B&G Foods (BGS 3.12%) is a consumer staples stock with a huge 8% dividend yield. Although the dividend was last increased in 2019, with such a high yield income investors will likely be pleased that it has remained steady since that point at $0.475 per share per quarter.
In some ways, this food maker is an attractive investment option. But there is one notable risk you need to consider before you jump aboard.
The basic model
B&G Foods isn't your typical food maker. Its core business is basically similar to that of larger peers like General Mills (GIS -0.37%) or Kraft Heinz (KHC -0.43%), in that the company makes branded food products. However, it differs greatly in that it tends to acquire unloved and smaller brands, often from larger peers. For example, it purchased the Green Giant brand from General Mills in 2015, and bought Cream of Wheat from Kraft in 2007 before that company merged with Heinz.
These were brands that the larger companies had basically neglected as they invested in other brands that were performing better. That sets up a spiral, since underinvesting in a brand tends to lead to further struggles for that brand. B&G steps in and takes on such "step children" -- investing in them in a way that the previous owners had not. For example, after buying Cream of Wheat, B&G started bringing out new flavors. More often than not, B&G is able to turn around the brands it buys.
In a way, B&G Foods is a contrarian investor looking for unique opportunities to create value for shareholders. Add in the huge dividend yield, and it's understandable that investors would be attracted to this story.
Not for the faint of heart
In fairness, it is a pretty compelling story -- but only if you have a strong stomach. This is not a good option for risk-averse dividend investors. The key here is to ask how B&G affords to buy the brands it takes on. The answer is debt, which leads it to be highly leveraged relative to its peers. Some numbers will help.
B&G Foods' debt-to-equity ratio is 2.4. That compares to 1.1 for General Mills and 0.4 for Kraft Heinz. This means that its balance sheet is more than twice as leveraged as General Mills', and a huge six times as leveraged as that of Kraft Heinz. That is a very big difference -- leverage can materially reduce a company's ability to deal with adversity.
Looking at this a different way, B&G Foods covered its interest costs by around 1.5 times over the trailing 12 months. That compares to nearly 2.2 times for Kraft Heinz and an impressive 9.4 times for General Mills. Simply put, if B&G hits a rough patch, it has far less leeway when it comes to paying interest to its bond investors than either Kraft Heinz or General Mills.
These facts don't make B&G Foods a bad company, but it does make it a far riskier one than peers with less leverage. That helps explain why investors have priced it the way they have, with a materially higher yield than peers.
Watch this now
Here's the thing: B&G Foods just worked with its lenders to give itself more financial leeway on a secured credit facility. It is also selling stock. Basically, the financial constraints of a highly leveraged balance sheet have become a headwind as B&G is dealing with the impact of inflation.
That shouldn't be shocking to anyone who understands the company's business model, but it is a huge warning that risk-averse investors should probably think twice before adding this name to their portfolios. When push comes to shove, one of the quickest and easiest ways to free up cash is to cut a dividend -- all worth keeping in mind.