Snack-food manufacturer Snyder's-Lance (NASDAQ: LNCE ) fell sharply after the most recent earnings announcement in November after it marginally lowered revenue growth guidance from 10%-12% to 9%-10%, even though earnings are still expected to grow 25%-30%. However, this short-term focus creates a long-term opportunity for patient investors who can see the bigger picture.
Focus on the core sounds cliche, but it works
The decision to focus on the four core branded products (Cape Cod potato chips, Snyder's of Hanover pretzels, Lance sandwich crackers, and Pretzel Crisps crackers) should result in higher growth and margin expansion. These core brands are growing faster than their respective categories with solid volume growth. An example of the strong growth is Pretzel Chips, which should help raise the company's operating margin from 7.8% to 10% , especially as the product line continues to expand.
In the quarter-ended September, revenue rose 11.4% to $453 million , although most of the increase was due to the October 2012 Snack Factory acquisition. However, the gross margin rose 110 basis points to 34.8% (due to a higher mix of branded products), while the operating margin rose 30 basis points to 7.8% . Although free cash flow declined to ~$33 million for the trailing-12 months from $38 million last year , this was due to increased investment, which should pay off over the long term.
Snyder's-Lance is able to fight the industry-wide pricing pressure through increased promotional activities, a focus on higher-quality products (e.g., gluten-free), and new product introductions such as pretzel pizzas . While the increased promotional activities typically result in lower margins, this is offset by the shift towards more effective marketing strategies such as social media, event-driven marketing, and in-store demos.
Successful "blocking and tackling" to drive greater profitability
Although the products typically receive the most attention, the behind the scenes "blocking and tackling" of major operational issues should not be overlooked. For example, in 2012 Snyder's-Lance completed the conversion of ~1,300 direct store delivery routes to an independent business owner distribution structure, which resulted in a significant reduction in selling, general, and administrative expenses. The overall distribution network continues to grow, which should result in additional volume growth.
The consolidation of multiple manufacturing and distribution facilities , as well as improved packaging and manufacturing automation, resulted in increased efficiency. Moreover, much of the charges associated with these closings were offset by the related asset-sale gains.
Snyder's-Lance is attractive on multiple levels compared to its two closest peers. Inventure Foods (NASDAQ: SNAK ) is also growing through acquisitions and posted strong top-line growth, and has a similar debt-to-equity ratio of 0.6. However the gross margin declined 190 basis points to 18.4%, which suggests it is having less success responding to the overall pricing pressure compared to Snyder's-Lance. Moreover, the operating margin is 110 basis points lower than Snyder's-Lance's at 6.7% . Furthermore, Inventure Foods trades at 23 times forward earnings per share compared to 20 times for Snyder's-Lance.
While Golden Enterprises (NASDAQ: GLDC ) may seem stronger given the significantly higher gross margin of 47.5% and lower debt-to-equity of 0.3, this does not translate into bottom-line profitability, as the operating margin is only 0.5% (which results in a non-meaningful P/E ratio). Moreover, a less favorable product mix resulted in an 80 basis point decrease in gross margin.
Investors should look for companies best able to respond to the current industrywide pricing pressure by selling higher quality and in-demand products, which should benefit with the greatest increase in shareholder value over the long term.
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