Friday, January 10, 2014

Post Holdings Annual Report 2013

So it's been a while since my last post (no pun intended).  I didn't mean take any time off. December was a busy month with some travelling, holidays and things like that (shopping etc.).  But I intend to keep posting here as before.  I know most blogs tend to peter out after a year or two, but I have no intention of slowing down here.  But I will only post when I think I have something meaningful to say.

It's a new year and this is the time that we all can't wait for the full year results to be announced to update our thoughts on various companies.  And of course, my favorite time of year is when all the annual reports start coming out.

Anyway, one recent idea that I really like, Post Holdings (POST) did come out with their annual report in December as their year ended in September 2013.

It's a well-written annual report by the outsider CEO, Bill Stiritz.  He explains his plan for POST going forward.  Here are some snips:

This is a quote in the beginning of the report from Shakespeare's Julius Caesar:
There is a tide in the affairs of men, which taken at the flood, leads on to fortune. Omitted, all the voyage of their life is bound in shallows and in miseries.  On such a full sea are we now afloat.  And we must take the current when it serves, or lose our ventures. 
This points to the opportunity Stiritz sees for POST. One of those areas is organic food.

Sales of organic food in the U.S. has grown around 18%/year since 1990 according to this figure (to the right).  That's a pretty big tide.  I've always been a fan of companies like Trader Joe's and Whole Foods and do feel that this trend will continue for some time.  The opening of Whole Foods and Trader Joe's in a neighborhood tends to increase demand for organic foods overall even at the crappy local supermarket.  In the neighborhood where I live this has happened too. Once a Fairways, Trader Joe's and Whole Foods opens, the local supermarket chain seems to increase shelf space for organics and higher quality foods to try to hold on to their customers.

So getting into the organic food business is sort of like selling pans and shovels in a gold rush Samuel Brannan-like. The big chains, local chains, mom and pops, convenience stores will all fight each other for market share, but it will increase the demand overall for organics as the crappier stores try to improve their product lineup.

Anyway, that's just my pedestrian observation.  I am seeing it happen around here and other neighborhoods.

Holding Company
Here is Stiritz explaining the concept of Post Holdings as a holding company:

Unlike other companies that do acquisitions to build empires, Stiritz will focus on "strategic portfolio management".  I think some companies focus on synergies as that's one way (or the only way) to justify their empire-building.  Stiritz is clearly focused on strategic portfolio management to create shareholder value.

It is relatively unique for a company to be this hybrid, public company/private equity fund entity.  But it's not completely unique.  This blog likes to focus on companies like that.

The other difference between POST and a private equity fund is that POST is investing with permanent capital whereas private equity funds have an exit date in mind when they enter a purchase transaction; at some point there needs to be a liquidity event to return capital to fund investors upon expiration of the fund.  POST doesn't have that problem (similar to Berkshire Hathaway and other Berkalikes).

So if you just look at the headline valuation measures, POST looks a little expensive.  For example, the EV/EBITDA on a trailing twelve month basis is 12.9x according to Yahoo Finance.  That's not cheap.   Well, General Mills is trading at 11x and Kellogg at 13x, so it's not totally out of whack for a 'cereal' company.

But this 12.9x EV/EBITDA is not reflective of the true value because POST did some acquistions last year boosting EV but the EBITDA hasn't kicked in for the full year.

POST expects adjusted EBITDA for the fiscal year 2014 to be in the range of $245-260 million.  Against the current EV of $2.6 billion, that's an EV/EBITDA of 10-10.6x.   The $245-260 million outlook includes only acquisitions completed through September 2013, and the EV reflects the September 2013 balance sheet (and current stock price at around $51/share).  There has been a $525 million senior debt offering and $300 million convertible preferred stock offering since then, and the  Dakota Growers acquisition that just closed.

Dakota Growers was bought for $300 million and is expected to add $42-46 million in EBITDA on a full year basis.

Either way, the 10-10.6x range looks within the range of other cereal companies.  Yes, of course, you notice that I am comparing trailing twelve month for comps versus forecast, forward EBITDA for POST.  But given that this industry doesn't grow much, it should be close enough.   

But of course, this is not just another cereal company as we know.  This is an outsider CEO company!  If you don't know what I'm talking about, here is the link to the outsider CEOs post.   And here is my original POST post.

Book Value
I don't really look at food companies on a book value basis.  Or at least not directly in valuation.  We all do to the extent that we look at return on equity, which of course, is based on book value. 

