In my ongoing search for spinoff opportunities, I just learned that Dean Foods' (NYSE:DF) creation of TreeHouse Foods (to be listed on the NYSE under the symbol THS) will take place on June 27. Dean Foods' shareholders on record as of June 20 will receive one share of TreeHouse for every five Dean Foods shares. Based on TreeHouse's Form 10, the new company may not a great bargain right out of the chute.
I think the reason for the spinoff is sound. TreeHouse will comprise three business units: pickles, nondairy powdered creamer, and the ubiquitous "other," consisting of household necessities such as pudding and cheese sauces. Since Dean Foods' core competency is dairy products, these secondary businesses tended to get lost in the shuffle. At 6.5% of 2004 sales, I'm sure the TreeHouse business units found it difficult to gain access to internal capital to fund growth projects. Spinning off these nonrelated segments makes sense.
Over the last couple of years, gross margins in the pickle and "other" business units have been under significant pressure, reduced by rising commodity prices. To make matters worse, Dean Foods seemed to lack pricing power to recoup the increase in the cost of sales.
Fortunately, the nondairy powdered creamer business, powered by the Cremora brand, has been performing exceptionally well. The business unit has been able to increase unit sales volume while passing through price increases. As a result, sales and gross margins are rising.
According to the company's pro forma income statement, the TreeHouse business units earned $0.32 per share in the first quarter of 2005. If we annualize this number, TreeHouse could earn $1.28 per share for the year. Currently, Dean Foods has a price-to-earnings ratio of 23. Although TreeHouse's operating margins are almost twice as high as Dean Foods' (10.8% vs. 5.5% in Q1 2005), sales have been flat and net income declining. If we gave it a P/E of 20, TreeHouse could be worth about $775 million.
Admittedly, this seems a bit aggressive, especially for a company with growth in only one business unit. But this valuation only implies a trailing price-to-cash flow ratio of approximately 11; at $26 a share, the company could be a decent buy depending on the strength of its growth prospects (and if you believe management, they are good). As I've said, TreeHouse's bargain status remains uncertain.
To further complicate matters, I see Dean Foods' share price has risen around 20% during the past few months. To me, that means enough investors have looked at TreeHouse and bid away any margin of safety. Regardless, I plan to keep my eye on this spinoff to see how it trades relative to my back-of-the-envelope valuation.
We've spun off these Foolish Takes:
- Spinoff Alert: Mestek
- Quiet Spinoff, Big Opportunity?
- MoneyGram Double Dips
- IAC Split is an Elegant Solution
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Fool contributor David Meier does not own shares in any of the companies mentioned. The Motley Fool has a disclosure policy.
