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Berenberg's Packaged Food Pair Trade: Buy Twinkie's Parent Company, Hold Flowers Food

Jayson Derrick

The dynamics of the entire food packaging business changed after Kellogg Company (NYSE: K) decided to exit its direct store delivery snack network to operate a warehouse model. The distribution method that packaged food companies use is becoming increasingly important to investors, according to Berenberg.

The Analyst

Berenberg Capital Markets' Adam Mizrahi initiated coverage of Hostess Brands Inc (NASDAQ: TWNK) with a Buy rating and $15 price target. The analyst also initiated coverage of Flowers Foods, Inc. (NYSE: FLO) with a Hold rating and $19 price target.

Buy Hostess Brands

Hostess Brands, the parent company behind the popular Twinkies snack, operates a warehouse model — as opposed to DSD — that's "underappreciated" by investors, Mizrahi said in the Monday initiation note. Hostess' focus on corporate culture along with marketing and innovation is well-known, but its supply chain shift shows it is also willing to "work closely" with important retail customers, the analyst said. 

A warehouse model for Hostess has resulted in the company achieving an industry-leading EBITDA margin at a time when its marketing levels are above average levels, Mizrahi said. The company stands apart from packaged food competitors that are notable for their complacency and high-cost DSD networks, he said.  

Hostess' key structural advantage should help generate organic sales growth even at a time of industrywide headwinds, according to Berenberg. 

Related Link: Credit Suisse's Winners And Losers In The Food Space

Flowers Foods

Flowers Foods, the parent company behind brands like Nature's Own and Tastykake, operates a business that is mostly exposed to bread but with a small sweet baked goods business, Mizrahi said. The company's DSD network is more necessary since it deals with perishable food, the analyst said. 

Flowers Foods is now able to focus on rationalizing its operating structure to better compete after decades of consolidating the "highly fragmented and regionalized" industry, Mizrahi said. But any earnings upside is limited, as the company has a history of struggling to offset any raw material inflation through pricing measures, presenting potential downside risk to the company's performance beyond fiscal 2018, he said. 

Berenberg's $19 price target implies a target P/E multiple of 16x on 2019 estimates, which is a discount to Hostess Brands' 17x P/E multiple.

The discount is warranted due to the more competitive nature of the bread category compared to the snack segment Twinkies operates in, along with "uncertainty" around Flowers Foods' ability to cost-cut as part of its "Project Centennial" savings program, Mizrahi said.

Price Action

Hostess Brands shares were rising 1.26 percent at the time of publication Monday afternoon, while Flowers Foods was up 0.78 percent. 

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