Morningstar | Hostess Reports Solid End to 2018 as Cloverhill Is Primed for Turnaround; Long-Term Thesis Intact
We do not expect a large change to our $14 fair value estimate for narrow-moat Hostess as 2018 results approximated our targets. Even after the high-single-digit percentage after-hours uptick after results were released, we believe the shares are attractive as the market likely underestimates Hostess’ brand strength.For the year, sales rose 9.6%, but Hostess’ adjusted EBITDA margin dropped about 780 basis points to 21.9%, primarily driven by the lower-margin Cloverhill business and cost inflation. Results were near our 9% and 21.7% estimates, respectively. Management offered 2019 targets near our marks: $200 million-$210 million in adjusted EBITDA and adjusted diluted earnings per share of $0.57-$0.62 (relative to our calls for roughly $204 million and $0.63, respectively).
While it was disappointing to see flat organic growth in the year, we were encouraged by the 1% increase in market share (to 18%, according to Nielsen) and 6% point-of-sale increase, highlighting the firm’s brand strength as it expands distribution in a highly competitive category. We believe two main factors will lift performance going forward. First, the firm successfully implemented a low-single-digit percentage price increase that will begin affecting results in the first quarter of 2019. We contend that pricing will not harm volume as Hostess has historically priced at a premium to the category and product innovations (such as peanut butter-flavored items) will continue to entice consumers. Second, we expect the Cloverhill turnaround will continue to progress as management appears to have fixed the operational issues that crimped EBITDA by approximately $14 million in 2018. We see the breakfast category as a large opportunity, considering Hostess’ baked goods strength. These factors support our long-term outlook for low- to mid-single-digit sales growth and mid-20s adjusted EBITDA margin over the next 10 years, on average.
Hostess Brands is a packaged food company. The company produces Hostess?, Dolly Madison?, Cloverhill? and Big Texas? products at bakeries located in Emporia, KS; Columbus, GA; Indianapolis, IN; and Chicago, IL. In-store bakery products are produced at bakeries located in Southbridge, MA. The company has invested in baking and packaging technology, including installing two Auto-bake systems and fully-automated packaging systems. A portion of the company's products are co-manufactured and packaged under its brands and sold through its distribution facilities. The company's Direct-to-Warehouse distribution model uses centralized distribution centers and common carriers to fill orders, with products.
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