TreeHouse believes Flagstone has "lot of runway" to grow

TreeHouse believes Flagstone has "lot of runway" to grow

Since the inception of TreeHouse Foods in 2005, the US private-label group has snapped up businesses supplying the centre of the store. Now, the company has used M&A to secure a foothold in the perimeter - with the potential for further deals.

TreeHouse, formed after US dairy giant Dean Foods spun off one of its divisions, has acquired businesses making products from soups and salad dressings to broths and puddings.

The company has become a business that generated almost US$2.3bn in sales in 2013 and a major player in the country's private-label sector.

However, TreeHouse's top-line growth has slowed in recent years. Last year, sales grew more than 5%; in 2011, TreeHouse was enjoying revenue growth of above 12%.

The company's management, which has made no secret of its confidence in the prospects of the US private-label sector or its desire to make more acquisitions, this week moved to make another - but this time in the faster-growing perimeter of the store.

TreeHouse has agreed to pay US$860m for Flagstone Foods, a manufacturer of healthier snacks like trail mixes, snack nuts and dried fruits. It appears a wise move. Sales of healthy snacks are rising nicely in the US on the back growing interest in diet and health.

The sector is catching the eye of branded food companies searching for areas of growth to offset stagnant core businesses. Announcing annual results that included lower sales and operating profit last week, General Mills said sales of its healthy snacks brand Larabar were up 30% in its last financial year, when sales from its total US retail portfolio were flat. Accelerating General Mills' "better-for-you" snacking business is one of its priorities for the new financial year, the company said as it tries to find ways to reignite its US business.

TreeHouse chairman and CEO Sam Reed, speaking after the announcement of the group's deal to buy Flagstone from Gryphon Investors, said the "rapidly-growing, mega category" of healthy snacks had once been the "enclave of national brands only". However, he said Flagstone was growing at 24% a year and is the leading private-label player in a space when retailers are looking to build their own offerings.

"Flagstone is involved in snack nuts categories and trail mix. That business is $8bn including brands. Their focus is private-label only and primarily value-added products that excludes much emphasis on commodity peanuts. In the categories of value-added nuts and trail mix, they are the private-label leader," Reed said.

Among analysts, there were questions about the price TreeHouse has agreed to pay for Flagstone. Stifel Nicolaus analyst Chris Growe suggested the multiple, which he estimated at around 13x EBITDA "seemed a bit high" for a private-label business.

TreeHouse CFO Dennis Riordan insisted the price was justified because of the opportunities Flagstone has to grow further. "It's a high-growth business and it is exactly in the on-trend category so the backwards multiple is going to sound a little rich but as we look at this on a going-forward basis, we think it's an excellent value and price to pay for a large, meaningful and growing business, especially in the perimeter of the store where the growth is."

The company plans to fund the transaction with its existing credit facility, a $325m equity raise and a $200m bond offering. Perhaps the combination of the multiple and the prospect of more shares in TreeHouse coming available muted the market's reaction. TreeHouse's stock, up over 16% between the turn of the year and Monday, the date on which the deal was announced, closed only 0.23% higher.

TreeHouse also faced questions about the potential diluton from the deal to the company's margins and the prospect of synergies. However, both Reed and Riordan were keen to emphasise the opportunities they saw to further grow the Flagstone business.

Riordan said: "That's almost secondary at the moment. What we want to do is maximise the opportunity for growth. Obviously we'll look for synergies, we'll attempt to get those but we have very modest assumptions on synergies. We have a view that we'll continue to have strong double-digit top-line growth."

Flagstone, Reed said, had a "lot of runway" to grow. The company had secured strong relationships with its current customers but is not doing business with the top 25 retailers in the country, as TreeHouse does. Reed said Flagstone had recently launched healthy snack bars similar to those produced by a key branded player, Kind LLC, and he insisted there was room to move into "adjacent" categories.

And when considering why TreeHouse has swooped to buy Flagstone, it is important to note the company's plans to grow in healthy snacks is not just based on the business it will buy. Reed said the acquisition of Flagstone is a "new growth platform for TreeHouse".

"Not only are there adjacencies but significant opportunities to put other healthy snacks through this business," Reed said. "One of our early-on analyses will be on not only bars but other products adjacencies that will lend themselves to being incorporated into this entity either through organic development or M&A." Riordan emphasised TreeHouse's willingness to make more deals: he said the equity offering to help fund the Flagstone deal would leave TreeHouse more free to make further transactions.

TreeHouse has been a business based on growing through acquisitions. Reed said that strategy was based on what he called building an "industrial might". Now, he explained, TreeHouse had re-examined the strategy and decided to "follow the consumer" and "look beyond the centre of the store and traditional private-label categories".

With private-label rival ConAgra Foods still occupied with integrating Ralcorp Holdings, as well as left with debt from that deal that will likely stop it - at least in the short term - from making major deals, TreeHouse has made a significant stride into a fast-growing, attractive category, with, it hopes, the potential for more to follow.