024, we should see revenue growth improve. Aided by pet foods, segment profits rose by 72% to $141 million.
Its UK business, Weetabix, saw sales rise by 16%, aided by 810bp of foreign exchange benefits, though volumes also rose by 2%. Foodservice revenue fell by 9% to $570 million with volumes down 1%. However, segment profits rose by 21% to $85 million, as revenue was merely hit by no-margin egg pass-through prices. Refrigerated retail saw revenue fall 6.4% to $244 million as volumes fell by 8.2%, pushing profits down 26% to $12 million. Essentially as you can see below, profit growth has been driven by a normalization in foodservice margins, thanks to lower input costs, as well as the pet food acquisition, with stagnant consumer demand causing weakness elsewhere.
This “mixed bag” of results is a reason why shares have underperformed this year. I would note that weaker consumer demand and consumers trading down to store-brand products have been the headwind, not poor Post performance. Its cereal share is up to 19.6% while Peter Pan peanut butter has added 90bps of market share over the past two years.
Even as sales ex-M&A have been soft, we are seeing the business generate much more cash flow as margins normalize. POST generated $750 million in operating cash flow and $447 million in free cash flow, up from $185 million in fiscal 2022. Due to this, POST executed $387 million of repurchases, down from $443 million last year, as it also completed the Smucker purchase.
Because of its acquisitive nature, POST carries a large debt load with $6 billion of long-term debt. Due to a floating rate term loan, interest expense rose to $77 million from $72 million. Post carries nearly 5x debt to EBITDA leverage, which I view as elevated, even for a business in a noncyclical industry. With the Federal Reserve poised to lower rates next year, we may see a modest downtick in interest expense in 2024 from the $77 million run rate. Importantly, the company’s fixed debt does not begin maturing until 2027.
My biggest concern for a company with a large debt load would be having to roll over debt at much higher rates. As markets have priced in more cuts, we have seen POST stock recover in recent weeks, as this risk is less severe than it previously was. Because its maturities are several years away, the company can withstand interest rate volatility. Still given its high debt load, if you expect interest rates to rise again, I would expect Post to underperform, given its leverage, even though it will not be materially impacted in the short-term by movements in long-term rates.
While M&A has left it with a higher debt load, I believe the shift toward pet food is likely to be accretive. As you can see, in recent decades, spending on pets has dramatically exceeded overall spending as more households have a pet and each pet-owning household spends more on their pets. This is a segment of the economy gaining share of wallet and should be a place where Post can generate faster sales growth.
Now one minor pushback could be that there was a bit of a “pet bubble” during COVID with 18 million households adding pet with half of those gains being retraced. Still, pet ownership is still 7% above pre-COVID levels. Despite the year-to-year volatility, there has been a clear uptrend over the past decade, which I would expect to continue, particularly as millennials continue to form their own households.
In the next few months, we are likely to see some margin compression as Post ramps up advertising for its newly acquired brands to deliver the same market share gains it has been able to deliver in cereal and peanut butter. Additionally, similar to “people food,” pet food input costs exceeded output costs on the way up, and now they are moving down in sympathy. If we see raw material costs continue to moderate, this may be an opportunity to regain margins lost in these businesses in 2021, just as we are starting to see in Post’s legacy businesses.
In December, Post completed its purchase of Perfection Pet Foods, a bolt-on purchase, and accordingly, it revised 2024 EBITDA guidance to $1.22-$1.28 billion for fiscal 2024, up by $20 million. A third-party contractor also has seen an outbreak of avian flu at an egg facility, but the impact is not expected to be large enough to impact guidance. Alongside this EBITDA guidance, it expects cap-ex to rise by a third to $400-425 million as it expands production facilities.
Based on this guidance, 2024 free cash flow should be $400-425 million, giving shares an 8% free cash flow yield. With this free cash flow, we are likely to see ongoing share repurchase as well as opportunistic debt reduction. For instance, in Q4, it bought back $150 million of debt at a 13% discount. With solid margin performance this year and Post shifting its business toward the faster-growth pet food segment, I view an 8% free cash flow yield as an attractive entry point, providing room for accretive share repurchases and modest debt reduction.
Barring a renewed rise in interest rates, I would expect shares to move towards $100, for a ~10x EV/EBITDA multiple and 7% free cash flow yield. Food disinflation is likely to be a positive for the company while its portfolio management activities help to spur faster sales growth over the medium term. After a disappointing 2023, cash flow has risen sufficiently for the company to grow into its multiple and have a much better 2024.
For further details see:
Post Holdings: Shift To Pet Food Should Benefit Shares In 2024