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Flowers Foods: Dividend Growth In a 30,000 Year Old Industry

Published June 21st, 2016 by Eli Inkrot

Nearly 99% of United States households purchase baked bread.  Bread is popular today, and it has been popular for a very long time.

Evidence suggests humans first started baking bread 30,000 years ago.  Making bread is one of the oldest businesses in the world.  In the business world, stability is very good – according to Warren Buffett.

“Our approach is very much profiting from lack of change rather than from change.”
– Warren Buffett

This article shows you how you can profit from the almost unnerving stability of the bread industry with Flowers Foods (FLO)

Flowers Foods is the 2nd largest baker in North America.  The company is ranked as a Top 30 dividend stock using The 8 Rules of Dividend Investing thanks to its compelling fundamentals.

This article takes a detailed look at Flowers Foods.  First, we will start with the company’s long history.

Flowers Foods’ History

Founded in 1919 by two brothers in Thomasville, Georgia the predecessor to Flowers Foods (FLO) opened to rave reviews. The local newspaper said that the bakery had “the latest and most sanitary machinery” and could produce 30,000 loaves of bread per day. When you’re starting a bakery, volume, technology and sanitary standards are certainly a good place to begin.

In 1968 the company went public, then known as Flowers Industries. In 1977 the famous Nature’s Own brand of soft bread was introduced.

In 1996 Flowers began acquiring Keebler, only to sell that investment in 2001 to Kellogg (K) and become Flowers Foods. Since then the company has continued to grow, making more acquisitions along the way.

Flowers Foods’ Business Today

I could describe the company as it sits today, but Flowers Foods does a nice job of detailing that information within its investor fact sheet:

Flowers Foods Overview

Source: Flowers Foods, Investor Fact Sheet

From its small roots back in 1919, Flowers has become the second-largest producer of packaged bakery foods. It’s not the sort of business that has that “wow” factor as many other companies – for the industry the best thing since sliced bread is, well… sliced bread.

Still, nearly 99% of U.S. households buy fresh packaged bread. The demand is enormous – on par with utility service – and Flowers has a important seat at the table. The company now serves more than ­85% of the population in its areas of business.

Here’s a look at the business if you were to think in terms of percentages:

Flowers Foods Breakdown

Source: Flowers Foods, Investor Fact Sheet

Flowers Foods gives the term “bread winner” a whole new meaning. Roughly 75% of the company’s product mix is related to this category, with much smaller fractions being attributed to the snack cakes and frozen segments.

The business is largely a direct to store model, using independent distributors which have autonomy within their regions. The delivery and sales channels are roughly evenly divided into three main customers:

Especially with the trend of large retailers offering more grocery selections, it makes sense that this will continue to be a large portion of the bread business.

If you’ve ever wondered where Wonder Bread comes from, wonder no longer…

Here’s a visual of company’s primary brands:

Flowers Foods Brands

Source: Flowers Foods, Investor Fact Sheet

In addition, Flowers Foods producers well-known and storied brands like Sunbeam, Nature’s Own and Home Pride.

It’s probable that you’ve heard of at one of these brands, and given the consistent demand even likely that you’ve purchased one of their products on a regular basis. This is the sort of thing that stems from a competitive advantage of a strong brand name:

Flowers Foods Brand Based Competitive Advantage

Source: Flowers Foods, Investor Fact Sheet

As it relates to brand share in the breads, buns and rolls division, Flowers Foods makes up nearly 20% of the market. Think about it this way: for every five loaves of bread sold in the U.S., roughly one of those is going to be attributable to Flowers Foods.

Leading the way for the company is its Nature’s Own brand, which is the #1 loaf bread brand in the U.S – with over $1 billion in annual sales last year.

