When it comes to the food sector, B&G Foods (BGS -1.18%) fills a unique niche. That said, a key part of its business approach involves making extensive use of leverage. With the consumer staples space facing material headwinds today, investors are worried that B&G Foods can't maintain its dividend.
That fear proved to be well-founded when third-quarter 2022 earrings were released. With the bad news out in the open, is the stock worth buying?
B&G Foods specializes in unloved brands
B&G Foods' specialty is buying small and unloved brands, often from larger competitors, and then lavishing them with the attention they need to grow. It has done this time and time again to fairly consistent success, highlighted by its agreement to purchase Pirate's Booty in 2013 for about $195 million and selling it just five years later to Hershey (HSY -0.13%) for $420 million. Clearly B&G Foods knows how to create value.
The trouble with the company's approach, however, is that acquisitions require a lot of money. With a $1 billion or so market cap, it is a food industry small fry. So debt plays a big role in its business model. To put some numbers on that, B&G Foods' debt-to-equity ratio at the end of the second quarter was around 2.4 times, compared to 1.6 times for Hershey and 1.1 times for General Mills (GIS -0.14%). That's a big difference, particularly at a time when interest rates are on the rise. When debt rolls over or lines of credit reset, B&G Foods' costs will likely head higher more quickly than those of its larger peers.
That, plus a fairly large dividend, had investors worried that a dividend cut was coming. That's one of the reasons why the stock fell over 60% from its early 2021 highs, pushing the dividend yield up to a massive 12%. Not only is the stock price massively underperforming that of its peers, but the dividend concerns proved to be correct. The company drastically reduced the dividend when it announced third-quarter earnings on Nov. 9.
Real problems for B&G Foods
The first problem for B&G Foods is costs, which have gone up quickly in the face of inflation and rising interest rates. These are issues facing all consumer staples companies, but given the company's small size, material cash outlay for the dividend, and heavy leverage, B&G Foods is being hit extra hard. To put a number on that, the company's second-quarter 2022 adjusted earnings fell more than 80% year over year. They were "only" down about 45% year over year in the third quarter, as price hikes being pushed through to consumers offset higher costs for things like ingredients and transportation. However, the company expects cost pressures to last into 2023, so there's no clear end in sight to this headwind.
Simply put, there's more near-term pain to come. That's highlighted by the fact that B&G Foods started 2022 guiding for an adjusted earning range of $1.70 per share to $1.85. By the second quarter that was down to $1.08 per share to $1.28. After the third quarter the guidance range dropped again, this time to $0.90 to $1.00 per share.
As if to punctuate the risks, the company announced in late June that it worked out a deal with lenders to amend a credit agreement. Basically, it needed more financial wiggle room because of the tough environment it is working in today. That's usually a bad sign.
One of the quickest ways for a company to free up cash is to cut its dividend, which is exactly what happened. The previous annual payment was a huge $1.90 per share, which clearly wouldn't be covered by even the top end of the new earnings guidance range. Dividends come out of cash flow, so the payout ratio isn't a perfect way to examine dividend safety. However, when the dividend is so far in excess of earnings (pushing the payout ratio way over 100%), it is a very important warning sign. The dividend was reduced to an annual rate of $0.76 per share. That's a reduction of 60% and brings the dividend yield down to around 5% or so.
The problem is that $0.76 per share in dividends still eats up a material portion of the company's $0.90 to $1.00 per share earnings guidance. In other words, even the reduced dividend is likely to be a heavy burden unless the business environment improves materially.
The risk is not worth the reward
With the bad news out, some investors might look at the 5% or so yield as attractive relative to those of larger peers with lower yields. For reference, Hershey yields 1.8% and General Mills 2.7%. While B&G Foods' yield is notable, the stock probably isn't a good call for conservative dividend investors because of the still-high payout ratio, ongoing business headwinds, and relatively weak balance sheet. Basically, the yield is so high because there are still very meaningful risks here. At this point, B&G Foods appears to have turned into a high-risk turnaround play only appropriate for the most aggressive investors.