Description

Introduction

At a current price of $83 per share, Post Holdings (POST) represents an attractive opportunity in a market that is largely devoid of value. Post has been written up before on VIC, most recently in October of 2015, and those reports contain good background information on the company. This write up will primarily focus on the company’s management and evolution over the past two years and why I believe the current valuation presents an opportunity.

Management

Although covered in previous write-ups, a background of Post must include the past successes of its current chairman, William Stiritz. Most of you are probably familiar with the book, “The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success”, in which Mr. Stiritz was profiled for the immense shareholder value he created during his time as the CEO of Ralston Purina. During his 19 years as CEO, the stock compounded at 20% annually. The book discusses the actions undertaken by Mr. Stiritz including divestitures, spinouts, buybacks, and debt-financed acquisitions to maximize cash flow per share and ultimately shareholder value. Two of the more important decisions were the 1994 spinoff of Ralcorp, which held several smaller consumer brands including baby food, cereal and a collection of ski resorts (the current Vail Resorts) and the 2000 spinoff of Energizer Holdings (the current Energizer Holdings and Edgewell Personal Care). Stiritz remained the chairman of Ralcorp until its 2011 acquisition by ConAgra and was the chairman of Energizer until 2007. Interestingly, both of these companies vastly outperformed their relevant benchmarks during the period of Mr. Stiritz’s oversight. According to a May 26, 2011 article from Bloomberg Business week, over the preceding decade Ralcorp’s stock gained 356% compared to 100% percent for the S&P MidCap 400 stock index, and this excludes the premium shareholders received when ConAgra acquired the company late in 2011.[1] Between the time of its spinoff and ultimate sale to ConAgra, Ralcorp made 29 acquisitions. The story for Energizer is similar as it returned immensely more than the S&P 500 while Mr. Stiritz was chairman. Of course, all of this information would be much more relevant if Mr. Stiritz was 45 years old rather than his current age of 83. Yet, I think it is still important to the Post story because it helps to demonstrate the success of the philosophy and how it was carried out not only by Bill Stiritz but also by those who worked closely with him. It also gives me confidence that the Post story won’t end when Mr. Stiritz is no longer affiliated with the company.

Since Post’s 2012 spinoff from Ralcorp, it is evident that it is being managed by a similar playbook as compared to Ralston, Ralcorp, and Energizer. This is not surprising considering not only Mr. Stiritz’s continued involvement but also the other members of management who have been his long-time associates. Post’s current CEO, Robert Vitale, was one of four equity partners in a private investment fund called Westgate Group which was launched by Mr. Stiritz in 1998. He and Mr. Stiritz worked closely together for over a decade prior to Mr. Vitale joining Post as CFO before the spinoff. Current Executive VP/President and CEO of the Private Brands Group, Richard Koulouris, worked alongside Mr. Stiritz at Ralcorp for many years.  Others who have worked closely with Mr. Stiritz in the past include board members Jay Brown and David Skarie. Mr. Brown had a long career at Ralston and also served as a director of Jack in the Box, which was sold by Ralston in 1985. He was also a founding partner of Westgate Group so has worked closely with Bill Stiritz and Rob Vitale for many years. Mr. Skarie was co-CEO at Ralcorp from 2003 until its acquisition in 2012.

Normally when considering an investment, I certainly focus on the quality of management as an important qualitative consideration, but in the case of Post, I consider the importance of management to be the key foundation underpinning the investment. An investment in Post is based in large part on a continuation of the past successes of management, especially Ralcorp, given its strong similarities with Post. For a better view into how Post management views the company, the 2013 shareholder letter is insightful. The letter reflects how management sees Post as a holding company that adds value by means such as:

·         identification of investment opportunities financed by the pooled cash flow and borrowing capacity of the holding company,

·         acquiring or recruiting capable management teams,

·         maintaining a decentralized operating structure to maintain each organization’s unique culture and incentivize and reward employees while also allowing for pooling and sharing of resources on an enterprise-wide basis for functions such as IT, purchasing, legal, HR, shared marketing services, tax, treasury, etc.

