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Flowers Foods: Big Gains Following Litigation Settlement


Published December 12th, 2016 by The Financial Canadian

As investors, it’s prudent to purchase shares in businesses that have long-term staying power. This provides the sleep-well-at-night level of comfort that comes from knowing your stock will still be doing well 5,10 or even 20 years from now.

Flowers Foods (FLO) definitely fits this bill. A bakery business with a market capitalization of ~$4 billion, this company is a darling for dividend growth investors.

It’s not hard to see why – with a dividend yield of >3% and 29 years of steady or increasing dividends, this company has a proven track record of growing income for shareholders.

Flowers Foods is a member of the Dividend Achievers Index, a group of elite companies with 10+ years of consecutive dividend increases.  You can see all 273 Dividend Achievers here.

On November 9th, Flower Foods reported earnings for the twelve-week period ending October 8, 2016. This article will cover that earnings release in detail, and discuss the investment prospects of this company.

On December 9th, Flowers Foods also announced some very favorable news for investors. Namely, they have settled a class-action lawsuit filed in 2013 in the state of North Carolina that has had investors worried for years now. The settlement was much smaller than expected, and the favorable economic conditions that led to this lawsuit are permitted to stay intact. This announcement will also be discussed in this article.

Business Overview

Key Stats:

The origin of Flowers Foods can be traced back to 1919 when two brothers, William Howard and Joseph Hampton Flowers, opened the Flowers Baking Company in Thomasville, Georgia. The company grew rapidly through serial acquisitions until, in 1968, the company went public as Flowers Industries.

After a ten-year transformational period starting in the mid-1990s, Flowers Industries became Flowers Foods and is now a force to be reckoned with in the baked goods industry. Their flagship product, Nature’s Own, is the #1 bread brand in the US.

Flowers Foods does a fantastic job outlining their business operations with the following summary from their 2016 investor fact sheet.

flo-business-overview

Source: Flowers Foods Investor Fact Sheet

One of the major selling points of Flowers Foods is the brand equity that their company owns. Their portfolio of products contains many household names, as illustrated in the following picture.

flo-primary-brands

Source: Flowers Foods Investor Fact Sheet

Historically speaking, Flowers Foods has allocated a lot of their capital towards financing acquisitions. Similar to Alimentation Couche-Tard, FLO operates in an extremely fragmented industry that lends itself very well to acquisition-based growth.

flo-uses-of-cash

Source: Flowers Foods Investor Fact Sheet

Now that we have a sense of the operations of this company, let’s dive into their third quarter financial performance.

Financial Performance

As I’ve already mentioned, on November 9th Flowers Foods reported third quarter financial results for the twelve-week period ending October 8, 2016. Here are a few financial performance metrics as highlighted in their press release.

Source: Flowers Foods Press Release

As you can see, FLO experienced declines in essentially every major financial metric. The company’s stock reacted accordingly, opening much lower than the previous close – though it recovered quickly through the course of the week.

The financial results of this company for the third quarter are concerning because diluted EPS declined (by 9.5%) even though sales actually increased (by 3.8%, though acquisitions actually boosted that number by 4.4% suggesting that sales declined on a pre-acquisition basis). Since EPS declined while sales increased, this suggests poor cost management – something I will be watching closely moving forward.

CEO’s Remarks and Ongoing Litigation Problems

The CEO of Flowers Foods said the following about the quarter’s financial performance.

“While we are pleased with the performance of Dave’s Killer Bread, which continues to gain share as America’s #1 organic bread brand, our results in the third quarter were affected by challenging category dynamics and elevated marketing and legal costs,” Allen Shiver, Flowers Foods president and CEO, said. “We remain acutely focused on driving growth and increasing efficiencies, including our Project Centennial efforts. The initial diagnostic phase is complete, and we are now finalizing our plans to implement strategies intended to grow sales and improve margins. Today, Flowers is a strong company with a team dedicated to excellence. Looking ahead, we are confident we are taking the right steps to build on our strong foundation and enhance shareholder value over the long term.”

I’ve included this quote to point out one thing. The company was affected by increased legal costs – this is largely due to various class action lawsuits that challenged the classification of the distributors of Flowers Foods as “independent contractors.”

Flowers Foods was being sued by 190 of its 5,100 independent distributors for being classified as independent contractors rather than employees. Earlier in this article I had hinted that the company had settled this lawsuit, and the settlement is very small for a company as large as Flowers – only $9 million dollars.

Here is what was announced in the December 9th press release:

“On December 9, 2016, Flowers Foods, Inc. and Flowers Baking Co. of Jamestown, LLC, reached an agreement to settle Rehberg et al. v. Flowers Foods, Inc. and Flowers Baking Co. of Jamestown, LLC , a class action lawsuit that was filed in March 2013 in the U.S. District Court for the Western District of North Carolina (Charlotte Division). The settlement provides for payment of $9.0 million, comprised of $5.2 million in settlement funds and $3.8 million in attorneys’ fees. The settlement also contains certain non-economic terms that are intended to strengthen and enhance the independent contractor model, which remains in place. This agreement, which covers approximately 270 distributor territories, is subject to court approval.”

