TreeHouse Foods‘ annual results were overshadowed by news of the emergence of an activist hedge fund the evening before publication, criticising the value of the shares in the largest private-label supplier in the US. And the investor has put a sale option on the table, too. Simon Harvey reviews the pertinent issues.

Only six weeks or so into the new year, a familiar (and oft-seen) trend seems to be unfolding – activist investors pressuring major packaged-food companies, with TreeHouse Foods the latest to come under scrutiny from a New York-based hedge fund.

Jana Partners revealed this week it had taken a 7.3% interest in TreeHouse, the largest private-label business in the US, which has been in the throes of a restructuring exercise for the past three years under president and chief executive Steven Oakland, with the aim to trim the portfolio and boost margins, whilst also engaging in potentially growth-accretive acquisitions.

And only a few weeks ago, Danone received news Bluebell Capital Partners, a London-based hedge fund, was seeking the removal of chairman and CEO Emmanuel Faber having acquired an undisclosed holding.

Share valuations are top of the tree for these activist investors, in tandem with going public with dissatisfaction with company strategy. In TreeHouse’s case, Oakland says the company has been making progress and he has suggested the portfolio reshaping is coming to an end, opening the door to more acquisitions to drive growth and margins, and possibly therefore shareholder returns.

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Jana stressed it bought the shares because it considers they are "undervalued". The hedge fund noted it has no intention of taking a controlling stake in the Illinois-based business, nor does it intend to join with another party in such an endeavour.

Before Jana's emergence on the TreeHouse share roster on Wednesday, the company's share price was down on the start of the year. Jana's acquisition of a stake in TreeHouse and its public comments on the performance of the business had driven up the company's stock to $50.69 at the close of trading yesterday, having started 2021 at $43.35. TreeHouse's shares traded at $81.20 five years ago.

It's a stance Wells Fargo analyst John Baumgartner agrees with. "We believe that today's news is likely to refocus the market's attention on what we believe is an asset that is significantly disconnected from fair value," he wrote in a research note on Wednesday.

Baumgartner believes a leveraged buyout of TreeHouse could be an option as it reported free cash flow (FCF) generation in 2020 of $298m (almost double the prior year's $117m) and a reduction in debt-to-EBITDA to 3.1 times from 3.7. Still, the company has debt of $1.86bn.

"We think the flexibility provided by strong FCF and declining leverage also opens optionality to an LBO situation in light of the Jana filing," he wrote.

Behind the scenes

Unlike Danone, Jana is not, at least on face value, calling for the removal of Oakland, although it has suggested a sale of the business could be an option as the hedge fund seeks to appoint three nominees to the TreeHouse board.

"The reporting persons acquired the shares because they believe the shares are undervalued and represent an attractive investment opportunity with the issuer nearly three years into a comprehensive turnaround," the hedge fund said in a filing with the US Securities and Exchange Commission before TreeHouse issued its 2020 financial results on Thursday.

Last year, TreeHouse's sales climbed 1.4% on a reported basis to $4.35bn and were up 2.7% organically, following declines the previous year of 6.5% and 5%, respectively. However, TreeHouse lost around $60m in sales revenue in 2019 from its SKU rationalisation, which diminished to $3.4m in 2020.

Adjusted EBIT margins rose 70 basis points to 6.9%, a slower pace than the 90-point increase in the prior 12 months. And the EBITDA margin climbed 50 points to 11.6%.

The share price headed south in early morning trading in New York on Thursday even as TreeHouse reported adjusted earnings per common share rebounded to 87 cents from 2019's $1.96 loss. And Oakland stated he plans to put the free cash flow to work in bolt-on acquisitions and to return whatever is left to shareholders.    

"Jana has had, and intends to continue to have, constructive discussions with the issuer's board of directors and management regarding avenues to resolve the issuer's undervaluation and total stockholder return, including evaluating a sale of the issuer, operations, capital allocation, corporate governance and compensation practices," Jana said.

The New York-based hedge fund has been in the situation before. It took a more than 9% stake in another US food business in April 2018 – Pinnacle Foods – before it was acquired a few months later by Conagra Brands. And it used what is now familiar terminology in that the shares were "undervalued and represent an attractive investment opportunity".

And in a 2015 scenario that has echoes with TreeHouse, Jana took a 7% interest in what was then ConAgra Foods and said it would hold talks with management on "value creation". Weeks later, that same business announced plans to sell its private-label operations.

Nicholas Johnson, an analyst at financial services firm Morningstar, described Oakland's response to Jana's "overtures" as a "non-adversarial approach".

On Wednesday evening, Oakland issued a statement saying: "Jana expressed strong support for the actions TreeHouse has taken to drive growth and profitability and enhance stockholder value. In particular, Jana has highlighted our strong position as a leader in private label, our progress in driving improved operating performance and cash flow, and the value-creation opportunity that our acquisition of Riviana represents."

He was referring to Riviana Foods, a subsidiary of Spain's Ebro Foods, which sold its branded pasta assets in the US to TreeHouse last year. Despite the lateness into the financial year, Oakland said that business contributed 1.7% to growth in the final quarter.

