Description

Summary:
Flowers Foods, Inc. is an undervalued super regional bakery in an industry that has seen a tremendous amount of consolidation. A number of problems with Mrs. Smith's Bakeries and problems with competitors have caused a recent 25% decline in an allready undervalued stock. Gabelli owns 12% of the company and has been putting pressure on the company to recogize its value. Traditionally a family run business all the family members have left the business recently. With loss of strong loyalty to operating the company independently there is a high probability company will be sold. Based on recent sales company could be worth twice its current price. The combination of an undervalued stock with a number of catalyst provides and oportunity for an investment with good upside potential and not much downside risk from here.

Company Description:
Flowers Foods produces and markets frozen and non-frozen bakery and dessert products. Flowers Foods consists of Flowers Bakeries and Mrs. Smiths Bakeries. Flowers Bakeries markets its packaged bakery products in the super-regional 16 state area in the southeastern United States under the brand names such as Nature's Own and Cobblestone Mill. The Company also markets fresh bread under regionally franchised brands such as Sunbeam, Roman Meal, Evageline Maid and Bunny. Company has a valuable direct store distribution system. Flowers Bakeries sales for 2002 are estimated at 1.07 billion with an operating margin of 8.2%. Flowers Bakeries primary competitors are Earthgrains and Interstate Baking. Though its competitors have experienced problems recently Flowers Bakeries has performed well and is believed to have taken market share from it competitors. Flowers Bakeries plants are considered to be in the best shape in the industry.

Mrs. Smith's frozen desserts are marketed throughout the United States and are sold at retail under the Mrs Smith, Pet-Ritz, Oregon Farms and Oronoque Orchard brand names. Mrs. Smiths is the number one brand in the frozen pies category with over 40% market share. Mrs. Smith's sales for 2002 are estimated at between $585 and $590 million with an operating margin of -2.2%. Mrs. Smiths has been a problem for Flowers Foods ever since they upgraded the plants several years ago. They operate at approximately 60% of capacity and with the high fixed costs must increase sales to leverage these costs. Have had losses for 3 years. Losses have steadily improved and management believes they can get to 10% margins as they build sales to $800 million range. This will take some time in our opinion as not a tremendous overall market and Sara Lee is very aggressive competitor.

Valuation:

Flowers Foods sells at .9x book but at 27 times 2002 estimated earnings of $.69/shr this company does not come up in many screens. However Flowers has spent a tremendous amount of money upgrading its plants in recent years as a result maintenance cap ex is substantially lower than depreciation. With depreciation at $70 million and maintenance cap ex at $40 million Flowers picks up an additional 30 million of cash flow. Next year company projected to have over $2 per share in cash flow. Thus even without Mrs. Smiths fixed the company has substantially more cash flow then reported earnings and has more reasonable valuation based on cash flow. With managments belief a 10% operating margin can eventually be achieved at Mrs. Smiths there is significant upside potential to the cash flows. We put less weight on the turn around of Mrs. Smiths which will require substantially more time to build sales to a point to leverage the high fixed costs of their new plant then the sale of the company which has a number of catalysts.

Traditionally bakeries have sold at 1 time sales and approximately 10 times EBITDA; however, more recently Bimbo bought Westons western bakeries for .8 times sales and 9.3 times ebitda. With Flowers EBITDA currently at $122 million, this would equate to a price per share, with net debt of $176 million less estimated $50 million cash generated 4th quarter and 30 million shares, of approximately $33 a share. In addition Flowers has 22 million of corporate overhead which could be eliminated if Flowers were purchased by another bakery. After Flowers latest press release about problems at Mrs Smiths analysts reduced estimates of 2003 EBITDA to $140 million. On the conservative side assuming multiples drop to 8 times EBITDA and a potential buyer only gives Flowers credit for $10 million of the corporate overhead I come up with an enterprise value of 1.2 billion. Debt less the distributor receivables is approximately $175 million. Reducing debt by available free cash flow of $100 million from third quarter 2002 to end 2003 (2/3 managements estimate of $150 million available to pay down debt. Note manament now authorized to buy back shares so may not pay down debt as much) I get equity value of 1.125 billion. With approximately 30 million shares outstanding this is value of $37.5 per share at end 2003 or about twice the current price.

Catalyst:

Mario Gabelli owns 12+% of the company and filed a 13d last quarter where he included a letter to the board asking them to remove the poison pill which takes affect once an investor owns more than 15% of the company. Gabelli indicated that he believed the company was undervalued and wanted to be able to buy more for his clients. Gabelli's involvement in the company is a significant catalyst in my opinion as he is known to be a tough shareholder activist. As a result of Gabelli's request the board raised the poison pill to 20%. I am convinced managements recent announcement that it has authorized the repurchase of 5 million of 30 million shares outstanding is a direct result of Gabelli's involvement. In the past we have discussed share buybacks with the company and have been met with resistance until Gabelli became more active. Also in discussions with Gabelli he believes Bimbo would be interested in Flowers. We also have heard rumors Weston would be interested in Flowers. With the number of shares Gabelli owns and the amount of float in Flowers shares the best way for Gabelli to get out of his investment is for the company to be sold. I believe he will be pushing for this but regardless he will be putting pressure on the board to increase value for the shareholders.

W.H. Flowers who built the company died 2 years ago. Since that time Marty Wood (former CFO and son in law) and Bob Crozer (former Vice Chairman and son in law) have resigned. Further chairman and ceo Amos Mcmullian(66) who is intensely loyal to Mr. Flowers vision is set to retire. With no family involved in the business anymore and no strong leadership to take over for Amos the proability of a sale in the next two years is very high.

Finally the company recently announced the authorized buy back of 5 million shares of the 30 million outstanding. In addition to bringing more attention to Flowers this should serve to help reduce the risk of further drops in the share price for some time given the volumn of shares typically traded as managmement will be buying shares supporting the price and increasing value of remaining shares.

Catalyst

Gabelli owns 12% and is shareholder activist pushing for maximun shareholder value.

Company recently authorized share buyback of 5 million of 30 million shares outstanding.

Family no longer involved in company and old time managment set to retire without strong successor increased proability for sale of company.