But in this case, book value seems to provide a valuation data point.  Much of POST's book value is in goodwill, and this goodwill was created by Ralcorp's purchase of POST back in August 2008, so it's a recent figure.  Also, the goodwill is tested for impairment every year.   

But still, these management estimates are not to be taken too seriously even if the CEO is Stiritz. These 'models' (discount cash flow etc...) can be flakey, but at least it can be a datapoint. 

Book value per share of POST as of September 2013 was $45.83, so POST is trading at around 1.1x BPS

Here is the cut and paste of the goodwill valuation from the POST 10-K.  Again, I wouldn't lean on this valuation too hard, but it is a datapoint: 

Goodwill - Goodwill represents the excess of the cost of acquired businesses over the fair market value of their identifiable net assets. In the fourth quarter of fiscal 2011, we adopted ASU No. 2011-8 “Intangibles — Goodwill and Other (Topic 350): Testing Goodwill for Impairment.” We conduct a goodwill impairment qualitative assessment during the fourth quarter of each fiscal year following the annual forecasting process, or more frequently if facts and circumstances indicate that goodwill may be impaired. The goodwill impairment qualitative assessment requires us to perform an assessment to determine if it is more likely than not that the fair value of the business is less than its carrying amount. The qualitative assessment considers various factors, including the macroeconomic environment, industry and market specific conditions, financial performance, cost impacts, and issues or events specific to the business. If adverse qualitative trends are identified that could negatively impact the fair value of the business, we perform a “step one” goodwill impairment test. For fiscal 2013, we determined that our recent history of goodwill impairment combined with limited fair value excesses in prior valuations were significant qualitative factors which required us to complete the “step one” goodwill impairment test for our Post Foods reporting unit. We also concluded that “step one” goodwill impairment tests were warranted for our Attune Foods and Active Nutrition reporting units because of the recency of acquisition of those reporting units during the current fiscal year. The “step one” goodwill impairment test requires us to estimate the fair value of our reporting units and certain assets and liabilities. The estimated fair values were determined using a combined income and market approach with a greater weighting on the income approach (75% of the calculation for Post Foods and Attune Foods and 100% of the calculation for Active Nutrition). The income approach is based on discounted future cash flows and requires significant assumptions, including estimates regarding future revenue, profitability, and capital requirements. The market approach (25% of the calculation for Post Foods and Attune Foods and 0% for Active Nutrition) is based on a market multiple (revenue and EBITDA which stands for earnings before interest, income taxes, depreciation, and amortization) and requires an estimate of appropriate multiples based on market data.
As of September 30, 2013, we had goodwill balances of $1,366.3 million, $75.1 million and $48.3 million in our Post Foods, Attune Foods and Active Nutrition reporting units, respectively. For the calculation of fair value of our reporting units, we used the following key assumptions:
Post Foods
Attune Foods
Active Nutrition
Future revenue growth
2.4% - 9.0%
3.0% - 4.5%
2.9% - 20.5%
Terminal revenue growth rate
Discount rate
EBITDA multiple for market approach:
Fiscal 2014
Fiscal 2015
Revenue multiple for market approach:
Fiscal 2014
Fiscal 2015
Revenue growth assumptions (along with profitability and cash flow assumptions) were based on historical trends for the reporting units and management's expectations for future growth. The discount rates were based on a weighted average cost of capital utilizing industry market data of businesses similar to the reporting units. For the market approach, we used estimated EBITDA and revenue multiples as listed in the table above for Post Foods and Attune Foods based on industry market data. For the Active Nutrition reporting unit, we did not use the market approach because we concluded that the selected industry market data was not consistent with a business with the near term growth expectations of the Active Nutrition reporting unit. An unfavorable change in forecasted operating results and cash flows, an increase in discount rates based on changes in cost of capital (interest rates, etc.), or a decline in industry market EBITDA and revenue multiples for any of our reporting units may reduce the estimated reporting unit fair value below carrying value and would possibly result in the recognition of a goodwill impairment loss. The table below provides sensitivities for certain key variables in our goodwill impairment analysis for each of our reporting units. In all cases, the table presents the amount of change in each respective variable, holding all other variables constant, that would have resulted in an indication of potential impairment for the respective reporting unit. Changes equal to or greater than the amounts reflected in the table would have resulted in a failure of step one of the test and would have resulted in a step two analysis to determine the amount of any impairment.
Post Foods
Attune Foods
Active Nutrition
Discount rate
increase 0.90%
increase 1.05%
increase 0.65%
Revenue growth rate
decrease 0.90%
decrease 1.00%
decrease 0.70%
Revenue multiple
decrease 0.45x
decrease 0.30x
EBITDA multiple
decrease 1.75x
decrease 1.30x

The above doesn't mean that the goodwill is worth the balance sheet value. But it does mean that it's within range where an impairment wouldn't have to be taken.  For example, an EBITDA multiple change of 1.75x is pretty big versus a 10x base; that would be an almost 20% valuation change.

