EUR 850.00 For Business Accounts Only

Morningstar | Narrow-Moat Hostess Leveraging Acquisition to Expand Distribution, but Secular Headwinds Persist

Although the previous owners of the Hostess brand filed for bankruptcy in 2004 and 2012, we contend it wasn’t due to a lack of brand equity but due to highly inefficient manufacturing and distribution systems, a powerful unionized workforce, combined with a high debt load. We believe the Hostess brand’s demonstrated pricing power, with the brand selling at a consistent premium to its branded competitors, provides evidence of an intangible asset. In addition, we believe Hostess is a valued partner in the convenience store channel (supporting another facet of the firm’s intangible based edge), where the sweet baked goods category drives a material portion of channel revenue and Hostess is the market share leader. Together, these competitive advantages lead to our narrow moat rating.We aren’t blind to consumers’ heightened focus on healthy eating, which has led to flat category growth for the sweet baked goods category in each of the past two years. However, the Hostess brand has continued to grow (albeit at a decelerating pace), as the brand continues to regain shelf space that was lost during its 2012 to 2013 hiatus. We believe the firm has additional distribution gains to realize as its current market share is just 18%, lower than the old company’s 22.8%. Further, Hostess’ share may expand beyond its prior peak, given its greater access to convenience, drug and dollar stores (following enhancements to its distribution network) and club stores after a recent acquisition. In addition, acquisitions into adjacent categories (in-store bakeries and breakfast pastries) could boost its growth.Despite these growth opportunities, Hostess isn’t immune to widespread headwinds. For one, due to a broad trend toward fresh and natural foods, the sweet baked goods category has been losing share of the food and beverage market, and we expect this trend to continue. The firm is responding by eliminating artificial ingredients from some products, but we think its ability to portray these products as healthy is limited. Further, Hostess faces intense competition inside its core aisle and across the broader snacking landscape, and we don’t posit these challenges will subside.