TreeHouse Foods is likely to end up in private-equity hands as the largest own-label provider in the US may struggle to find a trade buyer for all or parts of the business.
CEO Steven Oakland posed “strategic alternatives” this week for an outright sale of TreeHouse or a “significant portion” of its meal-preparation arm in order to put more weight behind snacking and beverages. Meal-prep houses dressings, sauces, pickles, dips and salsa, creamers and dough, but more importantly pasta, which contributed more than half of third-quarter revenue growth.
However, industry analysts argue both options face hurdles. There are, it’s argued, longer-term underlying structural issues at TreeHouse, combined with the more pertinent difficulties affecting the whole industry – inflation pressures and pricing, labour shortages and supply chain constraints.
Surging input costs have exposed the fragility of TreeHouse, essentially a contract manufacturer catering to the whims of retail clients in an area that’s supposed to offer value to consumers. While TreeHouse has succeeded in passing on some of the costs through price increases, it doesn’t have the same bargaining power and brand recognition as its branded counterparts. Attracting a trade buyer might be a challenge in the current environment, while private equity might be more willing to take on the risk over a longer time scale, market watchers contend.
Unlike TreeHouse’s branded peers, it doesn’t have the levers to cut marketing and promotional spending or reduce complexity in the product spread before raising prices. Oakland openly admitted the complexity this week, with 29 different retail categories to service and 40 plants to maintain in the absence of a plentiful supply of labour.
“There are two parts to the story – how difficult the fundamentals of the business are right now because of the cost inflation and the timing involved because effectively you’re working for the retailer,” a market analyst tells Just Food, requesting anonymity.
“For a company like TreeHouse, because you are private label, you don’t have an advertising budget, you don’t have any sort of new trade promotion dollars, so it hits you square on the chin. The meal-prep business tends to be slower growth and it tends to not really have a lot of innovation. Without innovation, there’s not a lot of growth, there’s not a lot of opportunities for pricing power and increased profitability.”
Whichever proposal the TreeHouse board pitches for, the same underlying market dynamics remain. And, looking back longer term, the company has been struggling for some time to improve value for shareholders despite a three-year process to eliminate 1,000s of SKUs, including the sale of the ready-to-eat cereals business to Post Holdings, and the disposal of some plants.
Analysts led by Christopher Growe at US investment bank Stifel, wrote: “A slimmed-down TreeHouse, focused on the right categories, would seem to provide a better, more consistent vehicle in the private-label food business. However, we believe this business in its totality will be better suited for the private market given the inherent volatility in the category and we continue to believe the number of suitors for all or even a large chunk of TreeHouse will be limited.”
TreeHouse last traded on the New York Stock Exchange around the $35 area and the shares have been on a rollercoaster over the past 12 months, reaching a high in March shy of $55. But they have mostly traded around $40 or below since the start of August.
Analysts have suggested an eight-to-nine times EBITDA multiple should the board put the business on the market. That equates to a valuation of $4-4.5bn based on last year’s $503m in adjusted earnings from continuing operations.
Oakland indicated this week he’d expect a price of around $2bn for the meal-prep business, or parts of, should the board decide for a piecemeal sale, instead of including cookies, pretzels, bars, powdered drinks, coffee and tea housed in the snacks and beverages segment.
TreeHouse’s free cash flow has been a positive element in the past, highlighted by both Oakland and analysts. But the full-year guidance has been cut to “at least” $100m from an actual print of $298m in the 12 months through December. Sales expectations were also downgraded after a cut in August and are forecast at $4.2bn to $4.325bn, while the target for adjusted earnings per diluted share was lowered to $2.00-2.50.
Timing may be an issue. Pricing takes time to have a beneficial impact and, while inflationary effects are expected to last into next year, they won’t be around forever. And own-label has generally been out of favour during the pandemic as consumers with more disposable cash from lockdowns turned to brands.
While TreeHouse raised prices by 3% in the third quarter and is poised for a further 4-5% in quarter four, rising to low-double digits next year, Oakland estimates a $75m retrieval lag in 2021.
“As certain federal stimulus programmes expire, we are seeing signs of a private-label recovery. This aligns with our expectations that, as things normalise, consumers will return to purchasing private label and share will continue to recover,” Oakland said.
The unnamed market analyst Just Food spoke with says an eight times EBITDA valuation for TreeHouse compares to around 12 times for a branded food peer, suggesting the market “is basically valuing this company as more of a structurally impaired business”, adding “it’s hard to see a branded food company wanting to buy a private-label company”.
