Lean Costs And Deal Potential: RBC On Lessons From ‘The Outsiders’

Lean Costs And Deal Potential: RBC On Lessons From ‘The Outsiders’

RBC Capital Markets analysts David Palmer and Christopher Carril believe that certain CEOs in the packaged food industry are much like those profiled in William Thorndike’s 2012 book The Outsidersa group of CEOs known for their obsession with (among other themes) capital allocation, free cash flow and growth in value per share.

“His performance as Burger King Worldwide Inc (NYSE:BKW) CEO demonstrated his (and 3G’s) intense focus on cost-cutting and his leadership at Heinz is one of the reasons why we believe H.J. Heinz Company (NYSE:HNZ)’s results have the potential to cause disruption in the packaged food world,” say the RBC analysts in their April 25, 2014 research note, referring to Bernardo Hees, current CEO of Heinz and ex-CEO of Burger King.

“Significant” earnings (or leaner costs) at Heinz

The authors seize on Buffett’s remark in his 2013 letter to investors that 2014 earnings at Heinz could be ‘significant’, and suggest that these could be driven primarily by cost savings engineered through the efforts of 3G Capital’s management team.

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“Based on 3G Capital’s past success in reducing costs at a significant level at companies that it had previously acquired, we believe that 3G may ultimately drive costs down to best-in-class levels at Heinz,” says the research note.

Previous research by RBC has identified that large cap packaged food companies offer substantial scope to drive down overheads and thereby bring operating margins to levels comparable with their peers.

Mondelez International Inc (NASDAQ:MDLZ) is a case in point, and according to the authors, the company has engaged Accenture to help in its mission to drive operating margins higher to the 14-16% range compared to only 12% as of now.

This is also what may transpire at H.J. Heinz Company (NYSE:HNZ), say the authors. “We believe that if 3G Capital is able to achieve the level of cost savings and margin growth it has driven in the past, the effects would reverberate around the packaged food world, particularly in light of the current weak growth environment for the industry,” they observe.

Their confidence is driven by H.J. Heinz Company (NYSE:HNZ)’ CEO Bernardo Hees’ previous stint at Burger King during which he was able to substantially reduce the company’s G&A expense as shown below.

2-Burger King cost cut Outsiders

David Wenner of B&G Foods another ‘Outsider’

“We feel the implementation of lean operating structures and the methodical allocation of capital by Hees, Wenner and Gamgort is reminiscent subject companies and CEOs of The Outsiders,” say the analysts. “We also feel that, in certain circumstances, such ‘outsider’ CEOs and companies present investment opportunities.” (Robert J Gamgort is CEO of Pinnacle Foods).

One such investment play, suggest the authors, is B&G Foods, Inc.(NYSE:BGS), a company which is gaining traction on its snack food acquisition and whose newest deal could prove positive for earnings numbers.

RBC recently improved the rating on B&G Foods, Inc.(NYSE:BGS) from Sector Perform to Outperform, on the basis that its recent acquisition of Specialty Brands of America could be highly earnings accretive.

“We now estimate $1.65 of EPS in 2014 (versus our estimate of $1.56, before the deal was announced) and $1.80 in 2015 (versus our previous estimate of $1.61, before the deal was announced),” say the analysts, adding that the company’s SG&A margin of 11% make it a cost leader in the packaged food environment.

3-BGS Outsiders

Other factors working in favor of B&G Foods, Inc.(NYSE:BGS) include strategically successful M&A deals of acquiring smaller companies, the learning experience from the logistical difficulties at the newly acquired snacks business, interesting new product launches on the horizon and further cost reductions.

Importantly, in recent months, both sales and volume trends are moving higher as shown below.

4-sales-and-vol Outsiders

B&G Foods, Inc. (NYSE:BGS) is currently trading at $32.43, up 2.95%.

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