Did TreeHouse Foods Make the Right Acquisitions?

Source: TreeHouse Foods

Based on research by Packaged Facts, the private label penetration rate of the retail grocery market has increased from 15.8% in 2008 to approximately 18% in 2013. TreeHouse Foods (NYSE: THS  ) , the largest manufacturer of private label non-dairy powdered creamer, single-serve coffee, pickles, salad dressings, and condensed soups in the US, has been one of the key beneficiaries of this. It has expanded its top line and bottom line by five-year compound annual growth rates, or CAGRs, of 8.9% and 25.3%, respectively.

However, TreeHouse Foods isn't resting on its laurels. TreeHouse Foods has done two key M&A deals in the past year to increase its share of retail private label products. It's also possible to compare TreeHouse Foods with peers such as Inventure Group (NASDAQ: SNAK  ) and Campbell Soup (NYSE: CPB  ) to understand the strategic rationale behind these acquisitions.

Snacks
TreeHouse Foods announced in June that it will acquire Flagstone Foods, one of the biggest manufacturers of private label healthy snacks in the US, for $860 million in cash. TreeHouse Foods estimates that this transaction will be earnings per share accretive to the tune of $0.24-$0.28 in the first full year after the deal closes, and will also grow its annual revenue by approximately $750 million.

The growth in private label snacks is validated by Flagstone Foods' recent financial results; it has expanded its top line by a three-year CAGR of 24%. In particular, Flagstone Foods is an innovator which has historically partnered with retailers for growth. Its past collaborations with retailers to merchandise healthy snacks along the perimeters of stores have seen encouraging results, with perimeter sales growing at an annualized rate of almost 50% over the past three years.

If one still has any lingering doubts about the potential of private label healthy snacks, one should look at Inventure Group, which sells healthy, natural, and indulgent specialty snack food products. Inventure was a pioneer in the healthy snacks product category, as it started to include healthy & natural snacks in its product assortment as early as 2006.

Inventure's Boulder Canyon brand of kettle-cooked potato chips and its Rader Farms brand of frozen berries are examples of snacks that cater to the needs of health-conscious consumers. The results speak for themselves. Inventure expanded its revenue by 29% in 2013, in line with the 14.7% year-on-year growth in industry-wide frozen fruit sales over the same period.

The results of a 2012 Mintel survey also showed that 42% of respondents 'make it a point to snack on foods that are healthy.' In addition, fruits were the healthy food of choice for 86% of respondents. With the acquisition of Flagstone Foods, which has the largest market share of dried fruit snacks in the US, TreeHouse Foods is well-positioned to capitalize on growth in this segment.

Source: TreeHouse Foods

Soups
In the packaged food industry, change is the name of the game. One category that has been losing favor with consumers is canned soup. According to research by Euromonitor, canned soup consumption has fallen by 13% over the past 10 years, with changing consumer habits (e.g. increasing on-the-go consumption) and health issues (e.g. the presence of bisphenol-A) to blame.

Both Campbell Soup and TreeHouse Foods are expanding into alternative packaging formats for their soup products.

Campbell Soup has experimented with various packaging options for its soups such as boxes, bags, and plastic buckets in recent years. Notably, it announced in September of last year that it will make its soup products available in K-Cups, which will allow its customers to make fresh soup using Keurig coffee brewers.

This new single-serve soup product is likely to be popular with consumers for two reasons. Firstly, preparing canned soup is too cumbersome for the new age of consumers, compared with a freshly brewed cup of soup that is available at the press of a button. Secondly, Campbell Soup's single-serve soup product could fill the gap for for snacks that also double as mini-meals to satisfy hunger. In contrast, most other snacks on the market don't fill the stomach like soup does.

In May 2014, TreeHouse Foods completed its acquisition of Protenergy Natural Foods, a manufacturer of private label broths, soups, and gravies, to gain access to its carton-packaging technology. Like its planned purchase of Flagstone Foods, TreeHouse Foods' deal with Protenergy Natural Foods is an accretive one as the company expects it to add approximately $0.11-$0.14 in EPS for 2015.

An estimate has found that 70% of broth is already sold in cartons instead of cans. Lower material & distribution costs and the health hazards of canned food products have led food producers and consumers alike to favor non-can packaging. Moreover, Protenergy Natural Foods' proprietary packaging technology is expected to help TreeHouse Foods reduce its production time and lower its packaging costs.

Foolish final thoughts
While the academic evidence for M&A isn't the most encouraging, maintaining the status quo isn't the next best alternative. I am positive on TreeHouse Foods' two EPS-accretive acquisitions in 2014.  Flagstone Foods will enable TreeHouse Foods to leverage the growing healthy snacks market; Protenergy Natural Foods will help ease TreeHouse Foods' transition from cans to cartons for packaging.

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