The source adds: “I think it’s really going to be private equity. A financial buyer might look at this business and say, ‘look, it’s a reasonably stable business, it’s got relatively stable free cash flow, and it trades at a very big discount in the market’, which is going to help with the total return they’re going to have on the investment because they can buy it cheap and then benefit from the cash flow during the ownership period. I have a hard time believing that they’re going to be able to sell the meals business at a reasonable valuation.”
And further: “If a financial buyer comes along and says ‘we’ll offer you nine-and-a-half, or ten times EBITDA’, that’s like 40% upside to the stock. Under what conditions is TreeHouse going to be able to increase their stock price by 30% or 40%? If you’re the board at TreeHouse, you’ve basically got your backs against the wall because you’re not creating much in the way of shareholder value.”
When former J.M. Smucker executive Oakland joined TreeHouse in the spring of 2018, the shares traded in a range of around $38-42 in March, not far off where they are now. In February this year, they were around $40 before New York hedge fund Jana Partners took a 7.3% interest, claiming the shares were undervalued, spurring a rally to almost $55. But they have since steadily declined.
Analysts at Stifel say a multiple of eight times normalised EBITDA would “be appropriate for selling all or a large chunk of TreeHouse”, implying a share value of $40 in the event the whole company is sold. If Oakland can reap $2bn from meal prep, then that drops to $32-37, they predict.
“We do not believe a buyer will come forward to purchase the totality of TreeHouse – no doubt the company has to explore those alternatives, but we do not believe this could or would be done at a value above the current stock price (or, at best, modestly above). Put simply, the degree of variability and volatility in the business will keep buyers from paying a multiple high enough to value the business above its current stock price,” Stifel analysts contend.
They add: “While TreeHouse, and Jana in particular, do not believe the current stock price properly values the business and what is normally a solid margin profile and cash generation for the business, we take a different view. The degree of volatility here has been significant and, while we can no doubt characterise this as a unique environment, TreeHouse has had a sequence of ‘unique environments’ across its history that has made for an unusual degree of volatility in its business.
“In the end, a period of rampant inflation, like we are seeing currently and as we have seen several times in its history over the past 15+ years, has created significant earnings and cash-flow volatility and that risk would likely be reflected in a lower multiple for the business.”
And the input cost “headwinds” described by TreeHouse have amplified to $125m more than the $100-100m the business originally anticipated. “The continued cost escalation in commodities, packaging, freight and labour is outpacing our pricing recovery,” CFO Bill Kelley said this week.
“Depth not breadth”
Credit Suisse analysts, led by Robert Moskow, are maintaining a $40 target price after TreeHouse cut earnings per diluted share guidance from the $2.8-3.2 outlook in August.
“The announcement reflects further acknowledgment that depth, not breadth works best in the private-label industry given that traditional grocer retailers still make their procurement decisions in a highly fragmented manner,” they wrote, adding that “given the highly competitive nature of the industry and the uncertainties regarding when or if consumers will trade down to private label, we expect TreeHouse’s volume to decline substantially as pricing increases.”
Describing pickles, dressings and creamers as “slow-growth categories”, Credit Suisse struggles to see much value coming from a sale of meal-prep. The investment bank has a nine times EBITDA assumption to get to its $40 share target.
“We assume a normalised multiple to account for the possibility of a change in ownership. Intense price competition, raw material inflationary pressures, and volatility in retailer demand are the biggest downside risks to our target price. Upside risk would be if the company executes a sale at a premium.”
TreeHouse is at a disadvantage over its branded peers because it can’t just put non-core, or less well-performing, brands on “cruise control”, as the market source calls it, to weather out the storm like in the current inflationary environment when demand for private label is not guaranteed.
Splitting up meal-prep, and retaining some parts, might not fit well within snacking and beverages either, particularly when TreeHouse would have to be selective in picking faster-growth products. Pasta, for example, where the company bought US brands from Ebro Foods last year, accounted for 3.2% of the 5.3% revenue growth in the third quarter.
“For a private-label business, it’s hard to really imagine the appeal of buying a private-label meal business outright, which is really difficult to defend against cost inflation, in categories that aren’t growing and you don’t even have the brand recognition that can drive a higher price because it is private label,” the source says.
Stifel analysts argue the current volatility in the packaged food market would make TreeHouse a better fit in private-equity hands, where the owner “would not have to worry about valuing the business each quarter and could take advantage of what will likely be tailwinds behind the private-label food category in future years”.
They conclude: “A sale of the portion of the meal-prep business comes with its share of risks, too – we believe investors and the company alike could be surprised by the lack of interest, a lower multiple given the volatility in the business, and the level of dis-synergy likely created by a sale of a portion of the business (which could reduce the profitability of the remaining business).”