Description

Situation Overview: Since its spinoff from Ralcorp in 2012, POST has been on an M&A tear, completing over ten acquisitions and levering its balance sheet to ~6.0x EBITDA. While the pace and strategic rationale for some of these acquisitions have given investors pause, the ongoing diversification of its business has transformed it from a pure-play cereal company to a higher growth packaged food company with a more diversified breakfast portfolio and estimated 60% of sales in higher growth categories. Despite transitory issues from operational missteps and headline risk from Avian Flu, POST’s strong FCF generation, which yields 6%+, highlights the 30%+ levered return of this public LBO. Price target of $90.  

Why Situation Presents Itself: Given the pace and breadth of recent acquisitions, and the resulting opacity in the earnings power of the pro-forma business, there is concern that POST has not "bought right" and that recent transactions do not justify their multiples and associated leverage. POST chunked Q3’14 earnings attributable to the performance of these acquisitions (Dymatize, Premier), significantly reduced FYE guidance (again), and raised concerns about the company’s integration ability. The stock sold off sharply – nearly 25% in the months after Q3 earnings. Although the stock has performed well since then on improved quarterly earnings, FYQ2 earnings were dampened from the AI overhang – stock sold off from $51/share to $42/share. Finally, the acquisition  of MOMs brands – which at first was received with a lukewarm response as it doubled down on the secularly challenged cereal category – will likely provide for significant bottom line contribution from rationalized trade spend and additional upside to the $50M synergy guidance (yet to be appreciated). At 10x EBITDA, a material discount to a lower growth competitor set, we believe that valuation today reflects low expectations in the turnaround in business fundamentals (cereal, Active Nutrition), conservative assumptions over the cost savings opportunities at MOMs, nor give credit to the rapid deleveraging power of POST’s business model. 

Notable Events: 

o   On 1/25/2015, POST announced the acquisition of MOMs Brands for $1.15bn.

o   On 4/28/15, POST reported that ~10% of its Michael Foods egg supply was affected by the current high-pathogenic avian influenza (AI) outbreak, with the expected impact raised to ~14% of its supply as of its F2Q15 report on 5/7/15, and then again to ~20% on 5/12/15. By August, POST announced that through its cost controls and force majeure pricing initiatives, the AI headwind had effectively been mitigated.

o   On 8/12/15, POST raised ~$300M in a mixed shelf offering for incremental M&A

o   On 9/2015, POST closes Dymatize’s manufacturing plant and permanently transfered to co-packers. POST also purchased Williamette Egg farms, which should add $15M in EBITDA to FY earnings.  

Catalyst Path & Timing:

o   We believe that POST sentiment has troughed and is already on the rise, and the “path to getting paid” will be from the following:

-    MOMs / POST integration updates, which will most likely start in Q3’15; we would expect either 1) an acceleration in the timing of synergies/cost savings realized and/or 2) increased synergy targets (increased from $50M guided).

-    Ongoing IRI data on POST/MOM cereal trends, which so far have demonstrated strong momentum. The latest scanner data shows POST growing sales in the latest 12 week by 3.8% vs. K (-4.1%) and GIS (-4.8%) and gaining 1pts of market share.

-    Active Nutrition earnings have troughed, and we expect this segment to contribute by the end of the year to early 2016. Although this is likely a $40-$60M EBITDA business (less than 10% of overall POST profitability), we expect trading multiple expansion vs. bottom line contribution to be a driver of share appreciation from this business.

-    We are in a holding pattern in Michael Foods as the fallout from AI has been ongoing and who emerges as a winner/loser remains to be seen. However, the most recent financial updates has shown POST to be adept at mitigating the epidemic and believe Michael Foods is in the best position to gain market share from competitors (Cargill/Rembrandt) as they cull customers. So far, AI has not negatively affected POST's profitability. 

i)        Avian Flu will most likely persist as an overhang for the foreseeable future with the possibility of a resurgence in the fall as the weather cools.

-    With career Chairman/CEO Bill Stiritz as the Chairman of POST, potential growth through M&A is always in the cards. POST currently sits on about $1billion in dry powder (including accordion facility), and given Stiritz’s reputation, we would expect continued M&A – both bolt-on and larger acquisitions (CAG rumors of buying back Ralcorp or the Consumer Foods Group are ubiquitous although the most recent news is that POST has not submitted a bid).  

Conditions / Miscellaneous:  Convertible Preferreds

o   Holders can convert the 2.4M shares at 2.1192 shares of common stock per share of convertible preferred ($47.19 conversion price; 5.09 share dilution impact)

o   Holders can convert the 3mn +.2 overallotment shares at 1.8477 shares of common stock ($54.12 conversion price; 5.54 share dilution impact). 