The letter goes on to state, “Perhaps uniquely, we view Post as a hybrid of a traditional public company and a private equity fund. We use many of the same tools as a private equity company – relatively higher leverage, investment analysis and adaptive management. We also view our portfolio as dynamic, reacting to opportunities as they develop. However, unlike most private equity firms, we also provide Centers of Excellence to create competitive advantages for our operating companies. And we do this in the public forum allowing our investors greater transparency and, most importantly, the ability to act on their own accord.”[2]

Company

With that background, let us now look at Post’s current portfolio. Since being spun out of Ralcorp in early 2012, Post has made 13 acquisitions spending approximately $7.4 billion. The company has five operating platforms including Consumer Brands (Legacy Post and MOM Brands), Weetabix, Michael Foods (primarily food service eggs, potatoes, and pasta), Active Nutrition (Premier Protein, PowerBar and Dymatize) and Private Brands (private label nut butters and granola.)  Proforma for the Weetabix deal, (which was completed earlier this month and was the first major acquisition in over two years) total sales and EBITDA will approximate $5.5 billion and $1.1 billion, respectively. Post Consumer Brands (i.e. legacy Post Cereal and MOM), Michael Foods, and Weetabix will account for 31%, 39%, and 9% and 36%, 39%, and 13%, respectively, of pro forma revenue and EBITDA.

Since Michael ($2.6 billion), MOM ($1.15 billion) and Weetabix ($1.76 billion) account for 3/4ths of the acquisitions based on enterprise value and account for a significant amount of Post’s EBITDA, these are the three deals that I will focus on.

Michael Foods

Michael Foods (MF) was acquired in June 2014 for nearly $2.6 billion from two private equity firms. MF is the nation’s largest producer of processed egg products in North America and it also produces and sells refrigerated potato products under the Simply Potatoes brand as well as cheese and other dairy products. At the time of the acquisition, egg products accounted for 3/4ths of revenue and MF served most of the QSRs in some capacity with the exception of McDonalds, which is supplied eggs by Cargill. With overall market share of 60% in processed egg products, MF had 3x the volume of its next largest competitor.  MF’s revenue and EBITDA were $2 billion and $255 million, respectively. Post paid approximately 10x EBITDA and given that MF was a new platform, there were minimal opportunities for synergies. Based on the purchase price of $2.6 billion, the unlevered free cash flow yield was between 6% and 7% and the levered free cash flow yield was in excess of 10%. The transaction was financed with 60% debt representing 6x EBITDA, which might appear aggressive, but MF’s historical cash flow had been quite steady. This would allow for delevering over time and would be a tailwind to free cash flow to equity. Shortly after buying MF, Post combined it with Dakota Growers Pasta, which like MF, has a large footprint in the foodservice channel and is located in the upper Mid-West.

Less than a year after the purchase of MF, the US experienced the worst outbreak of avian influenza (AI) in history which had a major impact on MF by infecting 25% of its flock. This led to a volume decline and sharp rise in revenue as prices rose as MF was able to declare force majeure on its supply contracts. Due to AI, it is difficult to discern MF’s subsequent performance as compared to its numbers in the period leading up to Post’s acquisition, especially last year as EBITDA exploded higher due to favorable AI pricing. For the YTD 2017 period, MF’s annualized EBITDA is approximately $340 million, which is in-line with Post’s estimate of a $100 million y-o-y decline as a result of normalization from AI. Backing out the contribution from Dakota Growers and two smaller egg acquisitions, EBITDA for the legacy MF business is probably between $270 and $285 million, implying a small amount of growth since the acquisition, which is not bad considering the upheaval in the industry.

On a normalized basis, Post continues to earn a double digit rate of return on the equity used in the MF acquisition and the returns have been very strong after factoring in the abnormal profitability due to AI. Post has said it expects margins in the egg business to be structurally higher compared to pre-AI as pricing going forward will likely include an AI premium. In addition, Post moved away from lower-margin food ingredient customers as it triaged supply to its most important QSR customers during AI. Currently with the flocks having been repopulated and egg prices abnormally low, MF’s egg business is facing a temporary headwind as customers that moved to shell eggs from processed liquid eggs during AI are slow to return to MF’s grain-based pricing model. However, over the intermediate term, the growth in away-from-home breakfast occasions and increasing demand for protein should lead to longer-term growth, especially given MF’s strong position in eggs as both the largest provider of processed egg products and cage-free eggs.

