Contrarian Value Ideas

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Flowers Foods (FLO) - >>> Sharp Price Decline Creates Opportunity



August 11, 2016

By Ben Reynolds



http://finance.yahoo.com/news/sharp-price-decline-creates-opportunity-213934245.html




Flowers Foods (FLO) stock has recently plummeted. In November of 2015 the stock was trading for more than $26 per share.

The stock is now trading for under $15 per share.



Regular readers of Sure Dividend know that Flowers Foods ranks highly using The 8 Rules of Dividend Investing. Here's why:

•Dividend yield of 4.4%.

•Twenty-nine years of steady or increasing dividend payments.

•Price-to-earnings (P/E) ratio of 15.7 (using adjusted earnings).



Flowers Foods is the second-largest bakery in North America. The company currently has a $3.33 billion market cap.

You can immediately tell something is amiss at Flowers Foods because of its low P/E ratio relative to other packaged food companies:


•General Mills (GIS) has a P/E ratio of 25.6.
•Camplbell Soup (CPB) has a P/E ratio of 26.8.
•JM Smucker (SJM) has a P/E ratio of 26.7.



These are just examples - there are many packaged food businesses with much loftier valuations.

What's wrong with Flowers Foods

Flowers Foods' stock price decline is a result of two factors:

1.Fairly weak quarterly earnings.

2.Lawsuits from independent contractors and a pending Department of Justice (DOJ) investigation.


First, we will cover the company's quarterly earnings. Flowers Foods released its second quarter results on Aug. 10.

Adjusted earnings per share (EPS) grew 4% and sales increased 5.2%. The sales increase was caused by the acquisition of Dave's Killer Bread and Alpine Valley Bread - which together added 5.6 percentage points to sales.

Here's what the company CEO Allen Shiver said about the performance:


"Benefiting from strong consumer demand for organic breads, our two recent acquisitions, DKB and Alpine, along with expansion markets, drove sales growth in the second quarter, offsetting sales declines in our core markets due to competitive pressures. Over the past five years, we have built a strong competitive position in the marketplace as we made strategic acquisitions to extend our geographic reach and enhance our portfolio of brands. I am confident that with Project Centennial, an in-depth review of our operations, we can enhance shareholder value by identifying new avenues for growth as well as focusing on ways to become a more efficient and profitable organization better able to deliver long-term value for shareholders."

Flowers Foods announced a new operational review (which will likely lead to cost reductions) called "Project Centennial." This is a positive development as it will likely lead to increased margins from efficiency gains and cost reductions.

On the downside, Flowers Foods reduced its guidance for this fiscal year. The company is now expecting the following metrics for fiscal 2016:

•Sales growth of 4.0% to 5.5%.
•Adjusted EPS growth of -2.2% to 3.3%.


While these numbers aren't great, they aren't cause for alarm, either. The reason for mediocre growth is heightened promotional activity in the bread industry. Competitors are trying to gain market share through promotions. This can hurt margins in the short run.

In the long run, Flowers Foods' combination of scale (it is the second-largest baker in the U.S.) and well-known brands will allow the company to grow in the bread industry. The image below shows Flowers Foods' brands:



Flowers Foods Brands -


Nature's Own
TastyKake
Wonder Bread
Sunbeam
Bunny
Roman Meal
Home Pride
Merita
Captain John
Country Kitchen
Butter Nut
Mrs Freshleys
European Bakers
Mi Casa
Frestillas




The first reason for the downturn is mediocre performance in the company's most recent quarter. All businesses go through periods of mediocre performance; this is no cause for alarm.

The second reason for the downturn is lawsuits from independent contractors and a recently announced DOJ investigation.

Lawsuits from independent contractors

Flowers Foods is being sued by 190 of its 5,100 independent distributers. The crux of the dispute is that Flowers Foods improperly classified its drivers as independent contractors instead of employees.

If Flowers Foods loses, the company would likely see its distribution costs increase. If Flowers Foods were forced to reclassify its independent contractors as employees, Flowers Foods' competitors would have to follow suit.


This means the costs would likely be split between bakers and consumers. The end result would be a slight increase in the cost of bread and a slight decline in bakery margins. The winners would be the current independent distributors.

The DOJ investigation into the matter is certainly not good news for Flowers Foods, but it isn't the end of the world, either. At worst, the company will be fined and have to change its independent distributor practices.

The lawsuit and DOJ investigation sounds scary. It is the biggest reason why the stock has dropped. Examining the long-term consequences, the company's valuation seems unfairly low at this time.

Flowers Foods is a bargain

Flowers Foods was a bargain dividend stock before it released second-quarter results and its price declined. The company is an even better bargain today.



"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."

- Warren Buffett


Flowers Foods is a great company. It owns a bevy of well-known brands in one of the slowest-changing industries in existence. Bread is not known for rapid innovation.

The company may not be on the operating table, but investors seem to be selling the stock in droves. This creates an opportunity for long-term investors to enter into (or add to) a position in the stock at an excellent entry point.

Where else can you find a dominant packaged food business trading for a dividend yield above 4% with a P/E ratio under 16? Those are metrics that are virtually impossible to find in today's market.

Flowers Foods' stock has not traded for a dividend yield this high since the year 2000. Investors who bought the company at the beginning of 2000 have realized a compound annual growth rate (including dividends) of 18.6% a year.

While a current investment might not generate that level of returns over the long-run, investors will likely do well to purchase this quality business at the (possible) point of maximum pessimism.

Disclosure: Not long any stocks mentioned in this article, but may purchase shares of FLO in next 72 hours.

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