Packaged-foods company TreeHouse Foods (NYSE:THS) has gained solid momentum since early February when it released its fourth-quarter results. The company has managed to sustain this momentum with its second-quarter report that revealed robust revenue and earnings growth. As such, it is not surprising to see that TreeHouse shares are up more than 15% in the last three months.
TreeHouse is looking to bolster its presence in the packaged-foods space further by acquiring Flagstone Foods. Acquisitions are a tried and tested way for companies in this space to grow, as evidenced by ConAgra Foods' (NYSE:CAG) acquisition of Ralcorp last year. Also, given the other strategies that TreeHouse is adopting, investors can expect its solid performance to continue going forward.
Why acquisitions are important
TreeHouse has acquired around six food companies in the past four years. Its latest acquisition includes Protenergy Natural Foods, which was announced last month, for $154 million. This added items such as soups, broths, and gravies to TreeHouse's portfolio and will add $200 million in revenue and $0.05 to $0.07 per share in earnings this year.
Moreover, the purchase of Protenergy will enable TreeHouse to bolster its position against both Campbell Soup (NYSE:CPB) and ConAgra. Campbell has been investing aggressively in promotional strategies and has bolstered its product portfolio significantly. The company launched eight new soups in January, including Chunky, Healthy Request, and Latin brands. Moreover, its broth condensed cooking soups and sauces are also growing at a good rate.
On the other hand, ConAgra strengthened its private-label segment significantly by acquiring Ralcorp in 2013. The size of ConAgra's private-label segment quadrupled after the acquisition, and Ralcorp gave it access to more retailers such as Trader Joe's and Costco. Moreover, Ralcorp's frozen bakery products will allow ConAgra to offer breakfast items to restaurant chains such as McDonald's.
Considering this industry landscape, TreeHouse has been making the right moves to acquire companies and improve its standing in the industry. The company's top-line growth has been driven by single-serve coffee, acquisitions, and productivity gains. TreeHouse expects 2014 to be a year of strategic advances that will generate dividends for years to come.
TreeHouse is also thinking of acquiring Flagstone Foods -- a Minneapolis-based maker of dried fruits and nuts -- for around $1 billion. Also, TreeHouse will leverage the potential of Protenergy to reinvigorate its private-label soup offerings and gain access to the private-label category found in virtually all household pantries. The company is tweaking its packaging from steel cans to resealable cartons while also introducing tetra packs. Such consumer-friendly moves should improve TreeHouse's performance going forward.
TreeHouse needs to overcome this challenge
However, TreeHouse needs to ensure that it integrates its acquisitions efficiently. The company recently experienced some margin weakness. Its first-quarter retail operating margin decreased from 17% last year to 16.6%, primarily due to the mix of new products from its recent acquisitions. Products by Cains Foods and Associated Brands, which TreeHouse acquired last year, generally have lower margins than its legacy businesses, thereby creating margin pressure.
Moreover, its overall operating income fell from 13.4% last year to 10.7% in the first quarter for two primary reasons apart from the one cited above. First, pickle margins fell due to the bad weather. Second, margins in its legacy antiseptic business were down due to manufacturing issues at its plant. So, TreeHouse needs to focus on its operating margin going forward if it is to sustain its solid performance.
TreeHouse has made some moves to reduce expenses. It decreased its net outstanding debt, which is why its interest expenses for the quarter declined by $1.9 million. It also refinanced its $400 million in senior notes that bore an interest rate of 7.75% and issued new senior notes that carry an interest rate of 4.875%. This will positively impact its future interest expenses. As a result of the refinancing, the face value of the interest savings will be more than $11 million annually.
TreeHouse is having a good run in 2014. And given the moves that it is making, it should be able to sustain its momentum going forward. Also, the company's valuation is quite attractive. TreeHouse currently has an expensive trailing P/E of 35, but the forward P/E looks promising at 18 and indicates earnings growth. Moreover, its earnings are expected to grow at an annual rate of 10% for the next five years, according to analysts, making TreeHouse a solid investment.
Shirish Mudholkar has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.