Shares of packaged food maker B&G Foods (BGS -0.64%) rose 36% over the first six months of 2020, according to data from S&P Global Market Intelligence. That's pretty impressive when you compare it to the S&P 500 Index, which ended that period down by roughly 5%. However, investors need to think a little more deeply about this company before they make any decisions based on its recent stock gains.
The big story at B&G Foods in the first half was the same one that propelled the stocks of a lot of packaged food companies: COVID-19. With consumers asked to remain at home and nonessential businesses closed in an effort to slow the spread of the coronavirus, people's dining options were materially curtailed. Moreover, many decided to pack their pantries just in case things got really bad. B&G's collection of brands benefited from that increase in the purchasing of packaged food. For example, its first-quarter sales increased 8.9% year over year, and adjusted earnings rose 4.5%.
Those may sound like modest gains, but in the food space, they're pretty good. And, without a doubt, B&G's sales have increased as consumers stockpiled food in response to the pandemic's rising threat. However, B&G's big stock price gain can't be looked at without considering its business model, which involves buying unloved brands from larger companies, as well as smaller, up-and-coming brands. The company then invests in them to increase marketing, distribution, and innovation. That sounds great, and B&G has done well with this model -- but it has required a lot of leverage.
Some comparisons will help. At the end of the first quarter, B&G's debt-to-equity ratio was a hefty 2.5. Compare that to Kraft Heinz, which had a debt-to-equity ratio of 0.62 or so at the end of Q1: Excessive debt and weak performance compelled that company to cut its dividend early in 2019.
Even General Mills, which spent billions to buy pet food maker Blue Buffalo a few years back, has a more modest debt-to-equity ratio of 1.7. So leverage is a big issue for B&G Foods -- one that's likely being forgotten by the market now because of the pandemic.
B&G's strong stock run in the first half was nice to see, but it may not provide enough of a justification for buying the stock at this point. That's because the company's business model is much different than other names in the packaged food sector, which is generally considered conservative. Yes, B&G's sales rose due to the changes in consumer behavior driven by the pandemic, but that doesn't change the fundamental ways the company operates -- and its high leverage is a big risk. Conservative long-term investors need to consider much more than just the recent momentum here.