Philippine Markets Daily

Uniform Accounting shows how an effective brand cultivation strategy led to this food company having returns of 10%+, not below cost of capital

March 11, 2021

Humans need food to survive, which is why food companies thrive even during recessions, and why many companies want to enter this industry. In order to do well in this saturated industry, food companies need to innovate.

This company specializes in food processing, and has a huge roster of grocery goods that offers a variety of food and beverages. However, as-reported metrics show that this company’s brand cultivation and portfolio expansion strategies aren’t translating into meaningful returns. Uniform Accounting displays that this company actually has higher returns than what investors think.

Also below, Uniform Accounting Embedded Expectations Analysis and the Uniform Accounting Performance and Valuation Tearsheet for the company.

Philippine Markets Daily:
Thursday Uniform Earnings Tearsheets – Global Focus
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Owning private label brands is a strategy for retailers in the food industry to gain competitive advantage. Private labels are goods made by a third-party manufacturer that are sold under a retailer’s brand.

Private labels are cost-effective since the third-party manufacturer is essentially the retailer’s supply chain, providing higher margins for retailers. Moreover, the retailer has complete control over its private label brands, including the packaging and marketing of its products. This allows retailers to drive brand loyalty among its consumers.

In the food industry, private label brands are popular among grocery chains, and one company riding this surge is TreeHouse Foods (THS:USA).

TreeHouse Foods is a multinational company that specializes in food processing, and is a leading manufacturer of private label packaged foods and beverages. It is currently a private label leader in 17 of its 29 categories.

The company’s subsidiary, Bay Valley Foods, is one of the largest suppliers of pickles in the United States, with more than 45% of their sales attributed to its pickles segment. Bay Valley Foods is also popular for its non-dairy creamer segment, which makes up 37% of its sales.

The company also made several brand acquisitions beginning in 2006 to expand its growing product portfolio with other established brands as well.

A few of these are the company’s acquisition of Del Monte Foods’ soup business and Nature’s Goodness’ baby food business, which allowed TreeHouse Foods to tap into different markets.

With Del Monte having an estimated 70% market share in the soup industry and Nature’s Goodness’ baby food business as one of the largest brands in the infant foods sector, the acquisitions have contributed about $300-$400 million in annual revenues for TreeHouse Foods.

Furthermore, TreeHouse Foods places an emphasis on sustainability, both on food production and on the products itself. Part of what separates them from others in the private label space is they use natural and organic ingredients—a niche market for a loyal customer base—which fits well with their private label strategy to drive brand loyalty.

Throughout the years, TreeHouse Foods has had a positive and stable performance in the market brought about by their brand cultivation and strategic acquisitions. However, looking at as-reported metrics, TreeHouse Foods doesn’t seem to be as profitable as one might expect. As-reported ROAs over the past sixteen years have been at or below cost-of-capital levels.

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Uniform Accounting, on the other hand, reveals exactly just how successful the company has been at managing its product portfolio, with Uniform ROAs ranging from 6% to as high as 20%.

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The distortion between Uniform and as-reported ROAs comes from as-reported metrics failing to consider the amount of goodwill on TreeHouse Foods’ balance sheet. In recent years, goodwill sits at about $2 billion, which is about half of its total assets, arising from its various brand acquisitions in the food industry.

Goodwill is an intangible asset that is purely accounting-based and unrepresentative of the company’s actual operating performance. When as-reported accounting includes this in a company’s balance sheet, it creates an artificially inflated asset base.

As a result, as-reported ROAs are not capturing the strength of TreeHouse Foods’ earning power. Adjusting for goodwill, we can see that the company isn’t actually performing poorly. In fact, it has been the opposite, with returns that are nearly 2x-5x greater.

TreeHouse Foods’ earning power is actually much more robust than you think it is

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As-reported metrics distort the market’s perception of the firm’s recent profitability. If you were to just look at as-reported ROA, you would think the company is a much weaker business than real economic metrics highlight.

TreeHouse Foods’ Uniform ROA has actually been higher than its as-reported ROA in the past sixteen years. For example, as-reported ROA was 4% in 2020, but its Uniform ROA was actually over 3x higher at 13%.

