Wednesday, April 12, 2006

Treehouse Foods -Commodity Businesses at Premium Valuation

Treehouse Foods (THS) is a private-label food manufacturer to retail and food-service channels. It is the largest manufacturer of pickles and non-dairy powdered creamers in the U.S. These are lo-margin commodity businesses. The company has purchased a soup business from Del Monte Foods (DLM) which THS management indicates has gross and EBIT margins below that of THS.

Gross profit margins for THS were 19% for the fourth quarter of 2005 versus about 23% for the full year. EBIT margins were 6.2% for the fourth quarter versus about 4% for the full year.

The profitability of Treehouse should be compared with that of Ralcorp (RAH) another food company with a commodity product roll-up strategy. Gross margins for RAH were 23.1% and EBIT margins were 6.7%. ConAgra (CAG), a company that is slowly (emphasis slow….ly) restructuring itself into more of a branded company has a gross profit margin of 24.7% and EBIT margin of 10.4% for its latest un-restructured year.

The Return on invested capital for THS is merely 2.2% versus RAH’s 6.2%. Reflecting some leverage, the ROE on RAH is about 13.1% versus THS’ 2.3%.ConAgra has an intermediate profitability of 7.1% on capital and 12% on equity.

THS sells on an Enterprise Value to EBIT of 16.2 X versus RAH’s 14.6 X and CAG’s 15 times. On a P/E basis, THS is selling at 28.9 times 2006 consensus earnings whereas RAH sells at 16.6 times. CAG sells at 15.9 times EV/EBIT. The processed food industry is selling at 18 times 2006 earnings.

Why is Treehouse so expensive given its commodity nature and its slow-growth characteristics? Is the market rewarding THS for value added in its soup acquisition when management has already indicated that this has lower margins than its existing business? Given the lacklustre prospects for growth (consensus 5-year growth for THS is 7%) why pay up?

Disclaimer: I, my family, and clients do not have a current position in THS, RAH, or CAG.


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