In the largest M&A deal in the US packaged food sector in 2017, on Tuesday (19 September) Post Holdings announced the acquisition of bacon, breakfast sausage and mac and cheese maker Bob Evans Farms. The transaction is the latest move by the deal-hungry Post, with the company, which some see as having a patchy record with its purchases, looking to inject some growth into its business, this time by targeting a business operating in more buoyant categories on the perimeter of US stores. Andy Coyne reports.

In some respects, Post Holdings’ acquisition of fellow US food manufacturer Bob Evans Farms for US$1.5bn may be seen as a deal waiting to happen.

Post Holdings has built a business through acquisition – UK breakfast brand Weetabix earlier this year, fellow US breakfast cereal company MOM Brands in 2015 and egg supplier Michael Foods Group back in 2014 the most notable of the company’s recent deal-making – and the group was known to be keeping a weather eye on further acquisition opportunities.

Meanwhile, the feeling in the market was Bob Evans Farms was ripe to be taken over after the company sold off the restaurant part of its business to focus on food manufacturing eight months ago.

But beyond that, the deal highlights the need for companies with a higher exposure to the sluggish centre aisles of US supermarkets to broaden their offerings to the more buoyant perimeters of stores.

Given more than a third of Post’s sales are in ready-to-eat cereals, the Grape Nuts and Honey Bunches of Oats owner is among those manufacturers in the US seen as needing to further diversify into growing parts of the market despite recent moves like the acquisition of egg, potato and cheese supplier Michael Foods. The US cereal market is a challenging place to do business, with companies ceding share to alternative breakfast options.

The Bob Evans portfolio includes breakfast items like sausage, bacon and breakfast potatoes but, notably, also contains a range of refrigerated sides (such as mac and cheese) and frozen food. In the year to 28 April, Bob Evans net sales from continuing operations rose by 1.9% to $394.8m. Excluding an extra trading week in the previous financial year, net sales from continuing operations were up 3.8%, with pounds sold rising 7%.

The sales of lower-priced side dishes dampened revenue growth but those products have better margins, which meant Bob Evans Farms underlying annual operating profit increased from $37.7m to $53m.

At the end of August, Bob Evans reported higher first-quarter net sales and profits – and lifted its forecasts for annual net sales, adjusted EBITDA and non-GAAP diluted earnings per share.

Post’s most recent set of numbers, for the nine months to the end of June, included net sales that inched up only 0.3%.

“It [the deal] will significantly strengthen Post’s portfolio of brands, expand choices for customers and increase Post’s presence in higher growth categories of the packaged food market,” Post said when it announced its move for Bob Evans last Tuesday (19 September).

Rob Vitale, the president and CEO of Post, said: “Combining with Bob Evans expands our portfolio of top brands and gives Post a leading position in the perimeter of the store.”

The transaction is expected to be completed in the first calendar quarter of 2018. Post plans to establish a refrigerated retail business, which will be led by Mike Townsley, the president and CEO of Bob Evans. The unit will comprise Post’s existing refrigerated retail egg, potato and cheese business with the Bob Evans portfolio.

Moreover, Post is also enthused by the ability of the acquisition to give it a greater presence in the foodservice sector where Bob Evans supplies products such as sausages, breakfast sandwiches and sides.

In its post-deal presentation to investors, Post talked of refrigerated side dishes having delivered a 14% volume compound annual growth rate from 2012 to 2017.

CEO Vitale said: “Bob Evans’ portfolio is aligned with key themes in food, both heat and eat and convenience. It increases our exposure to the attractive high-growth perimeter of the store, which is on trend with secular consumer trends.”

Post also highlighted Bob Evans’ strong distribution presence with products sold at more than 35,000 retail locations across 50 US states and claimed, when it comes to refrigerated side dishes, the company is outpacing the industry and competitors in product velocities and repeat purchase.

The company sees opportunities in both retail and foodservice. Under Post’s plans, Jim Dwyer will continue in his current role as president and CEO of the group’s Michael Foods Group division, managing the commercial foodservice egg, potato and pasta businesses, which will now include the Bob Evans foodservice operations. 

