There are certain times when being a value investor also implies taking a contrarian approach. However, the terms “value investor” and “contrarian investor” are not always synonymous. On the other hand, when faced with a significantly overvalued marketplace like we see today with blue-chip dividend growth stocks, value investing and contrarian investing tend to become one and the same.
The simple fact is that when faced with a strong bull market, true fairly valued dividend growth stocks become very hard to find. In a strong market, value typically comes about for a reason, and that reason is typically associated with problems. However, the key to long-term investing success is when you find fair value due to a temporary problem, and not a permanent impairment of the underlying business.
Flowers Foods, Inc (FLO): Once Highflying Investor Sentiment Has Recently Turned Negative
The fairly valued dividend growth stock research candidate I am featuring in this article is Flowers Foods, Inc. The company was founded in 1919, went public in 1968, and through organic growth coupled with a series of acquisitions and divestitures, it has grown into the second largest North American bakery. As a dividend growth stock, Flowers Foods is a member of David Fish’s Dividend Contenders as it has raised its dividend for 15 consecutive years.
Flowers Foods has historically commanded an above market P/E ratio in the marketplace. However, since the end of October 2015, the company’s stock price has fallen approximately 43% from its then overvalued high. This precipitous drop in stock price has brought the company into what appears to be attractive valuation levels based on earnings and/or cash flows, and has pushed its current yield above 4%. Clearly, the stock has become unpopular, and I see two primary reasons why this has occurred.
The most significant reason, in my opinion, has been a significant slowdown in earnings growth to a mere 1% average rate since the beginning of fiscal year 2014. Prior to that time, Flowers Foods had historically grown earnings at an average of more than 20% per annum. (I will cover both of these results in more detail later.) This previously high rate of growth essentially explains its historical normal P/E ratio of 22, and the recent significant slowdown of earnings growth partially explains the current reset in its valuation.
The second reason for the company’s current negative investor sentiment is based on the announcement that the Department of Labor is investigating whether or not the classification of its delivery drivers as independent contractors is legal and valid or not. This investigation has also resulted in a rash of additional lawsuits.
Flowers Foods has acknowledged the Department of Labor’s investigation without further comment at this time, and as expected, stated that they will cooperate with the investigation. However, management has indicated that they believe the additional lawsuits are without merit and plan to vigorously defend themselves against them. Also, Flowers Foods management indicated they see no reason to book a reserve for the DOL investigation. In an article on September 8, 2016 in baking business.com Flowers Foods Pres. and Chief Executive Officer Alan L. Schiver offered the following comments:
“Like many other companies operating independent contractor models, our model has come under recent scrutiny,” Mr. Shiver said. “To that end, we are cooperating with the Department of Labor in its review. Because that process is confidential, there is nothing more we can disclose.”
“Let me stress that we also consider our fiduciary duties and our financial reporting to be of the utmost importance,” Mr. Shiver said. “We have carefully evaluated the proper accounting treatment of our legal situation. Based on this review, we have determined that at this time booking a reserve is not appropriate, given the current facts and circumstances.”
“Additionally, as many of you are aware, there is pending litigation. We believe that the lawsuits have no merit, and we are vigorously defending ourselves against them.”
Personally, I am not overly concerned with the litigation issues which I consider as event risks. These are issues that management should be capable of dealing with, and I also believe that the DOL investigation will likely take years to resolve. Stated differently, I don’t see these events capable of instigating a permanent impairment in the company’s future business prospects.
However, I do believe the slowdown in earnings growth over the last few years represents a problem that requires more scrutiny and analysis. Consequently, the remainder of this article will deal with the current financial health and strength of the company, and most importantly, the future potential of the business over the longer run.
Why Get Interested in a Company Experiencing Problems?
I think most readers would agree that it’s getting very difficult to find quality and value in today’s long-running bull market – especially when looking for income opportunities available with blue-chip dividend growth stocks. As previously stated, there are usually reasons why a business (stock) is underperforming in a bull market.
On the other hand, low valuation on a good business offers the opportunity for extraordinary returns if the problems are temporary. Consequently, I approach these situations looking for the opportunity where others only see the risks. Legendary investor Warren Buffett taught me the benefits of this approach through his following quotes which I believe are full of investing wisdom:
“Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what’s popular and do well.”
“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.”
“Be fearful when others are greedy and greedy only when others are fearful.”
“The most common cause of low prices is pessimism—some times pervasive, some times specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer.”
Flowers Foods: Essential Fundamentals at a Glance
Next, I will utilize the F.A.S.T. Graphs™ fundamentals analyzer software tool in order to take the reader through a quick review of the important underlying fundamentals supporting this company. Additionally, I will be walking you through my personal analysis, and as previously promised, elaborate on the changes in the company’s growth rates. Through this process I will be analyzing and evaluating the company’s historical record and I will present a thesis regarding the company’s future growth potential.
Flowers Foods: Earnings Growth since 2002
As I have pointed out in previous articles, I prefer looking at the business behind the stock before I bring stock price into the equation. Stock prices can engender emotional responses, and I like to keep emotions out of my analysis – especially in the beginning. The following graph plots Flowers Foods’ earnings results since 2002.
There are a couple of points I would initially like to bring to the reader’s attention by asking you to look to the FAST FACTS boxes to the right of the graph. The first is the average earnings growth rate of 18.8% shown in the green rectangle. The next is the reported normal P/E ratio of 22.5, which is not yet shown on the graph, but it will become