Johnson wrote in a research note: "We think this approach is prudent, and ultimately, consistent execution is the key to value creation for this kind of business. If Jana's active stake fuels more urgency in this regard, then we have no qualms. Our $54 fair-value estimate should not materially change beyond time value after rolling our model."

Disposals ebb

TreeHouse has been more active on the disposal front since 2018 with deals including the separate divestments of its snack nuts and trail mix and McCann's Irish Oatmeal businesses, as well as two bakery facilities. A planned sale of the company's ready-to-eat cereals business in the US is still on the cards, Oakland said on Thursday, after a potential deal with Post Holdings was blocked by the US Federal Trade Commission. Since he came on board, Oakland said 11,000 SKUs have been cut from the portfolio, while the company has exited 11 manufacturing facilities to reduce costs.

The CEO has stamped his own mark on TreeHouse's strategy having seen through the three-year exercise launched under his predecessor Sam Reed in 2017, including a plan to boost innovation, a common theme in the current environment.

A year ago, Oakland unveiled a refined strategy designed to provide a clearer focus by category type, entailing a move to two divisions instead of three: snacks and beverages, concentrated on the obvious, and meals preparation, encompassing cereals, sauces, jam, pickles and pasta - each with its own management team.

"We are generating substantial cash flows that will enable us to not only deliver on our strategic growth algorithm but drive additional growth from disciplined investment and a balanced capital allocation approach," the CEO said. "I don't think there will be as much divestiture...There will probably be a few small things we will take out but I don't think it will be material." 

Christopher Rowe, an analyst at financial services firm Stifel, provided his take on what Jana's priorities might be. "We believe Jana will focus on improving the profitability of TreeHouse, the consistency to its growth, and/or a potential sale of the business," he wrote. 

"We believe our hold rating is appropriate for the shares as we assess the nines times EBITDA multiple currently in place against a more challenging near-term outlook for the business as cost inflation has accelerated of late. In addition, we do not foresee material upside from this level from Jana's stake in the business, even including some shift in the company's strategy or an outright sale of the business." 

TreeHouse anticipates incurring around $100-110m this year related to commodity inflation and rising freight costs, which are likely to result in price actions, possibly in the second half, finance chief Bill Kelley told analysts. But Oakland said the generation of $400m in run-rate savings last year helped to offset the inflationary impact.

Guidance was also provided for 2021, with reported sales expected in a range of $4.4-$4.6bn, with a strategic objective to achieve organic revenue growth in the region of 1-2%. Adjusted EBIT is envisaged at $290-$320m and its EBITDA counterpart at $525-$570m, with FCF of around $300m and adjusted EPS, diluted, forecast at $2.80-$3.20.

Rowe adds: "TreeHouse's growth algorithm calls for 1%-2% revenue growth and 10% EPS growth, however, results have been volatile and input-cost inflation is on the rise, which in the past TreeHouse and private label in general, has struggled to pass through in a timely fashion."

The finance firm is estimating EPS of $2.94 and revenue of $4.48bn, amounting to a 0.5% organic decline for the year. 

Confidence in private label

Oakland said in his commentary accompanying TreeHouse's results that he "remains confident in the private-label opportunity", an area where products tend to be sold at a discount to branded peers. 

"As we move into 2021, we look to capitalise on our leading portfolio of private-label foods and beverages and build upon our successes from 2020 to drive greater value for all of our stakeholders," the CEO said yesterday.

However, Baumgartner says the private-label channel has underperformed in recent months even as the US economy slows from the impact of coronavirus.

"Since Covid, the market has focused on measured channel market share losses for private label (put at an average 40 basis-point decline in the last seven months of 2020), despite only partial overlap with TreeHouse's business, as the impact of stimulus checks and a shift to at-home food consumption have offset a sharp GDP contraction that would typically prove to be positive for demand for private-label food," he notes.

And he suggests there's a potential leg-up in the share price compared to TreeHouse's competitors based on Wells Fargo's view that the company trades at 7.5 times its EBITDA estimate for calendar year 2022. "A 40% discount versus food peers, and far wider versus the long-term 10% average discount for private-label assets," he says.

In 2020, the snacks and beverages unit grew organic sales by 6.5%, while meal preparation lagged behind at 0.4%. Oakland has described the former as a "growth engine" - which is expected to contribute 35% to the group's revenue growth - and to the latter as a "cash engine". Sales for each were up 8.1% and 1.3% in the fourth quarter.

Johnson at Morningstar says: "Organically, while we expect meal preparation to be lumpy as we transition to some semblance of normalcy after the pandemic, we see steady growth in snacking/beverages, as low consumer risk-aversion in categories like crackers and broth support high private-label share, and TreeHouse's revamped commercial organisation positions it well to capture share."

With the portfolio reshaping pretty much done in terms of divestments, Oakland can now put his full weight behind the new strategy to deliver growth and margin improvements, replete with acquisitions to drive value creation for the business and shareholders alike. Whether that will be enough to deflect Jana's criticisms, we'll have to wait and see.