Over the past two years, POST has transformed from a one-category company (challenged RTE cereal category) to providing a diversified product offering in higher growth segments.  

o   POST has acquired over 12 companies in the areas of sports nutrition, egg products, pasta, cheese, refrigerated potatoes, and private label peanut butter/granola.

o   The chart below illustrates what the sales and EBITDA attribution is per acquisition in addition to the implied multiple. Assuming $250M in EBITDA contribution from the POST cereal base business – on a normalized basis and assuming NO organic growth, POST is a $800M+ EBITDA company (year-over-year bridge included later on). 

o  Pro-forma for these acquisitions, nearly 60% of POST’s business is in moderate/high growth product offerings outside the cereal category (although we believe cereal will actually be a flat growing category in the ST).

Upside to MOMs Brands Synergies is meaningful.

-    Background / Market Share: POST, which is the third-largest U.S. branded ready-to-eat cereal manufacturer, regained nearly 1.4 market share points since its 2012 low to nearly 20% (including MOMs) despite the category’s multiyear weakness (8% decline in retail volumes since 2011). Interestingly, POST (not including private label) was the only large cereal company to increase retail volume in 2014 despite the category declining 3%. The company expects the category to decline an additional 4% in FY2015, although POST has been able to buck this trend given the acquisition of MOM. POST has gained nearly 70 basis points of share in 2014 – the highest gain among the top branded and private label players – over the year-ago period, as 9 of its top 12 core brands have either stabilized share or gained market share.

-    The acquisition of MOMs Brands, which plays in the value end of RTE cereals, provides for significant upside to the $50M of synergies management has currently outlined.

i)    Distribution: MOM drives the majority of its sales (more than 60%) in more rural regions of the U.S. (e.g., Texas, Oklahoma, Washington, Idaho, Montana, Oregon, Iowa, Nebraska, Florida, Mississipii, Alabama, Georgia, etc) while Post’s top two regions are the more populated Northeast and Great Lakes regions (in-line exposure with GIS and K).

ii)   The best-in-class MOMs facilities and POST facilities are significantly under-utilized; IR has indicated that closing one of the facilities is definitely on the table. For reference, POST closed its Modesto plant (made Grape Nuts and Raisin-Bran) which was a $14M cost-savings off the bat.

-    To put this in perspective, see a representative list of mergers in the food space and the announced cost saving guidance as a % of the targeted sales. MOM’s outlined $50M of cost savings implies ~6.6% of targeted sales. Given the 100% overlap in product category, we would assume cost savings near 9-10% of sales or $75M. Table below that the floor in potential cost-savings is in the mid-6%. 

Avian Flu is a transient headline issue; Michael Foods will most likely be the winner at the end.

Brief Situation Overview

-    On 4/28/15, POST reported that ~10% of its Michael Foods egg supply was affected by the AI outbreak, with the expected impact raised to ~14% of its supply as of its F2Q15 report on 5/7/15, and then again to ~20% five days later on 5/12/15.   As of its 5/7/15 update (when ~14% of the supply was affected), POST had preliminarily expected the impact from AI to represent a -$20mm EBITDA headwind over the balance of FY15 (5 months), based on a combination of the expected impact from the lost volume associated with limited supply, as well as the higher cost of any supply POST is able to procure on the open market (as of 5/8/15, average egg costs had increased +40% from 4/22/15, for example)                

-    There was a false positive for AI on 5/27 according to the Nebraska Dept. of Agriculture at a MFI laying hen flock of three million head in Bloomfield. This coincided with an increased est. by Post of its egg supply impacted by AI to 35% from 25%. On 6/3, Norfolk Daily News reported that follow up testing has failed to confirm the positive test.

-    ***POST has enacted force majeure effective immediately on customers; as if the latest earnings, POST has declared that AI headwind to profitablility has been effectively mitigated.

What are the long-term implications? Absent AI, there will be clear winners and losers in the next two years. Qualitatively, we find that Michael Foods, which has had the least exposure to AI and a more diversified customer base, will be a clear winner while its competitors are either under financial duress or have key customer concentration. Furthermore, we would expect MFI to actually implement insurance surcharges to their grains-plus contracts, which will serve as a mechanism for further pricing gains.

-    There are currently three players in the egg processing space – Michael Foods, Cargill (has exclusivity on McDonald’s), and Rembrandt (private label).