Specifically, TreeHouse Foods’ Uniform ROA has ranged from 6% to 20% in the past sixteen years while as-reported ROA ranged only from 3% to 6% in the same timeframe.

Uniform ROA rose from 6% in 2005 to 20% in 2011, before falling to 11% in 2014. Uniform returns subsequently rebounded to 20% in 2016 before sustaining 13%-14% levels currently.

TreeHouse Foods’ Uniform earnings margins are weaker than you think, but its Uniform asset turns make up for it

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Uniform ROAs have been driven primarily by trends in Uniform earnings margins and to a lesser extent, Uniform asset turns.

Uniform margins rose from 3% in 2005 to 9% in 2011 before falling to 5% in 2014. Uniform margins have since recovered to 6%-9% levels through 2020.

Meanwhile, Uniform turns declined from 2.5x in 2005 to 1.8x in 2007 before rebounding to 2.0x-2.4x levels through 2020, excluding an 1.8x underperformance in 2017.

At current valuations, markets are pricing in expectations for continued declines in Uniform margins, coupled with no further improvements in Uniform turns.

SUMMARY and TreeHouse Foods Tearsheet

As the Uniform Accounting tearsheet for TreeHouse Foods, Inc. (THS:USA) highlights, the Uniform P/E trades at 18.3x, which is below the global corporate average of 25.2x, but around its historical Uniform P/E of 18.8x.

Low P/Es require low EPS growth to sustain them. In the case of TreeHouse Foods, the company has recently shown a 6% Uniform EPS growth.

Wall Street analysts provide stock and valuation recommendations that provide very poor guidance or insight in general. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, TreeHouse Foods’ Wall Street analyst-driven forecast is a 28% and 5% EPS growth in 2021 and 2022, respectively.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify TreeHouse Foods’ $50 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to grow by 1% per year over the next three years. What Wall Street analysts expect for TreeHouse Foods’ earnings growth is above what the current stock market valuation requires through 2022.

Furthermore, the company’s earning power is 2x the corporate average. However, cash flows and cash on hand are below its total obligations—including debt maturities and capex maintenance. Together, this signals a moderate credit risk.

To conclude, TreeHouse Foods’ Uniform earnings growth is below its peer averages. Therefore, as is warranted, the company is also trading below its average peer valuations.

About the Philippine Market Daily
“Thursday Uniform Earnings Tearsheets – Global Focus”

Some of the world’s greatest investors learned from the Father of Value Investing or have learned to follow his investment philosophy very closely. That pioneer of value investing is Professor Benjamin Graham. His followers:

Warren Buffett and Charles Munger of Berkshire Hathaway; Shelby C. Davis of Davis Funds; Marty Whitman of Third Avenue Value Fund; Jean-Marie Eveillard of First Eagle; Mitch Julis of Canyon Capital; just to name a few.

Each of these great investors studied security analysis and valuation, applying this methodology to manage their multi-billion dollar portfolios. They did this without relying on as-reported numbers.

Uniform Adjusted Financial Reporting Standards (UAFRS or Uniform Accounting) is an answer to the many inconsistencies present in GAAP and IFRS, as well as in PFRS.

Under UAFRS, each company’s financial statements are rebuilt under a consistent set of rules, resulting in an apples-to-apples comparison. Resulting UAFRS-based earnings, assets, debts, cash flows from operations, investing, and financing, and other key elements become the basis for more reliable financial statement analysis.

Every Thursday, we focus on one multinational company that’s particularly interesting from a UAFRS vs as-reported standpoint. We highlight one adjustment that illustrates why the as-reported numbers are unreliable.

This way, we gain a better understanding of the factors driving a particular stock’s returns, and whether or not the firm’s true profitability is reflected in its current valuations.

Hope you’ve found this week’s Uniform earnings tearsheet on a multinational company interesting and insightful.

Stay tuned for next week’s multinational company highlight!

Regards,

Angelica Lim
Research Director
Philippine Markets Daily
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