But it also means that goodwill is not totally worthless.

Precedent Transactions Analysis Valuation
And it occured to me that Ralcorp was purchased by Conagra right after POST was spun off, and I would hate to see the hard and expensive work of investment bankers putting together the deal go to waste so I decided to recycle their work here. 

There really is no 'comp' for POST, but it's a food company and so was Ralcorp.    There often isn't a perfect fit for comparing valuations, but it doesn't hurt to take a look at what food company deal valuations have been like in the recent past.  

This is from the December 2012 merger proxy, so it's pretty 'fresh'.  Here's what the bankers dug up: 

Selected Precedent Transactions Analysis.

Ralcorp’s financial advisors analyzed certain publicly available information relating to transactions in the packaged food industry since 2006. Specifically, Ralcorp’s financial advisors reviewed the following transactions:

Date Announced
Selected Branded Food Transactions
Campbell Soup Company  Wm. Bolthouse Farms Inc.  July 2012
Kellogg Company  Pringles (Procter & Gamble Co.)  February 2012
KKR & Co. L.P., Vestar Capital Partners, Centerview Partners
  Del Monte Foods Company  November 2010
Grupo Bimbo S.A.B. de C.V.  
Sara Lee Corp.’s North American Fresh Bakery Business
  November 2010
The Carlyle Group L.P.  NBTY, Inc.  July 2010
NestlĂ© S.A.  Kraft Foods Inc.’s Frozen-Pizza Business  January 2010
Pinnacle Foods Group LLC  Birds Eye Foods LLC  November 2009
Grupo Bimbo S.A.B. de C.V.  
George Weston Limited’s Northwestern U.S. Bakery Business
  December 2008
SOS Corporacion Alimentaria S.A.  Bertolli (Unilever Plc)  July 2008
The J.M. Smucker Company  Folgers (Procter & Gamble Co.)  June 2008
Ralcorp  Post Cereals (Kraft Foods Inc.)  November 2007
The Blackstone Group L.P.  Pinnacle Foods Group Inc.  February 2007
Selected Private Label / Food Service Transactions
The J.M. Smucker Company  
Sara Lee Corp.’s North American Foodservice Coffee and Beverage Business
  October 2011
Sara Lee Corp.’s North American Refrigerated Dough Business
  August 2011
Lassonde Industries Inc.  Clement Pappas and Company, Inc.  June 2011
TreeHouse Foods, Inc.  S.T. Specialty Foods, Inc.  September 2010
Cott Corporation  Cliffstar Corporation  July 2010
Aryzta AG  Fresh Start Bakeries (FSB Global Holdings, Inc.)  June 2010
Ralcorp  American Italian Pasta Company  June 2010
GS Capital Partners  Michael Foods, Inc.  May 2010
Viterra Inc.  Dakota Growers Pasta Company, Inc.  March 2010
CSM N.V.  Best Brands Corp.  February 2010
TreeHouse Foods, Inc.  Sturm Foods, Inc.  December 2009
IAWS Group, plc  Otis Spunkmeyer, Inc.  October 2006
While none of the companies that participated in the selected transactions is directly comparable to Ralcorp and none of the transactions in the selected transactions analysis is directly comparable to the merger, Ralcorp’s financial advisors selected these transactions because each of the target companies in the selected transactions was involved in the packaged food industry and, based on their professional experience and judgment, had operating characteristics and products that for purposes of analysis may be considered similar to certain operating characteristics and products of Ralcorp.
For each of the selected transactions, Ralcorp’s financial advisors calculated and compared the enterprise value of the target company, calculated based on the purchase price paid in the transaction as a multiple of EBITDA of the target company for the latest twelve month (which we refer to as LTM) period ended prior to the announcement of the merger. In addition, Ralcorp’s financial advisors calculated this multiple for Ralcorp based on the value of the merger consideration and using the LTM EBITDA as of September 30, 2012. The following table presents the results of this analysis:

  Selected Transactions  
  Range  Median    
Enterprise Value as a Multiple of:
  Private Label /
  Food Service  
  Private Label /
  Food Service  
  7.6x-10.6x  5.3x-11.7x  9.0x  7.8x  8.5x  12.1x