The purchase price for MF was fair but no bargain and Post issued equity to fund a portion of the deal. However, given its large presence in foodservice in eggs, potatoes and pasta, Post likely viewed MF as an attractive platform that had the potential to benefit from additional scale. Post reportedly has been interested in other food service assets including Lamb Weston and BEF Foods, yet no agreements were reached.

MOM Brands

When Post acquired MOM Brands (MOM) in May of 2015, Rob Vitale commented that Post had wanted to buy it ever since it went public. Based on the performance since the acquisition, he was right. Post paid $1.15 billion to acquire MOM using $700 million in debt, issuing $300 million of common stock, and issuing the seller 2.45 million shares to finance the deal.  Post initially guided for $50 million in synergies and, since having achieved those, has raised the estimate to $75 million. Given that Post and MOM were #3 and #4 in the cereal category in the US and had competed in the value segment for many years, the deal was a financial and strategic homerun. Including the $75 million in synergies, Post will earn a levered free cash flow yield north of 25% and the deal is highly accretive despite the share issuance.

In the 4^th quarter of 2015, which was the first full quarter Post owned MOM, the adjusted EBITDA margin was 22.6%. In the 4^th quarter of 2016 and 2^nd quarter of 2017, the adjusted EBITDA margin had risen to 24.2% and 28%, respectively. In the couple of years prior to the spinoff, legacy Post Cereal’s EBITDA margin was 26.5% and MOM’s historical EBITDA margin was under 16%. As of last quarter, Post Consumer Brand’s EBITDA margin was actually higher than that of Legacy Post Cereal even after including MOM’s revenue (which account for approximately 45% of PCB total revenue)!

While the market responded favorably to the deal, some questioned why Post would double down on a declining category and make the overall company that much more dependent on cereal. Obviously the acquisition was a great deal but it also makes the point that Post’s acquisition strategy is not necessarily about acquiring growth or getting into or out of a certain category. Rather the focus is earning strong returns on investment and growing cash flow per share which can be leveraged to fund additional investments.

Weetabix

Post completed the Weetabix acquisition earlier this month so the outcome is yet to be determined. However, based on the price paid and financing terms, there is a good likelihood the transaction will produce strong returns, especially considering no stock was issued. Weetabix owns the number one brand of cereal in the UK and is the number two cereal manufacturer overall. It also owns assets in North America including the Barbara’s Puffins brand targeting the organic and GMO sector, a private label business, and two manufacturing facilities. Although Weetabix has had, like most other cereal companies, flat to slightly declining sales in recent years, EBITDA margins and cash generation have remained strong. The company has also managed to develop a strong position in the UK protein breakfast drink category which Post believes it can use to leverage growth in its Premier Protein brand that has been very successful in the US. Post paid 1.4 billion pounds, or approximately $1.76 billion based on the dollar/pound exchange rate at the time (the timing was good as the pound was quite weak), which results in an EBITDA multiple 11.7x. The company estimates $25 million in synergies which results in an adjusted multiple of 10x. The synergies (which exclude potential revenue synergies) are expected to come from elimination of redundant costs, procurement and logistical savings, and footprint rationalization. Given the recent example from MOM, likely the synergy estimate is conservative, especially considering the Barbara’s North American operations and two manufacturing facilities. In addition, the recent integration success with MOM increases confidence that Post has the capability to successfully integrate Weetabix. As far as revenue benefits, Weetabix, and especially Barbara’s, should benefit from Post’s extensive distribution in North America and the reverse should hold true for Post and Premier Protein in the UK. Including synergies, incremental free cash flow from the deal will approximate $100 million, which will be highly accretive as no stock was issued to finance the acquisition and, despite the additional debt, there will only be a minimal increase in interest payments.

