Inflation has weighed on budgets, and that’s especially true at groceries, as basic necessities from cereal to sugar have soared. This sticker shock motivates cash-strapped consumers to shun their favorite brands for cheaper generics, often made by
TreeHouse Foods
.
TreeHouse (ticker: THS) is the only major publicly traded pure play in private label food products, an area that was booming before the pandemic and has since been boosted by price hikes, economic malaise and the desire for stores to sell exclusive products. That hasn’t helped the stock, which, in part due to high costs and supply chain issues, has climbed just 3.3% over the past three years, even as the S&P 500 gained 39%.
Today’s TreeHouse – a major supplier for retailers including
Wholesale Costco
(COST),
walmart
(WMT),
Amazon.co.uk
(AMZN), Aldi and Trader Joe’s – is much different than it was just 10 months ago. A combination of management changes and asset sales has made him leaner and more focused on what he does best: creating great products for companies looking to grow their off-label food sales. And that’s why JANA Partners is still optimistic about the company’s ability to capitalize on its strengths two years after its first equity investment in the company.
“TreeHouse is one of the only ways to invest [in] two of the most powerful underlying megatrends in food,” says Scott Ostfeld, managing partner and co-portfolio manager at JANA, who sits on the board of TreeHouse. “The first is the emphasis on private label expansion at the expense of national brands by large US retailers, as private label penetration is much lower than in other countries. And second, the search for value and affordability by consumers.
It was not easy for TreeHouse to get there. The company struggled as rapid commodity inflation squeezed its already thin margins and supply chain issues hurt operations. Additionally, he was burdened with poor acquisition integration — mistakes are inevitable with a business that was built from dozens of deals — and an underperforming meal prep business that included products like pasta and the syrups. This division accounted for about 60% of sales in recent years, but its low margins and operational issues have led to inconsistent profit growth.
“It’s been a very long and difficult road, but after the restructuring it’s finally well positioned,” says Benjamin Nahum, portfolio manager of the Neuberger Berman Intrinsic Value fund, which has held the shares since 2017. “TreeHouse has been tested, and out came a leaner, more profitable business.
The biggest change might have been the sale of its meal prep unit to a private equity firm for $950 million, or 14 times juicy earnings before interest, taxes, depreciation and amortization. This is a multiple higher than the stock, at 11.8x, is currently commanding. The move strengthened TreeHouse’s balance sheet and left it with a promising portfolio of snacks and beverages. Analysts now expect the company’s earnings per share to more than double in 2023, to $2.62, on a nearly 7% rise in revenue.
“We think it was a good deal, period,” Nahum says. “It was a great transaction that simplified the business.” Ostfeld agrees. “TreeHouse is now a higher-growth, higher-margin company that should trade at a premium to where it has historically traded,” he says.
It hasn’t happened yet. TreeHouse shares are trading at 17.5 times forward earnings, below its five-year average of 18.7 and that of peers like
Publish holdings
(POST), at 19.4 times. Even a better-than-expected earnings report last month could not boost the stock, as lower sales expectations in the second quarter, likely the result of supply chain improvements that shifted the orders from the second quarter to the first, weighed on stocks. “It was a great start to the year for TreeHouse, [which] included private label growth topping 2019 levels,” writes Truist Securities analyst Bill Chappell, who has a $60 price target on the stock, up 20% from Friday’s close of trading. $49.84.
The next step could be at TreeHouse’s Investor Day on June 13. CEO Steve Oakland said the company planned to provide investors with a “deeper understanding” of its strategy and improved capital structure, which enabled it to buy
farmer brothers
‘ (FARM) coffee processing facility and shipping business for $100 million, announced last week.
The move comes at a time when retailers are clamoring to enhance their brands with high-quality private label products. While consumers may have looked askance at these no-name options before, much of the stigma surrounding them has disappeared, thanks to cult favorites like Costco’s Kirkland brand and Trader Joe’s deals.
Target
(TGT) and Amazon have also steadily built their own brands that are less subject to competition and price comparison.
The biggest risk could be that slowing inflation and lower prices lead to fewer consumers. Still, major food deflation is unlikely to occur, especially as national brands seek to protect their margins, given higher packaging and transportation costs. Meanwhile, consumers are still facing higher bills for things like housing and childcare than a few years ago.
And if the economy continues to weaken, TreeHouse would likely benefit as well. “At the very least, TreeHouse is a place to hide in an uncertain market,” says Chris Terry, portfolio manager at Hodges Capital, which owns the shares.
Talk about comfort food.
Write to Teresa Rivas at teresa.rivas@barrons.com