Should Investors Bet on Value Creation at Bob Evans Farms?

Bob Evans Farms' (NASDAQ: BOBE  ) shares have been as hot as its famous chicken pot pie lately. The stock has risen more than 50% over the past twelve months as double-digit growth in Bob Evans' packaged foods business has piqued investors' excitement.  However, at least one investor is looking for more upside. Large shareholder Sandell Asset Management is agitating for a split of the company's restaurant and packaged foods businesses.  Similar value-enhancing moves have worked well at other food-related companies, including Kraft Foods, Dean Foods, and Hillshire Brands (NYSE: HSH  ) .  Absent a transaction, though, should investors bet on this story?

What's the value?
Bob Evans primarily operates a regional restaurant chain, with over half of its 560 locations situated in Michigan, Indiana, and its home state of Ohio.  Given heavy competition in the family dining arena, the company has pushed its mission of providing "farm fresh" meals at affordable prices, as well as adding larger bakery and carry-out areas in its stores to bulk up its to-go business.  The company has also successfully expanded its brand into the packaged food space, a segment that has generated sales growth through plant expansion and product innovation.

In its latest fiscal year, Bob Evans' top-line slipped slightly due to the sale of its Mimi's Cafe subsidiary. Its continuing operations registered higher sales tallies.  However, the company's profitability was negatively affected by lost selling days at restaurants undergoing the format refresh and higher development costs from new product introductions in its packaged goods unit.  On the upside, Bob Evans picked up incremental sales at its resigned stores, where comparable store sales rose 3.6%, and it benefited from a small gain in its average customer's check size.

Some investors see value from a business split. Management seems inclined to believe that an integrated enterprise provides the best sales opportunities because its restaurants drive sales of branded products in the wholesale channel.  Given management's non-response to the Sandell proposal, as well as inconsistent operating profit growth, investors might find better results with leading competitors that have more focused operations.

Promising segment alternatives
On the restaurant side, a better bet might be Cracker Barrel Old Country Store (NASDAQ: CBRL  ) , a similarly situated chain of family dining restaurants that also banks on its down home country image and reasonably priced meals.  Like Bob Evans, Cracker Barrel has had to deal with an activist shareholder who has forced the company into more shareholder friendly actions that include substantial dividend increases over the past three years.  The pressure has also made the company more efficient and productive in its store operations. It is currently riding four straight years of annual comparable store sales gains.

In its latest fiscal year, Cracker Barrel produced a small top-line gain versus the prior year, with its comparable store sales increase hitting a five-year high.  Further substantial growth in its store base is unlikely given its large base of over 600 stores. However, the company is trying to drive higher per-store productivity through an expanded retail product mix and the introduction of licensed products in the wholesale market.  More importantly, Cracker Barrel continues to generate strong operating cash flow, $209 million in its latest fiscal year, which it is returning to shareholders through dividend increases.

On the packaged goods side, a better bet might be Hillshire Brands, a company that also focuses on meat products, primarily through its Jimmy Dean and Ball Park brands.  The company has been in major divestiture mode over the past few years, selling or spinning off a range of food businesses, most notably its D.E. Master Blenders unit in 2012.  While the business transformation has shrunk its overall sales base, Hillshire Brands has emerged on the other side as a more focused, profitable enterprise.

In its latest fiscal year, Hillshire Brands' top line registered a small decrease, hurt by weakness in its deli meat, hot dog, and sweet goods product lines.  However, the company's smaller size allowed it to meaningfully cut its overhead which helped generate the highest adjusted operating margin of the past five years.  More notably, Hillshire Brands' greater profitability is providing the funds to reinvest in product innovation and marketing initiatives which strengthen its overall competitive position.

The bottom line
Despite a nice run, Bob Evans trades at a lower price to EBITDA valuation than these two named competitors, ostensibly due to its operating focus on multiple business segments.  However, until investors see a move toward a business split at the company, they are likely to find better rewards with competitors that have a singular focus and continue to create efficiencies and shareholder value through their operations.  As such, investors should take a wait-and-see approach with Bob Evans while this corporate drama unfolds.

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