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Flowers Foods Is Not Appetizing at These Levels

The gluten-free diet trend has been around for at least several decades as studies have found that eating gluten can negatively affect some people's health. Some studies suggest that 20% to 30% of the U.S. population follows a gluten-free diet.

Gluten, a protein found in grains such as wheat, barley and rye, is common in foods such as bread, pasta, pizza and cereal. Gluten provides no essential nutrients. However, there is no compelling evidence that a gluten-free diet will improve health or prevent disease if you do not have celiac disease.


One of the leading suppliers of gluten-filled products that is trying to overcome this shift in diet preferences is Flowers Foods Inc. (NYSE:FLO). The company produces and markets packaged bakery products, which include fresh bread, buns, rolls, snack cakes and tortillas, as well as frozen breads and rolls, under brand names like Natures Own, Wonder, Mrs. Freshleys and Tastykake.

The company distributes these products through a direct-store delivery distribution and a warehouse delivery system. It also operates 46 bakeries. Customers include mass merchandisers, supermarkets, convenience stores, national and regional restaurants, quick-serve chains, retail in-store bakeries, foodservice distributors and food wholesalers.

As is common with many consumer food product companies, Walmart Inc. (NYSE:WMT) and Sam's Club represents over 20% of sales, which does cause some concentration risk.

The stock is trading near all-time highs despite the change in consumer tastes. The Thomasville, Gerogia-based company was founded in 1919, currently has a market capitalization of $6.2 billion and is expected to generate revenue of almost $5 billion this year.

Flowers Foods Is Not Appetizing at These Levels
Flowers Foods Is Not Appetizing at These Levels

Gluten-free diets

It is still somewhat of a mystery to me how gluten-free diets become so popular for people who do not need to be on one. Part of it is intuition, meaning it just seems like a good concept. If gluten triggers inflammation for consumers with celiac disease, then maybe it will reduce inflammation for everyone else. There is no conclusive evidence that supports this idea. Celebrity endorsements for weight loss also support this concept, as well as social media testimonials that have gained traction.

But what is the downside? Many people think gluten-free diets are more nutritious and contain more minerals and vitamins than conventional foods, but the opposite is often true. Gluten-free foods are commonly less fortified with folic acid, iron and other nutrients than regular foods containing gluten. And gluten-free foods tend to have less fiber and more sugar and fat. Many studies have found a trend toward weight gain and obesity among those who follow a gluten-free diet (including those with celiac disease).

More importantly, gluten-free foods tend to be more expensive than conventional foods. It is similar to the organic food phenomenon. Consumers are often willing to pay far higher prices for foods they think are healthier, even if there is little to no proof that these foods are actually better for you.

Financial review

For the third quarter of 2022, which was repored on Nov. 10, sales increased 12.7% to $1.16 billion, but those strong numbers were almost entirely due to price increases as volume decreased 5.1%. Cost of goods sold, such materials, supplies, labor and other production costs, were 53.2% of sales, a 3.10% increase from the prior-year period. These increased costs were primarily due to input cost inflation. Fortunately for the company, they can easily pass on these inflationary costs as most American consumers want their bread and baked goods at any cost.

Despite the strong realized sales growth, Ebitda increased only 1.6% and net income increased 4.3% due to these cost pressures.

For the first nine months of 2022, operating cash flow decreased by $23.7 million to $291.5 million. Capital expenditures were $128.5 million and dividend payments were $140.1 million.

Cash and cash equivalents were $172.7 million at the end of the third quarter, while long-term debt was $891 million.

Valuation

The company provided guidance for 2022 with sales of approximately $4.8 billion and adjusted earnings per share in the $1.25 to $1.30 range. Consensus analyst earnings per share estimates are in the middle of that range at $1.28, which puts Flowers' stock selling at 23 times earnings. The current enterprise value/Ebitda ratio is approximately 14. The stock has traditionally sold at high valuation levels.

The GuruFocus discounted cash flow calculator creates a value of approximately $23 when using $1.28 at the starting point and applying a generous long-term growth rate of 10%.

The company has been paying dividends for several decades. The current dividend payment is 88 cents on an annualized basis, which equates to an above-market dividend yield of almost 3%. The payout ratio is above 50%, but that has been a consistent capital allocation policy for many years.

Guru trades

A guru who recently added to his Flower Foods position was Joel Greenblatt (Trades, Portfolio). Among those who reduced their holdings were Ray Dalio (Trades, Portfolio)'s Bridgewater Associates and Paul Tudor Jones (Trades, Portfolio).

Summary

Flowers Foods is a well-managed company with a somewhat competitive moat due to a massive installed production and delivery infrastructure. However, the stock is selling at all-time highs and above market valuations. Future gains from this level may be limited and a lower entry point for investors may be warranted to create a margin of safety.

This article first appeared on GuruFocus.