Balance Sheet

In financing the Weetabix transaction, Post used cash on hand, which stood at $1.48 billion as of March 31, and it raised $2.2 billion in term loans while retiring $800 million in 7.75% senior notes due 2024 and retiring $263 million of 8% senior notes maturing in 2025. In spite of the fact that incremental debt will increase by just over $1.1 billion, the annual increase in interest expense will be minimal as higher cost debt is replaced with lower cost debt. The leverage ratio will be 5.2x net after the transaction and cash will total approximately $850 million excluding cash generated during the quarter. EBITDA less capital expenditures will cover interest by 2.5 to 3 times. The debt maturity schedule is favorable as the next maturity is not until December 2022 and the company could very likely pay off every maturity through 2025 with internally generated cash.

Valuation

Assuming conversion of the Post’s preferred stock and tangible equity units, shares outstanding total 78.8 million and the market cap equals $6.54 billion. Going forward and inclusive of Weetabix, free cash flow to equity will likely range from $400 to $450 million for a free cash flow yield between 6% and 7%. This excludes the earnings potential of the $850+ million (or at least the portion that could be used) of balance sheet cash if it were to be used in a transaction or for debt repayment. Based on low single digit growth in EBITDA (which I believe to be very achievable) and a tailwind to the equity from either delevering or, more likely, share repurchases, I think the equity has a good probability of compounding at a double digit rate going forward, excluding the potential for additional value-enhancing transactions. At the current price of $83, there is no price premium for what I consider to be a strong management team with a focus on creating per share equity value.

Share Repurchases/Capital Allocation

One of the key learnings from the Outsiders chapter on Mr. Stiritz was the idea that all decisions were viewed through the filter of potential returns to shareholders. The book quoted Michael Mauboussin as saying, “effective capital allocation…requires a certain temperament. To be successful you have to think like an investor, dispassionately and probabilistically, with a certain coolness. Stiritz had that mindset.” Reinforcing this point, long-time associate at Ralcorp and current Energizer chairman, Pat Mulcahy, was quoted, “The hurdle we always used for investment decisions was the share repurchase return. If an acquisition, with some certainty, could beat that return, it was worth doing.” The author then states, “Conversely, if a potential acquisition’s returns didn’t meaningfully exceed the buyback return, Stiritz passed.” During his time as CEO of Ralston, Stiritz repurchased 60% of the common stock, much of it at very low multiples. You may be wondering how this is applicable to Post considering it has only repurchased a negligible amount of stock in its short corporate existence, but I think Post’s history with buybacks is instructive. Other than buying back a relatively small amount of stock from Ralcorp after the spinoff, Post had not had a buyback authorization until it announced a $300 million buyback in February 2016 when it announced results for the first fiscal quarter. Prior to the announcement, the stock was below $58 per share, having fallen from a high of $70 in the prior November. Bill Stiritz also made an open market purchase of approximately $35 million two days after the results were released at a price near $63.50. However, interestingly, because the stock had a strong positive reaction and was back to $70 per share later in the month, Post did not buy a single share of stock.

Although Post bought no stock at that time, it paid $133 million in the fiscal first quarter of this year (3 months ending December 31, 2016) to repurchase stock at an average price of $76.32. This is after the stock had fallen from a high of $88 in July 2016. The stock price during the fourth quarter fell below $71 in mid-November, but the selloff was short-lived and the stock closed the year over $80. It is worth noting that Mr. Stiritz made another open market purchase of $9 million on November 21 at prices between $74 and $76.

After reaching a high of $89 earlier this year, the stock sold off in June and early July to around $76, the same price at which Post bought back stock last year. In early June the company announced a new buyback authorization for $250 million which will be good for the next two years and will be in addition to the remaining amount under the previous authorization. At the time of this announcement, the stock price was at $82 so I think it is highly likely that Post was buying back stock in late June and early July as the price dipped into the upper $70’s - the same range it was buying in last year.

Given the amount of the buyback authorization relative to Post’s market capitalization, it is obviously a relatively modest amount. I am not under the illusion that Post is going to do a massive stock buyback if the price has a sharp decline. Rather, the point is that given their long-term track record, Post management believes in share repurchases and will not hesitate to carry them out, but will only do so if the buyback provides for compelling returns. Like the previous quote, all capital allocation decisions, including buybacks/share issuance, acquisitions, delevering, etc. are viewed through the lens of maximizing per share value. This is evident not only in the long-term track record of Mr. Stiritz and his associates, but it is also apparent in Post’s relatively short life as a standalone public company. And in spite of Post’s high level of acquisition activity, I have no doubt that capital allocation would be reoriented towards share repurchases if that is what would result in the highest potential return.

