Investors looking for small-cap stocks tend to seek out companies whose sales and profits are growing faster than the market as a whole, or have the potential to do so. One such company is Arizona-based PooreBrothers (NASDAQ:SNAK), which manufactures snack products such as chips, potato skins, and cookies.
I'm constantly looking for opportunities to invest in products that I either use or am familiar with. Snack-food manufacturers have historically carried low profit margins, so I wasn't really searching for this type of business when I ran across it. Why, then, did I have a change of heart?
Hidden among the company's various press releases for the past year was an award it received for its new Cinnabon cookie line. The press release implied that the rollout had achieved a level of retailer interest the company hadn't expected. Poore Brothers had a potential hit on their hands, and small-cap growth stocks are sometimes driven by these types of business anomalies -- the sort that launch a company into the stratosphere of growth. Poore Brothers might be poised for such a dramatic rise, but not yet; Cinnabon cookies still make up a relatively small portion of sales.
Also worth noting: the new business strategy the company began in late 2004. In a press release, CEO Thomas Freeze stated the company's intent to expand beyond salted snack products in an effort to broaden its product portfolio.
The company's plan has five basic points:
- Develop, acquire, or license additional niche food brands like the Cinnabon cookies. According to the company, the initial reaction has been overwhelmingly positive.
- Seek additional distribution for existing brands. To that end, Poore Brothers has begun shipping products into Canada, although I've yet to encounter them in the stores. I suppose I'll have to look more closely the next time I'm out shopping.
- Develop product extensions for existing brands. For example, the company introduced TGI Friday's-branded meat snacks in May to complement its existing TGI Friday's potato skins.
- Increase the capacity of its two plants, which currently operate between 40% and 50% of capacity. To that end, Poore Brothers is securing private-label potato chip business with local grocery stores. It's too early to determine whether this effort has been a success.
- Make a concerted effort to increase margins. The company seeks to improve efficiencies wherever possible and focus on higher-margin products. Second-quarter operating margins increased from 23.5% to 25.9%.
A quick check on financials reveals decent second-quarter results, with revenue up 34% and profits up 7.3%. (That's net of the costs associated with discontinuing their CrunchToons brand of salted snacks in 2004.) Those trends should continue to improve, assuming the company is able to improve capacity utilization.
Poore Brothers is making a compelling case for growth, provided it can license brands in a cost-effective and scalable way. Their five-point plan has some merit, but at the end of the day, the snack-food industry is littered with casualties that tried taking on Pepsi's (NYSE:PEP) massive Frito-Lay division.
The major drawbacks to investing in the company at this point are twofold. Licensing is a risky proposition, as evidenced by the $2 million writedown that accompanied the shuttering of the Crunch Toons line. In addition, an awful lot has to go right for their five-point plan to work. It's anything but a sure thing.
So the question remains: Will Poore Brothers live up to its namesake?
Fool contributor Will Ashworth lives in the Great White North. At the time of publication, he held no financial position in any stock mentioned.
