Drip
Portfolio Report
Monday, January 26, 1998
by Randy Befumo
([email protected])
ALEXANDRIA, VA (Jan. 26, 1998) -- We have arrived at the last contestant, only a few days short of zero hour when we will make our decision on which food company to add. Nope, this ain't a head-fake, folks. We are going to add one of these companies simply because so far they have all looked good on their own individual merits. In many ways, we have saved the most questionable member of the illustrious foursome for last, the much disparaged Quaker Oats (NYSE: OAT), still smarting in the investment community from its retrospectively disastrous acquisition of Snapple.
Like PepsiCo (NYSE: PEP), Quaker Oats demands less attention to the last 12 months and more attention to the last quarter. With Snapple now sold to Triarc (NYSE: TRY), Quaker Oats is an entirely different company. Profitability, returns, growth -- everything has changed in a scant quarter. Anyone paying too much attention to the Snapple-soaked trailing twelve months may in fact be missing an opportunity to invest in the world's finest sports drink and hot breakfast franchise.
When we last looked at Quaker Oats, Jeff stressed the dominant market share in hot cereal and sports drink, the company's two most significant remaining businesses. Beyond this, the company does have a decent cold cereal presence (Life, Cap 'n Crunch) in addition to Aunt Jemima, Continental Coffee and the Rice-A-Roni franchises. With the Gatorade business being the only beverage business left at Quaker, looking at the results from the last quarter the company might want to consider changing the corporate name to Gatorade. Approximately one-third of sales and 57.6% of operating profits came from this highly profitable, delicious, salt-enhanced sugar water. Unlike soda pop, Gatorade is also more profitable in North America than overseas, as the $93.2 million in overseas sales only netted $4.5 million in profits.
As with PepsiCo, we will be annualizing the last quarter of operations to get a sense of what Quaker can really do over the next year. However, the same caveats apply -- although we do not think Quaker's revenues or earnings are seasonal, they might in fact be and we might exaggerate a seasonal bump throughout the year. Last quarter, Quaker had $1,370.7 million in sales and $152.9 million in operating profits. Annualizing these numbers, we get $5,482.8 million in sales ($1,370.7 * 4) and $611.6 million in operating profits ($152.9 * 4). With 137.1 million shares outstanding, $891.1 million in long-term debt and $148 million in cash, remembering the formula for enterprise value (price), we get $7,940.9 million as the current value of Quaker Oats. This puts the company at a reasonable 1.45 times sales and 13.0 times operating profits. Only the flat revenue growth Anheuser Busch (NYSE: BUD), tobacco-plagued Philip Morris (NYSE: MO) and RJR Nabisco (NYSE: RJR) are cheaper based on revenues.
Looking to returns, we can see that the return on equity is artificially distorted because of the large write-down the company took to sell off Snapple. While the 119.9% number we get looks darn good, we have to dismiss it entirely because accounting problems have distorted it. However, the 26.1% return on invested capital we have is a solid number, as this is not reliant as changes in the relative amount of assets and liabilities that are on the balance sheet. This is a high number, above the adjusted average for the 20 companies we have looked at and well above the norms for American industry. Adjusted operating margins are only 11.2%, which is low for the group although should probably be viewed as improvable. The only concern that we might have is the rate at which Quaker is investing in new plant, property and equipment, as this is money that cannot be used for stock buybacks. Additionally, Quaker issued much more stock than it repurchased in the last quarter, although it has also reduced debt and issued a solid cash dividend.
Remember how we warned we might be annualizing a quarter that had a seasonal effect? Well, looking to the current estimates for Quaker this would seem to be the case. Consensus estimates call for $2.23 EPS in fiscal 1998, versus the $2.32 EPS the company would do if it just repeated the third quarter four times next quarter. Apparently the July and August months are better for Gatorade than the winter, although analysts may be still a bit pessimistic given all the changes the company has seen. In Gatorade's favor, year-over-year growth trends in food (4%) and beverages (9%) are much better than those we found at PepsiCo (NYSE: PEP), although not as good as either Campbell Soup (NYSE: CPB) or Philip Morris. If we may speak on this subject for a moment, revenue growth is one of the more important criteria for us as we are looking for actual signs of above market growth even in this non-inflationary economy, not just signs of eager cost savings and share repurchases.
With our second look at all four of our finalists done, tomorrow we will line 'em up again, talk pros and cons and throw it out to the readership for discussion before we announce our decision.
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