- A number of market commentators have drawn positive attention to the low PE multiple and high dividend yield of B&G Foods.
- While we would not go so far as to call B&G Foods a value trap, the stock still carries material downside risks.
- In particular, the long thesis should, at a minimum, take into account the B&G Foods leverage, payout ratio and management compensation incentives.
The Problems With This "Cheap" Stock
In recent months, a number of value investing commentators have drawn attention to the merits of a long position in B&G Foods (BGS). Their primary emphasis has been the company's revenue growth rate, coupled with a "low" PE multiple, and an attractive dividend.
However, upon further inspection, many of those positive attributes are associated with material downside risks that do not appear to be making their way into the current market commentary.
We briefly highlight, below, several red flags that value investors may want to keep in mind:
(1) Growth through acquisition: The BGS EBITDA and sales growth rates include a relatively large number of recent acquisitions. The BGS organic growth rate is nowhere near those levels. It is not clear that management will be able to achieve the growth rates implied in the current BGS valuation multiples without additional acquisitions. As we will discuss below, in point #6, management may not be incentivized to reduce its reliance on acquisitions to grow the business. Importantly, the prior acquisitions have led BGS to the edge of the envelope in terms of leverage (see #4, below);
By emphasizing top line growth and/or dividend yield as the primary drivers of their long thesis it is easy to overlook the fact that the ROIC has been trending in the wrong direction for several years.
(2) Public Trading Multiples: even with the benefit of growth from recent acquisitions, the stock is not overwhelmingly cheap at 3.5x PEG, over 20x CFFO and 2.5x EV/Revenue. Recent declines in the BGS stock price are associated with CFFO/FCF per share dilution rather than multiple compression (notice the association between a lower stock price and higher P/CFFO multiples);
(3) Payout ratio: You could potentially get comfortable with the high trading multiples if you view BGS principally as a yield play (circa. 5%) but we should not overlook the > 100% payout ratio. The current dividend may be unsustainable if management underdelivers on acquisition integrations and/or deleveraging targets (see #4, below). While we do not possess a crystal ball for evaluating future realized growth from recent acquisitions - we will leave that to the industry experts and macroeconomic forecasters - the history of organic growth at BGS is a potentially ominous warning sign;
(4) Leverage: it is worth asking whether the current leverage would permit BGS to achieve a P/E re-rating to reflect its supposed "high growth" status. For example:
- The adjusted EBITDA number, amongst other things, gives BGS the benefit of acquisition integration costs which *might* be reasonable for a less acquisitive company. Adjustments add a full turn of EBITDA to the leverage metrics;
- BGS already sports a sub-investment grade (high yield) credit rating (B1/BB-);
- Most of the recent acquisitions involve material purchase price allocation to trademarks and goodwill. The consolidated PPE is rather small ($245 million vs $1,263 million of intangibles) so the debt refinancing alternatives are going to be limited (e.g. a sale & leaseback won't move the needle on deleveraging);
- The credit agreement covenant does not provide a lot of headroom at 6.5x EBITDA for all of FY2017;
- The $300+ million FY2019 maturity exceeds LTM CFFO and may require an equity offering, a dividend cut, draconian cost cutting and/or asset sales if BGS cannot refinance and its revenues do not materially accelerate. High yield credit market conditions are currently very favorable for refinancings although this can always change on a dime; and
- To the extent that BGS revenues are highly correlated with economic growth, when you combine its current high leverage with a future GDP recession, it is not difficult to envisage a scenario where the dividend needs to be scaled back or eliminated entirely.
(5) Insider activity: there has been de minimus insider buying in the last ~18 months (~$20K by EVP of Bus Dev).
Partly as a result of the ongoing share issuances, and the lack of insider participation, insider ownership has declined from its peak of 5.5% to almost 2.5% of the shares outstanding, despite the purported "growth" prospects.
(6) Insider incentives: one of the reason we may not see any correlation between stock price performance and changes in executive compensation is that the two key performance metrics used in determining executive and Board compensation are Adjusted EBITDA and "excess cash" (which is itself an "Adjusted-Adjusted EBITDA" number that differs to the credit agreement Adjusted EBITDA definitions). The mere presence of an adjusted-adjusted number is always a bit of a red flag and when you combine that with the fact that the only two BGS performance metrics are very similar in nature, it does raise some questions for the Board's compensation consultants. Importantly, neither of these performance metrics are measured on a per share basis.
What does it all mean for value investors?
As mentioned earlier, we are not industry experts and cannot provide a robust revenue forecast, especially for a company which is commingling so many bolt-on acquisitions. Having said that, value investors can find similar growth profiles with less red flags in the current market environment. It may be prudent to avoid BGS until it works through its high leverage issues and/or delivers on the growth promise of some of its recent acquisitions.
If management and the Board wanted to send a strong signal to the market about its commitment to being a high growth company, we would recommend immediately amending the compensation incentives, performing a broad-ranging review of its entire portfolio of assets with an eye to divesting low ROIC business and maybe even committing to increasing its insider holdings.
More controversially, it may be prudent for the Board to commit to an immediate dividend cut. The retained cash could be committed to deleveraging. This would not only reduce some of the current uncertainty regarding future dividend policy - by reducing the payout ratio below 100% - it would also provide the company with a modicum of insurance for the next recession.
None of the available strategic choices will be easy. Hoping to dig yourself out of a hole through revenue growth is always going to be more appealing. Until it isn't.