Another telling observation from the Post presentation is that it sees “substantial existing capacity in place for future growth with a low need for additional capital”.

Financially the deal looks attractive. Post’s management expects the deal to be immediately accretive to its top-line growth and for Bob Evans to contribute approximately $107m of adjusted annual EBITDA. Cost synergies are expected to be about US$25m annually by the third year after closing.

Analysts at US investment bank Stifel Nicolaus covering Post noted the price the company was paying for Bob Evans was higher than in some of its recent deals but said there could be sales benefits for the business.

“This acquisition is relatively expensive in the context of previous acquisitions for Post, with the company paying a higher multiple for the advantaged sales growth potential of this business,” they wrote in a note to clients.

“The business is expected to be accretive to Post’s sales growth, profit/EBTIDA margins, and free cash flow (+9%). Bob Evans’ business has been growing mid- to high-single digits; the growth is further levered by cross-selling opportunities, given the expanded reach by combining the two organisations.”

Stifel, which has maintained its ‘buy’ rating on Post’s shares, added: “Given the pending EBITDA contribution from Bob Evans and the benefit to its growth, we continue with our constructive outlook for the shares.”

There are, however, some concerns elsewhere on Wall Street about the prospects for Bob Evans in the Post stable.

US investment research firm Morningstar acknowledges there is industrial logic to the deal, pointing to Post being exposed to a declining cereal category defined by larger competitors and, elsewhere in its portfolio, lacking non-cereal differentiated branded products that can deliver a sustainable competitive edge.

However, Morningstar argues Post’s acquisition record is patchy and asserts that, despite the acquisition of Bob Evans, the group will still rely on its breakfast cereal and Michael Foods divisions.

“Post is a prolific acquirer, with deals including Michael Foods, MOM Brands, PowerBar and Weetabix. The Michael and active nutrition acquisitions have diversified Post’s offerings away from its nearly pure-play cereal orientation at its 2012 IPO,” it said. 

“However, the record is chequered, with successes offset by costly rebuilding projects (such as Dymatize) and additions without significant synergies. Furthermore, while the company has achieved diversification, Post’s purchases have done little to add brand intangible assets.

“Michael Foods (43% of fiscal 2016 sales) is a leading producer of egg, refrigerated potato, and cheese products, but we do not believe the line-up is sufficiently diversified as to ward off competitive threats.” 

Morningstar said the Bob Evans deal does not meaningfully change its outlook for Post.

The firm uses a moat analogy for its analysis – referring to how likely a company is to keep competitors at bay for an extended period. 

On Post, it said: “We do not expect Bob Evans (whose fiscal 2017 pro-forma net sales of US$437m are less than 10% of Post’s 2016 revenue) will alter our no-moat rating, nor should it change our view that Post’s competitive standing is deteriorating amid strong competition. 

“While Bob Evans has shown strength in refrigerated side dishes (14% compound annual volume growth over 2012-17), the combined entity will still rely on the declining cereal category and Michael Foods’ hard-to-differentiate portfolio for the vast majority of sales.”

Looking ahead, with Bob Evans set to be Post’s third acquisition in a year (following that of Weetabix and of US egg business National Pasteurized Eggs) and with the company part-funding the deal through borrowings, we could see the business ease back on M&A for a spell. 

The analysts at Stifel Nicolaus suggested M&A is likely to be less of a priority for Post for a spell. “This acquisition will push the balance sheet up to 6x debt/EBITDA, with the company planning to return to its targeted leverage ratio of 5x debt to EBITDA within 24 months. M&A is likely to be pushed down the capital priorities for now, with additional M&A likely requiring equity,” the analysts wrote. That said, they added they believed Post “will be flexible should the right opportunity present itself”.

In the short term, the acquisitive Post will likely busy itself in bedding down its latest asset, one it hopes will boost its top line as US consumers broadly shop less in the centre of the store and more for fresher options at the perimeter.