Flowers Foods: Irrational Selloff After Fourth Quarter Earnings

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On February 14, 2017, Flowers Foods (FLO) reported earnings for the fourth quarter and fiscal year of 2016.

Despite it being Valentine’s Day, investors did not love the stock after the company’s earnings announcement.

Flowers Foods stock dropped 8.8% that day.

Flowers Foods

Source: Yahoo! Finance

However, this is not necessarily a bad thing for the long-term investor.

When companies experience (or are perceived to experience) short-term trouble, it can be a great opportunity to pick up shares at a discounted price.

“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.” – Warren Buffett

This article will discuss why Flowers Foods current stock price presents a buying opportunity rather than a reason to be fearful.

Flowers Foods – Business Overview

The predecessor Flowers Foods was founded in 1919 by two brothers in Thomasville, Georgia. The company became known for its high production volumes, state-of-the-art technology, and great sanitary standards.

The company first went public in 1968 as Flowers Industries, and introduced their famous Nature’s Own bread in 1977. The company was renamed Flowers Foods in 2001 and has gone by that name ever since.

Flowers Foods is now the second largest bakery business in the United States. With four product mixes, two distribution networks, and three sales channels, Flowers Foods has become a force to be reckoned with in the bread industry.

Flowers Foods

Source: Flowers Foods Investor Presentation, slide 5

Flowers Foods has a distinct competitive advantage that comes from their many brands of popular bread. Most notably, Flowers Foods owns Nature’s Own, Dave’s Killer Bread, and Wonder, among others.

Flowers Foods

Source: Flowers Foods Investor Presentation, slide 8

Financial Performance Overview

Flowers Foods reported earnings for the fourth year and fiscal year of 2016 on February 14, 2017.

In their press release, Flowers Foods announced the following financial results for full-year fiscal 2016, with comparisons being made to fiscal 2015:

  • Sales increased 3.9% to $3.927 billion. The acquisitions of Dave’s Killer Bread and Alpine Valley Bread contributed 4.0% to the sales increase.
  • Diluted GAAP earnings-per-share decreased 12.4% to $0.78
  • Adjusted earnings-per-share decreased 1.1% to $0.91
  • Costs associated with Project Centennial were $6.3 million, which translates to $0.02 per share

There are three main things to note from Flowers Foods’ full-year figures.

The first is that sales increased 3.9%, but 4.0% was contributed from the company’s two major acquisitions during the year. This means that the company’s top line growth was driven entirely by acquisitions. Flowers Foods would have seen a minor 0.1% contraction in revenues ex-acquisitions, and this may have contributed to the stock’s drop after the earnings announcement.

Secondly, GAAP earnings-per-share decreased 12.4% but adjusted earnings-per-share decreased only 1.1%. This is a large difference, and the company cited the following reasons for the lack of comparability:

  • Trademark and Asset Impairments of $24.9 million
  • Legal Settlements and Related Tax Liabilities of $10.5 millions
  • Pension Plan Settlement Losses of $6.6 million
  • Loss of Extinguishment of Debt of $1.9 million

With the exclusion of the last two items on that list, the majority of these costs were incurred in the fourth quarter. So, this substantial difference between GAAP and adjusted earnings-per-share will also be seen in the company’s fourth quarter results.

Lastly, the company reported costs from Project Centennial of $0.02 per share (which is 2.6% of GAAP earnings-per-share and 2.2% of adjusted earnings-per-share). Project Centennial is Flowers Foods initiative to return growth to the company, and will be discussed in more detail later; I’ve mentioned it here to show that the company is investing a significant amount of capital into the initiative.

Flowers Foods also announced the following financial results for the fourth quarter of fiscal 2016. Each of the comparisons is being made to the same quarter one year ago.

  • Sales increased 1.2% to $868.7 million
  • Diluted earnings-per-share decrease 60% to $0.06
  • Adjusted earnings-per-share remained unchanged at $0.16

Diluted earnings-per-share decreased 60%, likely on the back of the substantial legal impairment incurred in the fourth quarter. Before moving on, I’d like to elaborate these legal charges.

In December, you may remember that we published an article describing how Flowers Foods recently settled a class action lawsuit with respect to the company classifying some of their drivers as independent contractors rather than employees.

Here’s what Flowers Foods said in the December 9th press release surrounding the settlement:

“On December 9, 2016, Flowers Foods, Inc. and Flowers Baking Co. of Jamestown, LLC, reached an agreement to settle Rehberg et al. v. Flowers Foods, Inc. and Flowers Baking Co. of Jamestown, LLC , a class action lawsuit that was filed in March 2013 in the U.S. District Court for the Western District of North Carolina (Charlotte Division). The settlement provides for payment of $9.0 million, comprised of $5.2 million in settlement funds and $3.8 million in attorneys’ fees. The settlement also contains certain non-economic terms that are intended to strengthen and enhance the independent contractor model, which remains in place. This agreement, which covers approximately 270 distributor territories, is subject to court approval.”

Investors were generally expecting the settlement to be much worse than that, so when the settlement was announced, FLO’s stock price shot up accordingly.

Looking Ahead

One of the main growth prospects for Flowers Foods in the immediate future is Project Centennial. This is an initiative that is aimed at cutting costs and restoring earnings-per-share growth to this company. Project Centennial has gone through two stages so far.

The first stage consisted of a comprehensive diagnostic evaluation of the company’s opportunities to drive growth, reduce costs, and invest internally. The goal of identifying these opportunities was to boost Flowers Foods’ competitive positions and improve the company’s operating margins. The company announced on November 9 that this first stage had been completed.

Flowers Foods also stated that mid-October saw the beginning of the second stage of Project Centennial. Management is now developing and executing on the opportunities that were identified in the first stage of Project Centennial.

In the company’s most recent press release, here is what was noted about Project Centennial:

With Project Centennial we are taking decisive action to pivot towards the consumer and remove complexity and costs from our business. In fiscal 2017, we are moving forward with urgency to reinvigorate our core business, reduce costs, and build capabilities to efficiently grow our brands.” — Allen Shiver, Flowers Foods CEO

Project Centennial is expected to seriously ramp-up in fiscal 2017, with the company expecting costs from the program to be in the range of $0.07-$0.09 per share.

I am confident in Project Centennial’s ability to return Flowers Foods to growth.

Secondly, fiscal 2016 saw Flowers Foods close two significant acquisitions – Dave’s Killer Bread and Alpine Valley bread. With these assets still fresh on the books, Flowers Foods should still be capable of realizing cost synergies which will translate to the company’s bottom line. Further, I’m sure that Flowers Foods will continue to complete acquisitions that they deem attractive.

All in all, Flowers Foods still has good growth prospects over the long run.

Final Thoughts

Without a doubt, Flowers Foods stock price is at a depressed level. The company is currently trading at its lowest point in calendar 2017.

It’s important to keep in mind that this company just reported flat fourth quarter adjusted earnings, a 1.1% decrease in full-year adjusted earnings, and 3.9% sales growth for fiscal 2016. The company’s stock dropped 8.8% – but has the company’s value dropped 8.8%?

I would argue that is hasn’t. Flowers Foods is trading at more of a bargain than at any other time in 2017.

“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
– Warren Buffett

Value-oriented investors may benefit from picking up shares of Flowers Foods before the company’s stock returns to a more normalized level.  Flowers Foods is currently the 10th highest ranked stock in the United States using The 8 Rules of Dividend Investing thanks to the recent price decline.

Artiicle by Nick McCullum – Sure Dividend

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