Along those same lines, I have no doubt that Post would consider spinning off or selling portions of its businesses if that would enhance value. On the most recent quarterly earnings call, the following Q&A took place:

Andrew Lazar - Barclays Capital, Inc.

Okay. And last thing, just in Active Nutrition, I seem to remember – although, again, I could have this a little wrong, but you've talked in the past about getting that business up to a certain level of scale from an EBITDA generation perspective that would give you enough scale to think about, over time, strategic optionality with it, if you felt maybe that you either weren't getting the proper credit for that business and the growth opportunity and your current valuation, or other things. And I seem to remember maybe it being kind of more like $100 million or so of EBITDA would give you that kind of scale. I could have that wrong, but if it's right, it looks like potentially, that's where you could be by the end of this fiscal year. So I was hoping you could just comment a little bit on that, and let me know if I have that right or wrong.

Robert V. Vitale - Post Holdings, Inc.

You certainly have it right, that that is the way we think, in terms of viewing our portfolio as a dynamic one that we would look to try to create ownership where the ownership is most appropriately valuing the assets, whether that's a spin or whatever it may entail. Whether that's a bright line $100 million EBITDA or something higher than that is less clear, and there are more facts and circumstances than simply the level of EBITDA. But I think, to the key point, that the growth in the business creates optionality that previously didn't exist is absolutely accurate.

While I have no idea if Post will do something with its Active Nutrition segment, the point is that the company views itself as a holding company, and I doubt it would hesitate to buy or sale an asset if management determined the transaction be value enhancing. On the other hand, I do not believe the company would do a deal just to do a deal if it felt the economics were not favorable. There have been multiple reports in the media about assets Post has been interested in but that it ultimately walked away from.

Risks

·         While the overall acquisition track record is very strong, there is always the risk of a large transaction going badly which could be exacerbated by leverage. The one instance so far where Post blew it was the $380 million acquisition of nutritional supplement company Dymatize. Post missed production and supply chain deficiencies in its diligence and began to experience problems shortly after acquiring it. This ultimately led to Post drastically cutting SKUs and outsourcing manufacturing. Thankfully within the Active Nutrition segment, the Premier Protein deal has been a grand slam and more than made up for the Dymatize failure.

·         Prices for commodities such as grains, transportation fuel, and natural gas have been low in recent years which has benefitted margins. Rising commodity input costs, to the extent they could not be passed on, would be detrimental on the margin.

·         If shell egg prices remain at or fall below current levels, Michael Foods will be detrimentally impacted as shell eggs will be favorably priced relative to processed liquid egg products. In the aftermath of AI, MF has witnessed demand destruction in the food ingredient channel as food manufacturers reformulated recipes and are unlikely to switch back.

·         Rising interest rates or the loss of tax deductibility would make the use of debt less favorable. Also, high yield markets are currently very accommodating for heavily indebted borrowers. All of Post’s notes currently trade above par, however a swing in credit markets could make it more difficult to borrow or refinance. At least for Post, it could likely delever with internally generated cash flow and pay off maturities as they come due, at least through 2025.

Conclusion

Trading at a levered free cash flow yield between 6% and 7% with low to mid-single digit growth in EBITDA and a diversified and stable stream of cash flow, Post will likely compound at a double digit rate from its current price in the low $80's. If the price were to fall back into the mid-to-upper $70s like it was earlier this month, that would present a very compelling opportunity as that is where both Mr. Stiritz and the company bought stock last year. Although Mr. Stiritz likely won’t be on the scene too much longer, based on his actions thus far, I am confident that Rob Vitale is cut from the same cloth and, along with the board, will continue to make smart decisions for shareholders. Finally, I believe Post would be well positioned to invest in a less-than-hospitable market environment. If market risk premiums were to rise (which they eventually will), Post’s cash flows are relatively defensible and would likely hold up well and the capital allocation options would be much richer in terms of lower acquisition multiples and larger and more value-accretive stock repurchases.

Catalyst

• Additional accretive transactions
• Delevering
• Time