The iconic plastic wrapper with its primary color circles and familiar typeface is coming back to the pantry. Wonder Bread is now part of the five star CAPS-rated Flowers Foods (NYSE:FLO) brand portfolio after Hostess Brands sold it in July.The Wonder Bread buy is a good move by Flowers Foods, but does it make the company worthy of being a part of Warren Buffett's portfolio?
A strategic business model
Flowers Foods' business model is built on acquisitions of smaller bakeries (~100 since its 1968 IPO) and strategic acquisitions of beloved brands like Wonder and the 2011 acquisition of the Tastycake brand (which has enjoyed compound annual growth rate of 29.1% since 2010)..
Flowers Foods also acquired regional bread brands Merita, Home Pride, Nature's Pride, and Butternut in the Hostess transaction. These brands and Wonder Bread had one year retail sales of $828 million combined before Hostess' exit. Before the Hostess buy, Flowers also acquired the distribution rights for Sara Lee in California.
Even after these latest acquisitions, the company's leverage ratio is 2.3 times. For the $355 million it paid for the ex-Hostess brands it also got 20 bakeries and 36 depots. Warren himself would be proud to make such a sweet deal.
We all know how much Warren likes his Coca-Cola and how much he respects enduring companies with iconic brands like Heinz. Flowers Foods marketing executive vp Keith Aldredge said, "Wonder has been a part of the American food scene since 1921. Generations have grown up on Wonder sandwiches. It's a classic." Buying up beloved food brands is a perfect example of a business model Buffett likes.
A competitive moat
Buffett also likes a competitive moat. There are only three key players in the US bread box, down from eight in 2000. These are Flowers Foods, privately held Grupo Bimbo, and Pepperidge Farm, which is owned by Campbell Soup (NYSE:CPB). Flowers has been number two in market share after Grupo Bimbo Bakeries so far this year. The Wonder buy should boost Flowers Foods' US bakery market share up from 17.3%, thus building the kind of economic moat Buffett recommends.
The Hostess breads purchase also offers a gateway into midwestern markets like Cincinnati and Kansas City, where Flowers Foods is expanding. Rival Bimbo is concentrated in the US Southwest.
Pepperidge Farms' breads seriously lag Flowers Foods at only 5.7% market share. Campbell Soup is a big cap company at $13.4 billion, and its Pepperidge Farms bread division is a small part of the company. Furthermore, its breads are the only part of Pepperidge Farms that compete directly with Flowers Foods.
Pepperidge Farm breads cost much more than Bimbo or Flowers Food breads. With a cash-strapped consumer it's unlikely that they will take much market share from Flowers Foods. Campbell Soup's global baking and snacking division contributes 28% to net sales, but its sales growth has mostly come from Goldfish crackers and cookies. The division did gain share in fresh bakery products, though.
Campbell Soup has grown by acquisition with the purchases of healthy brands Plum Organics and Bolthouse Farms providing fresh veggies and organic juices. These added to Campbell Soup's debt load (total debt is now $4.45 billion to total cash of $333 million), but this was needed for the multi-year turnaround of the iconic brand.
Campbell Soup has a lower trailing earnings multiple of 19.67 and a higher yield of 2.90% compared to Flowers Foods. Campbell Soup's stock has risen 60% in the last five years.
Free cash flow, growth, and above all, value
Buffett does love growth. Flowers has expanded its geographical footprint from serving 35% of the US market, mostly in the Southeast and mid-Atlantic in 2004, to 77% today, covering the southern half of the US and extending into New England.
Buffett also loves companies that generate free cash flow, and Flowers has $129 million in free cash flow just for the first half of this year. Flowers Foods' ten year EBITDA compound annual growth rate is 10.44%, and this latest Wonder acquisition should help it rise higher. It's no surprise that the market agrees--the stock is trading at 52 week highs.
Above all, value is what Buffett loves most dearly. This mid-cap company offers a 1.9% yield, which has grown 6.3% over the last year. Net profit margin of 6.60% has been growing from its five year average of 4.80%. The Wonder purchase should keep margins rising as well because of its synergies of distribution and cost reduction.
A Buffett blessing
This purchase of Wonder Bread expands Flowers Foods' market share and its addressable geographic market. This strategic and opportunistic acquisition of five brands, 20 bakeries, and more outlets will elevate Flowers Foods to a higher level of performance.
Buffett would surely bless a buy of Flowers Foods for its widening moat, free cash flow, iconic brands, and value.
AnnaLisa Kraft has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and Flowers Foods. The Motley Fool owns shares of Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.