Treehouse Foods Heading for a Bad Case of Indigestion

Source: Flagstone Foods.

Treehouse Foods (NYSE: THS  ) is on a buying spree, spending some $1 billion in less than three months on two acquisitions that add to the six food companies it's taken over in the past four years. Such a voracious appetite in a relatively short amount of time is bound to cause a bad case of indigestion for investors.

The private-label food maker announced last week that it was acquiring Flagstone Foods for $860 million from private equity firm Gryphon Investors. Flagstone is the largest maker of store-brand fruit and nut snacks, one of the fastest-growing categories in the food industry.

According to the market researchers at Packaged Facts, the number of "healthy snackers" -- consumers looking for treats derived from healthy ingredients, such as vegetables, legumes, and protein-rich foods -- has grown from 29 million people in the U.S. in 2004 to 41 million today, and Innova Food Insights says nearly 60% of all snack foods are now positioned as being better for you. Indeed, it's been the growth of snacks that was the primary reason billionaire investor Nelson Peltz wanted PepsiCo to spin off its beverage business and focus solely on its Frito-Lay division.

Treehouse says Flagstone will add approximately $0.05 to $0.08 per share to 2014 earnings while raising annual revenues by $750 million and adding $0.24 to $0.28 to per-share earnings in the first year after the deal closes. Thus far the private-label food maker has been a good steward of its resources when it's come to acquisitions and hasn't had any need to write down any of the acquired companies' assets so far. Investors should not be confident that record will stand.

First, companies that make a lot of acquisitions rarely find the process runs smoothly, and it's been widely reported that anywhere from 50% to 75% of all mergers fail to add any value to the acquirer.

Then there's perhaps the problem that the ascendance of private-label foods has run its course. Although research group IRI says private-label grocery store goods now account for 21.9% of unit sales and 18.2% of dollar sales, and store brands are still growing faster than national brands -- over 4% annually compared to a less than 3% industry average expansion  -- that's actually down from its peak of 29%, and the best growth is actually happening only in select areas, such as in drug, convenience, and dollar stores.

A look at ConAgra's latest earnings report shows just the type of difficulties Treehouse may face. Following its acquisition of private-label goods maker Ralcorp, the consumer foods giant stumbled badly, and expects a $60 million decline in fourth-quarter profits from its private-label business while cutting prices to meet falling sales volumes. 

Similarly, Snyder's-Lance sold its private-label food business to Shearer's Foods in May for $430 million to focus instead on branded snacks. Even though the division accounted for $288 million of Snyder's revenues of $1.76 billion last year, or 16% of the total, it believes brand-name foods are a better opportunity. 

Brazil's global meat-processing powerhouse JBS was also looking to diversify away from selling generic meats to supermarkets when it engaged in a bidding war with Tyson Foods to buy branded packaged-meats maker Hillshire Brands.

Source: Treehouse Foods.

In short, the consumer may be saying the ardor of its love affair with private-label goods has cooled, suggesting the industry consolidation Treehouse Foods is engendering may create difficult times for it down the road. It does have the benefit with the latest acquisition that it's diversifying away from its heavy reliance on just canned goods, much like its acquisition earlier this year of Protenergy Natural Foods gave it exposure to shelf-stable carton packaging methods with its aseptic processing and Tetra Recart packaging.

Yet like with most things, it's not a problem until it's a problem, and going on an acquisition spree just as the niche is petering out and others are leaving the space (or having difficulty integrating their own acquisitions) suggests Treehouse Foods investors might be about to experience some heartburn of their own.

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