Restatement Wilts Q2 Profits For Flowers (News) September 1, 1999

Restatement Wilts Q2 Profits For Flowers

By Brian Graney (TMF Panic)
September 1, 1999

Baked goods and frozen foods maker Flowers Industries (NYSE: FLO) turned into a cactus this morning and pricked investors by restating its second-quarter results. Instead of the profit of $0.10 per share (excluding charges) reported two weeks ago, a tweaking of the company's books has prompted those results to be changed to a loss of $0.03 per share (excluding those same charges).

The maker of Famous Amos cookies, Nature's Own bread, and the addictive Cheez-It crackers is in the midst of what it calls a "massive production realignment" of its Mrs. Smith's Bakeries, which was acquired in 1996. Revenues haven't been a problem at Mrs. Smith's, which was the fastest grower of the company's three major business units last year. However, costs at the unit are bulging like a loaf of bread with too much yeast as the company installs new production lines.

Operational snafus at Mrs. Smith's ended up forcing the company to post only half-baked Q2 earnings. Meanwhile, higher reserves for customer deductions that were initially thought to be collectible -- and reduced estimates for recoverable revenues from stale, half-eaten, or otherwise out-of-date inventories -- prompted the earnings restatement. Disappointed that management is still failing to get things cooking at Mrs. Smith's after three years in the kitchen, Merrill Lynch cut its near-term rating on the firm to "neutral" from "accumulate."

However, not everyone is viewing the situation in such a negative light. "The current disappointing level of performance at Mrs. Smith's is not a reflection of its long-term potential," reassured chairman and CEO Amos "Not-So-Famous" McMullian. Warburg Dillon Read seconded McMullian's view this morning, upgrading the company to "strong buy" from "hold" and setting a 12-month price target of $24 per share.

So, what are investors to make of this? Part of the logic behind the Warburg call is no doubt tied to the underlying value of Flowers' largest and most well-known asset -- its 55% stake in number two U.S. cookie and cracker maker and number one elf employer Keebler Foods (NYSE: KBL). Unlike Mrs. Smith's, Keebler is performing "extremely well," according to McMullian.

At $30 per share, Keebler currently has a market capitalization of $2.64 billion. That valuation puts Flowers' stake at $1.45 billion, or about $14.47 per Flowers share. It follows that with Flowers trading at $16 per share, the company's namesake bakery business and Mrs. Smith's is being valued at a paltry $1.53 per share, or $154 million. That's dirt cheap for business units that generated $355.8 million in sales (excluding intersegment sales) and $12.3 million in operating income last quarter alone. Right? Well, not quite.

While this "sum of the slices is greater than the frozen pie" analysis is an attractive and logical heuristic, it fails to capture a couple of important points. From a practical standpoint, Flowers cannot just dump its 48.4 million Keebler shares into the market at once and expect to fetch the $30-per-share going rate.

More importantly, this type of analysis is only appropriate if Flowers were indeed considering the possibiliy of shedding its Keebler stake. With Flowers boosting its stake last year and management making Keebler the centerpiece of its future strategy, that scenario seems unlikley. Rather than considering Keebler as an investment for Flowers on par with 30-year Treasury bonds or something to that effect, analysts and investors would be better off treating Keebler as an integral part of Flowers' asset base and making a valuation judgment from there.

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