EBITDA multiples for Wm. Bolthouse Farms Inc., Pringles (Procter & Gamble Co.), Kraft Foods Inc.’s Frozen-Pizza Business, Sara Lee Corp.’s North American Refrigerated Dough Business and Cliffstar Corporation excluded value paid for step ups in tax basis.
Because of the inherent differences between Ralcorp and the parties to the selected transactions, Ralcorp’s financial advisors considered differences between the business, financial and operating characteristics and prospects of Ralcorp and the parties to the selected transactions that could affect the values of each. Based on their judgments and experience, informed by the transaction multiples of these selected transactions, Ralcorp’s financial advisors selected a reference range of 8.0x to 10.0x and applied this range to the LTM EBITDA of Ralcorp, resulting in illustrative per share values for Ralcorp common stock ranging from $50.42 to $69.72. 

So the bankers figured Ralcorp was worth between 8-10x EV/EBITDA.   From this (and the above table), it seems like POST is a little on the high side of valuation.  But again, POST is not just any old cereal or food company. 

This is not one of those situations where I can say POST is worth this, and it's trading at some discount to that. It's more like, it's trading at what others are trading at and in a reasonable range, but forward returns may not be so reasonable given the history of the current CEO. 

Stanley Druckenmiller in a TV interview said that Stiritz is the greatest capital allocator of all time.  I think he based this on his study of insider purchase of shares; he had the best timing by far of anyone in the universe they looked at.  Druckenmiller is so impressed with Stiritz as a capital allocator that he bought shares in Herbalife (HLF) without much knowledge of the HLF business.  He said that when someone so good at capital allocation puts so much of his own net worth into a stock, you don't really need to know all that much about the stock. 

I know many people don't think very highly of hedge fund managers, but I have always respected Stanley Druckenmiller, no less than many other of my investment 'heroes'.  His style is a little different than what I have become interested in.  And I don't always agree with what he says (well, I don't always agree with what Munger and Buffett say either).   But he is the real deal.  All the criticism about hedge funds that I hear doesn't apply to Druckenmiller.  He is truly different. 

Anyway, back to POST.  I do sort of wish Stiritiz owned a lot more POST stock; that would really make this a perfect story.  Oh, and if Stiritz was a little younger too.  He is 79.   That's the one 'hole' in this story.  But hey, let's put it this way.  Looking at Munger, Buffett, Icahn, Soros etc...  maybe 80 is the new 50. 

Otherwise, as I said before, it's a great story:
  • It's a perfect Greenblatt-type spin-off; a neglected business spun off with renewed focus and incentivized management to turn the business around (in this case, goal is to stabilize legacy business enough to use as a base to expand into new areas).
  • It's run not by an outsider-like CEO, but an actual outsider CEO featured in the great book.
  • The company is getting into new areas with growth potential; not only industry growth potential (organics, private label), but potential for consolidation (roll-ups).  I've always loved Trader Joe's, but unfortunately you can't buy the stock. And Whole Foods is too expensive (I'm talking about the stock price, but I know what you all are thinking).  Here is a way to get into the trend at a reasonable price.  Private label is also very interesting (Trader Joe's is basically a private label.  Costco's Kirkland is also very interesting.  This is a big trend that will continue for some time. Actually, Costco's Kirkland may be interesting for COST but maybe that will be another post for another day). 
  • It is reasonably priced.  There is no "outsider CEO" premium.  The headline EV/EBITDA figure (of close to 13x) is misleading due to one-time reasons.  When the EBITDA from 2013 acquisitions begin to flow through, the valuation will look cheaper.  I know this sounds silly, but the market does often act like this (maybe due to a lot of robots trading off of unadjusted, nominal valuation figures not to mention value investor screens not showing adjusted valuations.  A great example of this 'silliness' is Pzena Investments; when the lousy performance figures of the financial crisis drops off in the five year returns, the performance metrics look better, investor demand rises and the stock goes through the roof.  Pzena said he understands this makes no sense, but assured us that this is how the markets work.  When things 'look' better, people think it's better.)

So anyway, this is a lazy, light post, but I wanted to put something out there.   And even though there isn't much 'meat' in this post, I really do like POST. 

And I do want to keep posting more but I want to resist the temptation of just posting for the sake of posting.  I would rather have a long gap of no posts than have the blog filled with nonsense, like a bunch of rants about one thing or another (who can't write pages and pages of that every day?!).