Take a bite out of Pinnacle Foods

Pinnacle Food's stock price can approach $32 in the next 18 months.

By TheStreet.com Staff Dec 3, 2013 10:48AM

Image: Full Shopping Cart in Grocery Store© Fuse/Getty ImagesBy Richard SaintvilusTheStreet.com logo


NEW YORK (TheStreet) -- It's not often that I discuss relatively unknown small-cap companies, much less those that have operated publicly for less than one year. But I do see a winning formula emerging with Pinnacle Foods (PF), whose stock has been up roughly 20 percent since the company went public this past April.


I'm not going to pretend that 20 percent gains in 18 months is something to write home about. But in the packaged food industry, where companies like ConAgra (CAG) and General Mills (GIS) have been ravaged by weak volumes and shrinking margins, I believe Pinnacle's relative performance has been top-shelf. And with Pinnacle's recent deal with Unilever (UN) to acquire salad dressing brand Wish-Bone for $580 million, Pinnacle should now be at the top of every investor's wish list. Not everyone agrees, however.


The deal, expected to finalize some time in 2015, is being dismissed by some analysts as being too expensive. But on what basis? Now, even if we were to get into all of the financial details and dissect the specifics of this deal line-item by line-item, we still won't find an exact apples-to-apples comparison.


Take, for instance, ConAgra, which paid a hefty 28 percent premium in a deal last year for Ralcorp at $90 per share. And given that this premium equated to roughly 11-times EBITDA, I questioned ConAgra's judgment, especially since the value of this deal was above what the industry average would pay (around 9.5 to 10 times EBITDA at the time). I felt ConAgra overpaid. The Street, meanwhile, felt differently.


While ConAgra hasn't exactly filled investors' appetites for growth, the company has shown modest fundamental improvements since the deal. Synergizing these deals doesn't happen overnight. But investors should nonetheless expect a leaner and more valuable company in the long term. This is assuming that management can continue to remove costs associated with Ralcorp, while also improving asset utilization.


Given that growth in this sector has been virtually non-existent, Wish-Bone, which has annual sales of $190 million, should help "dress up" Pinnacle's long-term revenue growth. What's more, management said it expects this deal will add not only $65 million to Pinnacle's EBITDA by fiscal year 2016, but Pinnacle will also realize $125 million in tax benefits on a net present value.


Essentially, while the growth is not going to happen overnight, it doesn't make a whole lot of sense to evaluate this deal solely on the basis of $580 million, which, by the way, will be financed by cash and debt. And from the standpoint of overall valuation, this deal, which is basically valued at 8.9 times EBITDA, falls in line with the industry average. Not to mention, the deal is cheaper than what ConAgra paid for Ralcorp.


Now, I'm not saying that this is a slam-dunk deal that will propel Pinnacle to higher heights. But when walking down grocery aisles, it's hard to miss the company's strong brands, which are said to be in 85 percent of American homes. These brands include (among others) Birds Eye, Duncan Hines, Mrs. Paul's and now Wish-Bone, which is -- behind Kraft (KRFT) -- the second leading salad-dressing brand with a 9.1 percent market share.


Since reaching a 52-week high of $28.52 a share in August, the stock has experienced a pullback by as much as 12 percent. But with earnings expected to grow by roughly 12 percent next year, I would be a buyer here on this small correction, which has now priced the stock at a forward P/E of just 15, which is in-line with General Mills and cheaper than Mondelez (MDLZ).


And given the expected value-add of Wish-Bone, Pinnacle's fair value can easily approach $35 in the next 18 months, especially with free cash flow recently growing at a compound annual growth rate of 25 percent above 2010 levels.


At the time of publication, the author held no position in any of the stocks mentioned.


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