Drip Portfolio Report
Wednesday, December 10, 1997
by Randy Befumo (TMFTemplr@aol.com)

ALEXANDRIA, VA (Dec. 10, 1997) -- Today we take a look at bread again by examining Interstate Bakeries (NYSE: IBC). We looked at a major competitor, Flowers Industries, on November 11th.

Description: Interstate Bakeries does bread and baked goods. They bake white bread, wheat bread, reduced calorie bread, rolls, buns, English muffins, and the very scary sounding "variety bread," as well as all manner of pastries and fried bread products. Although the bread biz is one of the lowest-margin food businesses around, it is also one of the most consistent growers.

Interstate Bakeries has completely transformed itself from a bread company into a bread and baked goods company over the past two years. In July of 1995, the company bought Continental Baking Company from Ralston Purina for $220 million in cash and 17.0 million shares of stock. Since then, the company has focused on cutting costs to get the most out of this acquisition.

Major brands include: National bread brands include Wonder, Home Pride, and Bread du Jour. Regional brands (which tend to be a little cheaper) include Beefsteak, Buttermaid, Butternut, Colombo, Cotton's Holsum, DiCarlo, Eddy's, Emperor Norton, Holsum, Merita, Millbrook Farms, Parisian, Sweetheart, Toscano, and Weber's. Emperor Norton is my favorite in the bunch. Probably the best-known remaining brands are Hostess and Dolly Madison snack cakes, Marie Callendar croutons, and the whole line of Roman Meal breads.

Core Moneymaker: Wonder bread and the Hostess and Dolly Madison snack cakes rake in the most dough for Interstate Bakeries.

Financials: Because this is an overview, we'll only look at a few key things: how is the company priced relative to sales, earnings per share, and the expected growth rate (valuation); what are the current operating and net margins (margins); how much long-term debt does the company have (leverage); and what does management do with the cash that it generates (capital allocation)?

Valuation and Growth, and Share Performance: At $34 3/16 per share, Interstate Bakeries' market cap is $2.5 billion (share price multiplied by 73.2 million shares outstanding). With trailing sales of $3.2 billion, the company trades at 0.78 times sales (which is the market cap divided by the trailing sales).

Interstate Bakeries has no cash, $269 million in long-term debt, and $232 in long-term liabilities. No cash, you say -- isn't that alarming? Well, let's just say that this Drip Portfolio Fool thinks cash can be a little overrated. If there is cash sitting there on the balance sheet earning 5% instead of creating value for shareholders, it is not necessarily the best situation. In fact, it is what is known to financial people as having an "overcapitalized" balance sheet. As a creation of the leveraged buyout craze of the '80s, Interstate Bakeries is pretty good at deploying cash as soon it comes in.

Also, for our purposes, we count long-term liabilities of $232 as debt, even though these are probably leases and mortgages on plants. You cannot be too conservative.

The enterprise value of Interstate Bakeries (enterprise value was described in last Thursday's report) is closer to $3.0 billion, and that value in relation to sales is 0.94. This is well below the average company we have seen over the past few weeks, although this is because operating margins at Interstate Bakeries are half of what the other food companies have generated.

On the earnings per share side, Interstate Bakeries trades at 24.1 times trailing earnings per share. While expected to grow earnings per share 12% annually for the next five years, the stock trades at 20.1 times earnings estimates for this year and 18.5 times fiscal 1998 estimates.

Margins Reviewed: Again, operating earnings divided by revenue gives us the operating margins. This number shows what the company is earning after the cost of the product and all the costs of running the business are subtracted. It indicates how efficient management is at running the business "operations" -- hence, operating margins.

For the last twelve months, Interstate Bakeries had $3.2 billion in sales and $186.6 million in operating income, giving operating margins of 5.8%. This is well below the average food company, but as we noted above, bread bakers usually have lower margins. However, the growth is more consistent with bread companies, so there is a bit of a trade-off.

Leverage reviewed: With $501 million in long-term debt and $3.2 billion in sales, Interstate Bakeries has a 15.7% debt-to-sales ratio. This is actually very low -- reassuring, given the company does not have a lot of debt.

Capital allocation: The dividend at Interstate Bakeries is a whopping 0.7%, which is well below the average for S&P 500 companies. However, the company has repurchased $60 million in stock over the past nine months and seems to be well on its way to buying back a whole bunch more as cash flow comes in to do so.

The Snapshot for Interstate Bakeries:

Ticker: IBC
Recent Price: $34 3/16

Trailing 12-month sales: $3.2 billion
Trailing 12-month oper. earnings: $186.6 million
Operating Margins: 5.8%
Trailing 12-month EPS: $1.42

Fiscal '97 EPS estimates: $1.65
Fiscal '98 EPS estimates: $1.85

Enterprise value to sales: 0.94
Current P/E: 24.1
P/E on 1998 EPS: 20.1
P/E on 1999 EPS: 18.5
Long-term expected growth rate: 12%
Yield: 0.70%

Conclusion: My preliminary opinion is that despite the low margins, the valuation on the earnings is low relative to its peers and the debt is actually not that bad. I like it.

Have You Given? The Fool Charity Fund


Stock   Close    Change
INTC  $74 11/16  -15/16
JNJ   $66        +1
              Day      Month     Year       History
Drip        (0.43%)   (1.35%)   (11.84%)    (11.84%)
S&P 500     (0.61%)    1.51%     30.92%       1.94% 
Nasdaq      (1.48%)   (0.25%)    23.67%       0.18%  

Last Rec'd    Total #    Security    In At    Current
11/03/97      4.835       INTC     $81.623   $74.688
11/14/97      1.000       JNJ      $62.125   $66.000

Last Rec'd    Total #  Security    In At     Value   Change
11/03/97      4.835     INTC     $394.69  $361.15  ($33.54)
11/14/97      1.000     JNJ       $62.13   $66.00    $3.88 

Base:   $900.00
Cash:   $389.75**
Total:  $816.90

GOAL: The portfolio began with $500 on July 28, 1997, 
adds $100 on the 15th of every month, and the goal 
is to grow the port to $150,000 by August of the year 2017. 

**Transactions in progress:
11/24/97: $100 sent to purchase more Intel.

The Drip Portfolio has been divided into 
37.063 shares with an average purchase
price of $24.283 per share.