1 Bunny That Won’t Win First Place

Annie's (NYSE: BNNY  ) wants your kitchen cabinet full of bunny-branded organic snacks.

So far, the company has done a phenomenal job of making Bernie, its rabbit mascot, a household staple. In the process, Annie's has cultivated a premium aura around its products and devoted following. Yet its brand-built strengths are unable to masks operational problems in its business.

BNNY likes macaroni, crackers, and money
Since its founding in 1989 and through its IPO in March 2012, Annie's has stood for hearty, healthy snacks without artificial flavors, synthetic colors, or preservatives. Annie's has communicated its brand effectively with its colorful packaging and cute bunny mascot.

Customers have clearly taken notice. Annie's reports that not only has the company's mac and cheese become No. 1 in its category, but Annie's is also No. 1 in snack crackers, graham crackers, and fruit snacks. All the while, the company has grown successfully into 125 other popular product categories across 25,000 retail locations.

Annie's brand has bolstered the company financially. Compared to Hain Celestial (Nasdaq: HAIN  ) , a pure natural foods competitor, Kellogg (NYSE: K  ) , with its popular "Kashi" brand, and General Mills (NYSE: GIS  ) with "Cascadian Farm," Annie's still commands a great gross margin.

Gross Margins

Company

2012

2011

2010

Annie's

39%

39%

34%

General Mills

36.3%

40%

39.6%

Kellogg

41.3%

42.7%

42.9%

Hain Celestial

27.8%

28.9%

28%

Source: Annie's, General Mills, Kellogg, and Hain Celestial 10-Ks from 2010 to 2012.

With margins in the high 30s, Annie's is impressive. And its pricing power appears on par with that of Kellogg and General Mills -- the dominant, long-standing players in the industry.

BNNY can't hop over these hurdles
Unfortunately, Annie's compelling brand cannot hide the fact that this $660 million company is a niche consumer goods operator with little clout. Looking at Annie's operating margins, we can see how the company has yet to capture the full benefits from its premium branding.

Operating Margins

Company

2012

2011

2010

Annie's

12%

13%

8%

General Mills

15.4%

18.8%

17.8%

Kellogg

14.9%

16.1%

15.7%

Hain Celestial

11%

10%

9%

Source: Annie's, General Mills, Kellogg, and Hain Celestial 10-Ks from 2010 to 2012.

Though the differences in these companies' operating margins seem small, they are not. Consumer goods companies are massive organizations, so a few percentage points in improvement add greatly to the bottom line. That said, Annie's looks like a lackluster operator in the consumer goods industry.

So will Annie's operating margins increase? Maybe, but any meaningful, consistent improvements do not seem likely: The company relies heavily on a few distributors and contract manufacturers. In 2010, Costco (Nasdaq: COST  ) single-handedly lowered Annie's sales growth by buying $3.2 million fewer goods than in 2009. In another instance, it took Annie's six months to identify a new partner for one of its product lines. If either event occurs again, Annie's will see a major disruption in sales -- investors, take note!

The Foolish bottom line
Despite Annie's brand and pricing power, the company has even greater operational problems. With the stock at a P/E ratio of 86.3 in an industry that typically trades at 17.1, I'm wary that Annie's will be unable to meet its demand. As we see how Annie's plays out, I'd hop over this stock and look for a delicious stock elsewhere.

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Fool contributor Kevin Chen has no positions in the stocks mentioned above. The Motley Fool owns shares of Costco Wholesale and Hain Celestial. Motley Fool newsletter services recommend Costco Wholesale and Hain Celestial. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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