Description

Flowers Foods, Inc. (FLO)

Thesis

• This idea will not light the world on fire, but I think it is an opportunity for fairly safe 20-25% return without a lot of downside risk
• Flowers Foods, Inc. (“Flowers” or “FLO”), the #2 packaged foods bakery in the US, is poorly positioned for the current inflationary environment
• Heavy branded focus leaves company highly vulnerable to pressured consumers
• Recent growth has been driven solely by price/mix, as unit volumes have been declining consistently across both primary product categories

• Market share losses have accelerated into the end of 2022

• Industry trends are not working in the company’s favor
  • Company’s products skew towards branded, with a 67/33 split between branded and non-branded (i.e. store brand and institutional)
  • Company has been moving focus towards branded in recent years, with branded share of total revenue going from 60% in 2019 to 67% in 2021
  • This has worked in the company’s favor until recently, as branded has been consistently gaining share from private label for the past few years
    • From 2017 to 2021, private label gained 490bp of industry share
  • However, as inflation began to bite in 2022 this reversed, and private label took share (20bp) for the first time in recent memory
  • This trend has accelerated throughout 2022, with private label taking 90bp of share in 4Q; we expect the shift to continue into 2023 and possibly beyond
  • Specialty premium bread, a sweet spot for the company, lost 50bp of unit share in 4Q which was more than any other category of fresh packaged bread
• Cost trends are unfavorable, raising earnings risk
  
  • Input costs have been an obvious headwind, and the company has limited ability to pass these on given its branded skew and the evolving demand environment
  • GMs have compressed by >200bp over the past two years; EBITDA margins have compressed by 150bp over the same time period
  • Management expects “significant” continuing input cost inflation in 2023
• The company is in the midst of a multi-year ERP implementation, which is always a risk factor; it just upped its total cost for the implementation from $275mm prior to $350mm current estimate
• Valuation remains generous for a company that is poorly positioned for the current consumer environment with ongoing margin pressures
  • Healthy absolute levels given limited expected earnings or FCF growth over the next few years
  • Business currently trades for 12.5x EBITDA and 21x EPS
    • Both levels are at a premium to longer-term averages; roughly 1x turn premium on EV/EBITDA and 4x turn premium on P/E
    • We expect that given the current challenging environment the business could/should trade down to levels commensurate with the outlook; on numerous prior occasions the business has traded at a discount to market multiples
      • Assuming 85% of S&P levels implies ~9.5x EBITDA and 15x EPS, yielding ~25% downside

Business

• 2^nd largest US producer and marketer of packaged bakery foods; 2021 US market share of breads/buns/rolls 22%
• Products include breads, buns, rolls, snack cakes, and tortillas
• Company identifies its brands’ strategic positioning as follows
  • Mainstream: Nature’s Own, Wonder, Tastykake
  • Organic: Dave’s Killer Bread
  • Gluten Free: Canyon Bakehouse
• 2/3 branded, 1/3 non-branded (store brand + foodservice/restaurant/institutional)
  • Fresh packaged breads roughly 80/20 split between branded/non-branded
• Walmart/Sam’s = 21% of sales

Target

Catalyst

 Continued market share losses, ongoing margin pressure, reduced earnings expectations