-    Anecdotally we are hearing the following from our channel checks:

i)   Cargill is culling high profit business in order to serve its largest customer, McDonald’s. Currently, approximately 45% of Cargill’s supply has been infected with AI. MCD is also now rolling out an all-day breakfast menu, furthering contraining Cargill to focus on its largest customers. We believe POST will be the beneficiary of further customer attrition and potentially winning some of MCDs business. 

ii)  Rembrandt is financially constrained and is potentially on a life-line. Out of 700 employees, they have already laid off 270 employees due to AI outbreaks. According to public sources, Rembrandt has about 14.5M hens, of which 50% have been exposed and destroyed.

(1)    5/1: Rembrandt, Iowa, announced that it will lay off 231. One barn housing about 250,000 hens was infected, but 5.5 million birds were killed as a result.

(2)    5/21: Renville, Minn., announced it will have to lay off 39 workers in addition to killing 2 million chickens after suffering Minnesota’s single largest contamination.

o   Additionally, the current backdrop in the commodity complex (corn and soy), which are at multi-year lows, will provide some tailwind to MFI’s egg EBIT as feed costs fall on delayed pass through. Chart for illustrative purposes only.

 The complexion of POST’s earnings in recent quarters has been obfuscated by the myriad of acquisitions in addition to integration mis-execution. Normalizing for what we believe are only momentary issues, we believe POST has the ability to generate over $800M+ in 2016 and close to $900M in EBITDA by 2017

-    POST raised their FY guidance from $585M-$615M to $635M - $650M on in August, even admist the AI headwind.

-    The below 2016E EBITDA bridge attempts to reconcile the “noise” of the aforementioned integration issues.

-    Note: that assuming no organic growth, 2016E EBITDA would be $800M+ purely on FY contribution from the MOM’s acquisition and from realized cost savings from the MOM’s acquisition vs. a fully-baked $780M consensus 2016 EBITDA number. Including organic top-line growth of 3% or so would contribute ~$25M in incremental EBITDA or ~$830M in 2016E EBITDA. 

At the heart of POST’s business model is a public LBO – levered ~6.0x+ with significant FCF generation that will be the ultimate transfer of wealth from debt to equity holders. The table below illustrates this deleveraging scenario.

 o   Historically, POST has traded between 8.5x EBITDA and 11.5x EBITDA. This was during a time in which the company was either a secularly challenged one-category food company or in the midst of integrating multiple acquisitions. Although the company is currently trading ~10.2x EBITDA off PF 2016E EBITDA, we would expect the business to hold this multiple (in-line with mature businesses GIS, CPB, CAG) as the companies integration strategy bears fruit in the form of FCF generation/deleveraging.  

o   Reviewing the comps, note that the space trades fairly tightly in the 10x-15x EBITDA range. The names we comp POST to are GIS, CPB, and CAG (which trade tightly in the 12x-13x range).

-    In comparison, POST has a vastly superior top-line growth algorithm driven by above-average growth in Michael Foods and Active Nutrition, which is offset by the more challenged cereal business, although we see vastly superior bottom line contribution from this business.

i)   From comps table, CPB, CAG, and GIS have either contracted top-line growth in forecasted ’14-’15 and which is flat in ’15-’16. By comparison, we forecast POST to grow in the MSD to HSD for the next two years, built on a constructive industry backdrop for Michael Foods and turnaround in Active Nutrition (albeit, still conservatively modeled). Note that we do not model a turnaround in the cereal/MOMs segment but conservatively give credit for bottom line contribution from cost-savings.

-    Although comparing the margin structures of POST vs. the comp set is less favorable and somewhat difficult, we note that the growth rate in EBITDA from 2014 to 2017 for the vast majority of the space is in the LSD. In particular, CPB, CAG, and GIS are forecasted to growth from 2014-17 at -1% to 3% CAGR . Laying over the synergies from the MOM’s acquisition alone yields close to a DD growth. POST’s EBITDA margins of 13%-14% is inline with CAG vs. CPB and GIS which are in the 18%-19% range.  

-    We believe investors are over penalizing POST for execution and a levered balance sheet. However, as the analysis shows per below, POST superior FCF generation will de-lever rapidly to a manageable ~4.0-4.5x EBITDA range, which is similar to CAG’s leverage, and should yield a re-rate to a more appropriate 12x EBITDA multiple.

Catalyst

o Ongoing M&A: mgmt is focused on acquiring bolt-on platforms and divesting non-strategic businesses (would not be surprised to see cheese portfolio, a drag to Michael Foods profitability, being divested).

o   Weekly RTE Cereal Nielsen Data, which should show continued pricing / market share improvement from the combined MOMs/POST portfolio.

o   MOMs targeted cost savings - Q4’15: Mgmt announcing cost savings update from MOM’s acquisition; FY 2016 should highlight upside to $50M cost savings target.

o   AI – Fall 2015: headlines have played out – would expect to see some material improvement on margin side from force majeur and POST gaining new customers from competitor fallout.