Capital Allocation at Flowers Foods

When you’re thinking about the benefit of that strong brand name and healthy sales, you can see the result via how the company utilizes the cash that it generates:

Flowers Foods Capital Allocation

Source: Flowers Foods, Investor Fact Sheet

You can think about a few items of note here. First, capital expenditures make up a reasonable amount of the total use of cash – highlighting the need to keep the machinery up-to-date along with ongoing investments in the business.

Next you have the dividend payment, which has been an important part of shareholder returns for some time now.

Flowers Foods has not only paid but also increased its dividend for 15 consecutive years. Just recently the company announced a $0.16 quarterly dividend – representing an increase of 10.3% as compared to last year. Based on a share price ~$18, this represents an above average “current” yield of ~3.5%.

And this trend of impressive payout increases has been the norm as of late. Prior to the 10% increase this year, Flowers boosted its payout by 9.4%, 10.4% and 6.7% in a matter of two years.

Part of this has been fueled by Flowers earnings growth and part of it is attributable to a willingness to increase the payout ratio. The payout ratio has climbed to 60% of so of last year’s trailing earnings, up from something closer to 40% to start the last decade.

Share buybacks have not been a large contributor to shareholder returns thus far – but that’s a component that could be increased in the future depending on how the payout ratio develops and what the company’s sees as its best opportunities.

What has been a large focus is acquisitions, which have dominated the use of cash story – often going well beyond dividends paid and requiring debt along the way. Still the company has a current ratio of about 1.4 (current assets divided by current liabilities) and a total interest coverage ratio north of 10 times.

Which brings us to the opportunity for growth.

Growth Prospects

Naturally you have the ability to increase prices as time goes on, improve the process and add on profitable acquisitions. In addition, Flowers Foods is looking at new markets to potentially expand its market:

Flowers Foods Expansion

Source: Flowers Foods, Investor Fact Sheet

Now, to be sure, headwinds to growth certainly exist. With large players like Wal-Mart (WMT) becoming more and more grocery-like, you have to compete against ever increasing (and lower priced) generic brands. Moreover, the company is dealing with the potential for adverse lawsuits related to the classification of the company’s delivery drivers as independent contractors. There are always reasons for hesitation.

Still, analysts are anticipating quite solid growth from the company in the coming years. Over the intermediate-term greater than 9% annual growth is anticipated. And this jives with what the company is suggesting as well. In April of this year the company indicated that it was expecting 8% to 10% yearly earnings-per-share growth.

Let’s think about what this could mean for today’s investor, scaling it back a bit to utilize a bit of conservatism. Last year Flowers Foods earned $0.92 per share. Should this number grow by say 7% annually – lower than expectations – you’d come to an anticipated EPS number of about $1.30 after five years.

Over the past decade the average earnings multiple has been around 21. Usually you want to bake in (no pun intended) a bit of conservatism, but in the case of Flowers shares have always traded at a “premium” – staying above 15 times earnings even during the recession. Using a future earnings multiple of 19 – lower than the historical average – equates to a future anticipated price of nearly $25.

If you anticipate that the dividend could grow in-line with earnings, you would also expect to collect $4 or so in dividend payments. In other words, you might believe – using the above assumptions – that a share of Flowers Foods is capable of producing $29 or so in value during the next half decade prior to thinking about reinvestment.

Expressed differently, using those numbers an investor could think about generating 10% annualized gains as a baseline.

Naturally things could turn out much better or worse, but that’s a reasonably solid starting point. As a point of reference, it’s the sort of thing that could turn a $10,000 starting investment into $16,000 or so after five years.

Final Thoughts

In short, Flowers Foods has proven itself to be a solid and growing company. You might not think about the investment all that often, but you’ve certainly been exposed to the product.

Naturally there are concerns with the business. However, there are a lot of positives as well.  Flowers Foods is a high quality dividend stock that ranks in the Top 30 using The 8 Rules of Dividend Investing.

With Flowers Foods, you have the number one brand in its category, with a stock offering interesting growth prospects, a reasonable historical valuation and an above average dividend yield.

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