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The Fairy Godmothers of Food Companies

Sunday - 4/7/2013, 2:40pm  ET

Who doesn't love a good Cinderella story?  Corporate makeovers are generally the province of hedge funds and activist investors, but three companies specialize in taking Cinderella food companies and readying them for prime time.

BGS Foods , Pinnacle Foods and Hain Celestial buy dowdy companies at low prices, dress them up with new labels or packaging and get a ride to the shelf space ball with promotion and marketing. Maybe they get some makeup with new flavors. Finally, a haircut with some coupons or price cuts makes them look better immediately. There isn't a much better business model.

Leave Pinnacle in the cold

Pinnacle Foods priced at $20 for its IPO on March 28 and has gained over 15%. At $23.50 its yield is just over 3%. The company has products in 85% of US pantries with well known brands like Mrs. Butterworth's, Duncan Hines, Vlasic Pickles, Aunt Jemima, and Hungry Man dinners.

The company is valued at a 39.16 P/E and even with $580 million raised in its debut earmarked to pay off debt it has $1.80 billion debt remaining. The company achieved net sales of $2.5 billion in 2012. While one of the most anticipated IPOs of the year and a leader in the frozen food aisle, Pinnacle leaves me cold.

Its product portfolio is well known, but that's a high P/E for a company competing with Campbell Soup and JM Smucker, both hitting 52 week highs again on April 2. More rivals include Kraft Food Group, Unilever, and Kellogg. That said, the company has made some accretive buys with Armour canned meats in 2006, those little Vienna sausages and chili, and Birds Eye, the frozen vegetable and frozen side dish brand in 2009. Pinnacle originally started with Hungry Man, which it bought from Campbell.

This valuation isn't appetizing when sales growth is barely in single digits for last year, only up 0.40%. Blackstone Group, which took the company private in 2006, still owns 70% of the common stock. 

In its prospectus (a 145 page slog) stated that risks include the consolidation of grocery chains meaning possible price cuts and increased expense for promotion and advertising. Also, not stated as a risk; Wal-Mart accounts for 25% of net sales and the big box behemoth is noted for some shrewd negotiating with suppliers.

The company plans to pay down debt with free cash flow left after paying the dividend. Net interest expense has been decreasing annually and the IPO proceeds should help.

Its Leadership brands, the ones that they spend 80% promoting, are generally number one or two in their brands' market share. These are supported by the free cash flow of the Foundation brands, stable but not growing cash cows. The EV/EBITDA is at 12.44.

While the company has some leading iconic brands, its P/E, debt load, and slow growth are compelling reasons to avoid the stock with its IPO runup.

Warming up to B&G Foods

B&G Foods has a 3.80% yield and a 24.63 P/E. The food processor had a superior 2012 growing revenue and earnings but has lately pulled back. The company's business is to buy unloved brands and then make them over and they've done this to a portfolio of over 30 brands, most notably with brands Cream of Wheat, adding a Cinnabon and chocolate variety to the hot cereal.

B&G Foods is a lean machine with only 999 employees. They reported Q4 and full year 2012 results on Feb. 14 with an increase of 15.4% for the full year diluted EPS and net income rose 17.9% for the full year. Net sales were $633.8 million for the year.

The company was strongly affected by Hurricane Sandy last fall with its headquarters in Parsippany, NJ (Pinnacle is also headquartered there) without power for 9 days. CEO David Wenner estimated that its biggest markets, New York and New Jersey accounted for almost half of the sales volume decline in the fourth quarter of 2012.

The disadvantage to B&G is they're low on cash holding $19 million with debt of $637 million after acquisitions of Culver Specialty Brands in 2011 and Old London in 2012. Although accretive, debt from these purchases has weighed heavily on the stock. B&G has come down 10% from its 52 week highs, but is up 32.26% over the last year. Piper Jaffray still likes the name with an overweight reiterated in March.

The company has an admirable rating for corporate governance of 2. But the EV/EBITDA is high for the industry at 13.20.

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