Description

We recommend purchase of Treehouse Foods (NYSE-THS):

• Both inflationary and recessionary environments present a golden opportunity for the private-label ("PL") industry, and specifically the Snacks/Beverages ("S&B") categories, to gain market share. Looking past supply-chain and service level challenges in 2021-22 that management has mitigated and is now firmly in rearview, we see continued sector tailwinds propelling the industry further along  

• The increasing popularity and market-share growth of low-cost PL-focused grocery retailers (Trader Joe's, Aldi, Lidl etc) will continue across economic cycles and benefit THS as the undisputed industry leader among PL S&B suppliers. 

• A strengthened Balance Sheet, optimized portfolio mix, following the divestiture of its Meal-prep segment in 3Q22, stronger supply chains/service levels, and updated pricing will drive margin expansion of ~150-250bps towards pre-pandemic levels. Management has guided to MSD revenue growth and HSD EBITDA growth which should not be a heavy lift thru pricing, volume/mix, and operational improvements

• Trading at 10.5-11x EBITDA or 12-13x 2024e FCF with further growth and expense levers, net leverage of ~2.5x (fixed rate. No Maturities until 2026), and a leading position in an expanding end-market with minimal price elasticity and somewhat non-discretionary items seems compelling.

• Recent industry transactions and peers trading in the low-teens xEBITDA range increases the probability THS is acquired once capital markets settle and the company's pricing actions and service lines stabilization take full effect. Other options include further deleveraging or stock buy-backs.

• THS underwent a badly-timed strategic review in late 2021/early 2022, just as the capital markets were beginning to tighten and the company was coming off a unique TTM affected by the pandemic as manufacturers, suppliers and retailers faced supply chain challenges and consumers flush with cash favored branded goods. Ultimately, the company decided to simplify the business and sell the meal-prep segment (more on the structure below), delever, but retain the higher growing S&B segment. Having achieved supply chain stabilization, they can now get full value for the S&B segment. 

Illinois based Treehouse Foods began as a spin off of Dean Foods in 2005. Over the next ~10 years, the company consummated numerous acquisitions - Ralcorp (Conagra's PL business) being the largest and adding significant leverage to the BS. A management change in 2018 and recent sale of its meal prep segment to de-lever the BS and refocus on higher growth/higher margin snacks & beverages lines of business gives this business a fresh look.

For more color on industry trends, data providers IRI/NPD provide monthly trends, much of which is illustrated in investor decks or sell-side primers. Some highlights illustrating the secular trends and further upside: PL now accounts for ~19% of grocery aisle sales and has been growing ~50-100 bps y/y. In the EU, PL-market share is almost double. Price savings can be ~30% vs branded goods.

Although there are no pure-play PL peers, the basket of branded consumer goods companies  (.MDLZ, HSY, SJM, TR, TWNK etc) provides the best comparative set.... The branded group generate gross margins and EBITDA margins nearly double THS (~30-35% and 18-20%, respectively v. ~18% and 10%), indicating the price differential, mark-up, and marketing expenses branded companies undertake and the difficulty involved in restructuring their business to compete in the private-label space. THS' moat is strong - the challenge is managing input costs, lead times, pricing, logistics, supply chain optimization etc. All of which, management has already either rectified or indicated where they anticipate expense savings, as discussed at length during its recent Investor Day. 

The meal-prep segment was sold in mid-2022 for 13.6x EBITDA or $950mm using a mix of cash (55%) and seller's note (45%. due 2027. ~11% interest rate). Note: We count the seller's note against debt when calculating total debt. There is a significant arbitrage to the company's benefit. This sizable note and interest income negatively affects how THS screens. 

Here are some optimistic read-throughs and channel checks from recent earnings, investor calls or industry conferences

1. Target: Rick Gomez, Target’s chief food and beverage officer, said in a session at The Wall Street Journal Global Food Forum in late June that the retailer’s own brands including Good & Gather and Favorite Day are growing almost twice as fast as national brands in its stores. “The number one thing that is on our guests’ minds is affordability,” Gomez said.

2. Campbell Soup: CEO Mark Clouse said recently that competition from store brands is eating into the company’s market share in some categories, such as condensed soup. 

3. Walmart: John Furner, Walmart’s U.S. chief executive, said consumers are switching to store brands in dry grocery more than any other category

4. Casey's: We leaned into private label, where we went from selling primarily bottle water and some bag candy at the beginning of the plan to a private label program that has over 300 SKUs and makes up nearly 10% of the units and gross profit dollars in the grocery and general merchandise category 

5. Costco: If you go back over the last 10 years, my guess is that on a year-over-year basis, maybe we've gone from, I'm guessing, 22% or 23%, the 25% or 26%, so call it 300 basis points over 10 years or eight years, so you 30 to 50 basis-points versus 120 basis points and 150 basis points in the last couple of quarters. So, yeah, that would again and at least anecdotally suggest that we've seen people looking for better bargains. - Costco management on increased PL penetration

6. PepsiCo: Hugh Johnston, PepsiCo’s finance chief, said that while consumers are pulling back on bigger-ticket purchases like cars, they aren’t skimping on snacks. Chief Executive Ramon Laguarta said that although customers have been staying with the brands despite raising prices, lower-income shoppers have been looking for better deals. “They’re going to channels that have better perceived values,” he said. “They’re buying more in dollar stores, or buying more in mass.”

We believe there are multiple options to surface value:

1. Continued operational improvement and margins trending back to pre-pandemic levels

2. FCF allocated to de-lever the BS or share buybacks

3. Multiple expansion towards the low-teens EV/EBITDA

Using a blend of EBITDA growth prospects and conservative multiple revision, we see shares valued at ~$70, an ~35% upside with further upside as FCF is allocated towards share buybacks or de-leverage.

Other considerations

- THS owns many of its facilities unencumbered and recently spent $100mm to acquire manufacturing assets. Considering the variability of real estate pricing and complication evaluating 20+ sites, we exclude these assets from our valuation, but believe it can be attractive to a PE buyer that would sale-leaseback the real estate 

Risks

- Walmart accounts for ~22% of revenue. There are no other customers that account for >10% of sales

- Although the company hedges input costs and has generally been able to pass along price increases, albeit with a slight lag, sudden input cost inflation from geopolitical events can put temporary downward pressure on margins

Catalyst

Operational Improvements 
Secular Tailwinds
Eventual Takeout