For investors, this is fantastic news, and the stock price reflected that by jumping 13% On December 9 (the date of the announcement). One thing to point out is that the settlement contains “non-economic terms that are intended to strengthen the independent contractor model, which remains in place.” The continuation of this independent contractor model is a highlight from a great press release for Flowers Foods.

This was the single biggest concern that investors had about Flowers Foods, so the investment prospects of this company just became even better.

An Update on Project Centennial

When the company released their second quarter earnings earlier this year, they announced a new initiative called Project Centennial will run through the fiscal year 2019 (marking the company’s 100th anniversary, hence the name). The project, done in conjunction with consulting firm Accenture and aimed at reducing the operating costs of Flowers Foods, is seen as a key driver of future earnings growth.

In their earnings release, the company provided the following update on Project Centennial:

“During the quarter, Flowers progressed towards the completion of the first phase of Project Centennial, which included a comprehensive diagnostic evaluation of opportunities to drive growth, reduce costs, and make investments intended to strengthen the company’s competitive position and improve margins over the long term.

In mid-October, Flowers began the second phase which entails formulating and executing new strategies to capture growth opportunities. To fund these initiatives, the company is currently finalizing the specific actions necessary to achieve savings through identified operational improvements that include further use of the company’s shared services capabilities, network optimization, and better leveraging the company’s expenditures on goods and services. The company anticipates finalizing the implementation plans in early 2017, and expects to provide additional details on Project Centennial when Flowers fiscal 2016 results are released in early February.”

The company has admittedly been quite vague about the inner workings of Project Centennial. However, as a business that has historically driven growth through acquisitions, I suspect that Project Centennial is focused on identifying cost synergies related to recent acquisitions (like Dave’s Killer Bread and Alpine Valley Bread).

I’m excited to see how Project Centennial unfolds over the next few years.

Investment Thesis & Valuation Analysis

My investment thesis is mostly centered around the stock’s attractive valuation and great dividend.

Recent years have not been kind to the stock price of Flowers Foods, with the stock price experiencing a distinct downturn. After the announcement of the settlement of the lawsuit, the stock price increased noticeably, but the company is still trading below normal levels.

flo-stock-price

Source: Yahoo! Finance

Now that investors’ largest fear has been addressed, I believe that FLO’s prospects look better than ever. The underlying business remains quite strong and I believe this continued price downturn presents a buying opportunity rather than a reason to be fearful. Here’s why.

Based on this quarter’s adjusted diluted EPS of $0.21 (which corresponds to a run rate of $0.81), the company trades at a multiple of 23.0 times adjusted diluted earnings. This compares favorably to the overall stock market – as the S&P 500 currently trades at a PE ratio of ~25. So the company is attractively valued based on earnings.

Based on assets, the same trend holds. Flowers reported $1,177.22 million of total equity on their balance sheet for the most recent quarter, with no preferred equity outstanding and total common stock outstanding of 207.63 million. This means that Flowers Foods has a book value per common share of $5.67.

Based on their current stock price of $19.30, the company is trading at a price-to-book value of 3.4. This is well-below FLO’s historical average – for example, the company traded as high as 4.5 times book value towards the end of 2015.

Based on either earnings or assets, Flowers Foods trades at an attractive valuation.

Dividend Prospects

As I’ve mentioned earlier, Flowers Foods has a incredible 29 year record of steady or rising dividends. There are very few companies that can match this kind of dividend longevity, particular companies that are this small in size (<$4 billion market capitalization).

The dividend growth has not been slow, either – dividend payment growth from $0.09 in 2004 to $0.57 in 2015 represents a cumulative annualized growth rate of 18%.

Due to the recent price drop, FLO’s dividend yield is at a high level compared to historical levels. Based on their $19.30 stock price and their current annualized dividend payment of $0.64, the company pays a forward dividend yield of 3.3%.

Lastly, Flowers’ dividend is safe. As mentioned, their adjusted diluted earnings per share this quarter was $0.21. Given their quarterly dividend of $0.16 per share, this means the bakery company has a payout ratio of 76%. Keep in mind that this comes during a year that has seen FLO’s earnings decrease – the ratio will reduce as earnings growth resumes.

Their dividend is sustainable and should continuing growing along with a recovery in earnings.

The Bottom Line

While I maintain that investors should not pay too much attention to quarterly results, there is no denying that Q3 2016 was not the most impressive quarter for Flowers Foods.

However, the underlying business remains strong. They continue to operate in a recession-resistant industry (people will always buy bread), and they are a source of consistent, reliable dividends for shareholders.

The concerns surrounding the litigation made the stock price drop to irrational levels, and though the stock still trades below historical averages, this doesn’t worry me. Now that the litigation is over, this stock should return to a level more closely resembling fair value.

This presents a buying opportunity rather than a reason to avoid this stock. Warren Buffett said it best:

The best thing that happens to us is when a great company gets into temporary trouble…We want to buy them when they’re on the operating table.”


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