Why Pinnacle's Latest Acquisition Isn't That Lucrative

The investing community often considers IPOs as one-time opportunities to lock-in stellar returns. The exponential growth of successful IPOs is discussed frequently but seldom the failures of bust IPOs. I believe that Pinnacle Foods (NYSE: PF  ) is one such case. It is trading at a lofty valuation, and its latest costly acquisition of Wish-Bone limits its growth prospects .

About the acquisition
Shares of Pinnacle Foods have appreciated by nearly 20% since its IPO in April 2012. Its recent rally has been quite rewarding for investors, but its high trailing P/E of 52x and PEG ratio of 1.41x indicates that its shares are trading at a premium. Its lofty P/B and P/FCF ratios of 1.96x and 25.48x also suggest the same. And despite its recent rally, major investment research firms are yet to initiate their coverage on the company.

In order to boost its growth momentum, Pinnacle acquired Wish-Bone brand from Unilever for $580 million recently. Wish-Bone has annual sales of $190 million and is expected to add $65 million to Pinnacle's FY16 EBITDA. Additionally, the joint synergies post acquisition should result in $125 million worth of tax savings for Pinnacle Foods. The deal will be finalized by 2015, and will be financed by cash and debt. However, the acquisition doesn't appear that attractive.

Was this acquisition too expensive?
Pinnacle Foods currently has an EV (Enterprise Value) of $5.54 billion with $426.1 million under FY12 EBITDA (Earnings Before Interest Taxes Depreciation and Amortization). This equates to an EV/EBITDA of 13x, which is higher than most of its competitors. General Mills, Kraft Foods (NASDAQ: KRFT  ) and Kroger (NYSE: KR  ) trade at relatively lower EV/EBITDA ratios of 11.58x and 12.39x and 4.2x respectively.

On the other hand, Wish-Bone is estimated to add $35-$50 million EBITDA to Pinnacle Foods FY14 earnings.  With a price tag of $580 million, Wish-Bone's EV/EBITDA ranges between 11.6x-16.57x. Since Pinnacle is already trading at lofty valuations , the future earning projections from its Wish-Bone acquisition offers minimal headroom for stock appreciation.

Fierce competition for your salad bowl
The hypercompetitive nature of the salad dressing industry is also detrimental to Pinnacle's growth potential. According to a report by Euromonitor International, Wish-Bone operates with a 9.1% market share, which has shrunk by 150 bps over the last 5 years.

On the other hand, Kraft is currently the market leader in the salad dressing industry, with around 50 different offerings and a 19.6% market share. However, due to the increasing number of products and competitors in the industry, Kraft's market share has shrunk by 550 bps over the last 5 years.

Similarly, Kroger also operates with over 50 different salad dressings, but with a 14.4% market share. Its market share has swollen by 410 bps over the last 5 years, thanks to its relatively nutritional and affordable salad dressing offerings.

The management of Kraft once referred to the salad dressing industry as an "Armageddon Environment," and recently stated that it plans to launch an undisclosed number of new salad dressings to regain its market share. Its management asserted that it won't involve in mass advertising, and would rather focus on rolling out competitive products.

Since Wish-Bone and Kroger don't have any plans to launch new salad dressings, Kraft might succeed in capturing a greater market share. Furthermore, Kraft's new launches will most likely intensify the competition in the salad dressing industry, thereby reducing the potential gains from Wish-Bone. This doesn't paint an optimistic picture for Pinnacle Foods.

An investor's take
At the current price, shares of Pinnacle Foods trade with a PEG ratio of 1.41x. This indicates that its shares are overvalued with respect to its growth prospects, and there isn't much headroom for stock appreciation. Its towering debt/equity ratio of 131% doesn't paint an optimistic picture either.

So if an overvalued company with towering liabilities acquires a company (or segment) at a premium, its shares may not necessarily head north. Therefore, I believe that investors shouldn't get too carried away by Pinnacle Foods' recent acquisition.


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