Flowers' largest brands include Nature’s Own, Wonder and Tastykake.

THOMASVILLE, GA. — In the face of an increasingly skeptical investment community, executives of Flowers Foods, Inc., Thomasville, Ga., remain confident in the company’s outlook. On April 13, Allen L.  Shiver, president and chief executive officer, and other Flowers executives offered an upbeat picture of the company’s future in the wake of a difficult several months.

Allen Shiver, Flowers Foods
Allen Shiver, president and c.e.o. of Flowers Foods

“By combining prudent top-line growth with margin expansion, our goal is to accelerate growth of earnings and cash flow,” Mr. Shiver said April 13 in a presentation at the New York Stock Exchange. “On that front in particular we have identified specific opportunities to reduce cost and improve our profitability.”

The second largest baking company in the United States, Flowers sales in 2015 totaled $3,778,505,000. The company’s largest brands include Nature’s Own, Wonder and Tastykake.

In trading on the N.Y.S.E. in recent days, shares of Flowers have held in the $18 range. Shares were far less stable in mid-February when the company announced earnings well beneath its own fairly recent guidance. A 52-week low of $15.64 reached on Feb. 12 represented about a 40% drop from the 52-week high. Adjusted for cash and stock dividends, it was the lowest price for Flowers shares since December 2012.

In last week’s presentation, R. Steve Kinsey, Flowers’ executive vice-president and chief financial officer, attributed the earnings disappointment to a range of factors.

R. Steve Kinsey, Flowers Foods
R. Steve Kinsey, executive vice-president and c.f.o. of Flowers Foods

“This shortfall was primarily due to lower-than-expected sales the past two years, costs associated with the acquisitions, higher net interest expense, carrying cost associated with our closed facilities and increased amortization as well as cost for developing our expansion markets,” he said.

With the lower-than-expected earnings, mostly attributable to factors that should not have been a particular surprise, securities analysts turned cautious.

For instance, uncertainty over pricing prospects for the baking industry prompted Eric Katzman of Deutsche Bank in February to downgrade Flowers to a hold from a buy recommendation. At the time, Mr. Katzman said the decision was not an impulsive one.

Eric Katzman of Deutsche Bank

“We usually take a more contrarian view when packaged food stocks react negatively to a missed quarter, often seeing the market disintermediation as an opportunity,” he said. “Despite our reluctance to lower our opinion in the face of a 20% stock dip today and weak performance over the last few months, we nevertheless feel compelled to do so. As most investors who have read our research the last few years are aware, we viewed U.S. fresh bread and roll category consolidation as a likely catalyst toward better pricing, mix and profitability. Between Mexico-based Grupo Bimbo, Flowers and Campbell Soup’s Pepperidge Farm, the leaders control 50% of category share. Our work suggested this could result in better margins for all assuming more rational behavior around pricing and promotion along with reinvestment to grow the category vis-à-vis new higher end products.”

However promising the consolidation appeared, it has not translated into the improved results Mr. Katzman expected. In public, the top players “said the right things,” but their actions have not always mirrored their words.

While the environment appeared to be improving in 2015, conditions seriously worsened in the fourth quarter. Mr. Katzman characterized results as a “major disappointment” and prompted a “reset” on his part in how he views the company and the industry.

“In retrospect, this period of mixed performance is best characterized when looking at the last three years, which includes essentially flat sales, EBIT and e.p.s.,” he said. “Again, with hindsight 20-20, this is not indicative of a category that is acting better because of consolidation nor reflecting a company that is taking advantage of it. Looking more broadly at the U.S. packaged food group, we have harped on the idea that realistic financial targets are critical in this environment. It doesn’t appear the last three years are an anomaly for Flowers and certainly the fourth-quarter 2015 results are worrisome. Whether it is a slowdown in overall consumption, less rational category behavior or Flowers’ internal challenges, it would suggest the company’s long-term growth rates are too aggressive. This is another reason to become cautious, albeit with the stock already down significantly.”

Not a major factor in Mr. Katzman’s analysis is the overhang of litigation from independent operators who believe they should be classified as employees.

“Our sense is the issue will take years to resolve (favorably or unfavorably),” he said.

Concern also was expressed by Brett M. Hundley, an analyst with BB&T Capital Markets. Following the fourth-quarter earnings results, Mr. Hundley affirmed his hold recommendation first issued in early 2015. Before that, BB&T had a buy rating on Flowers.

With the disappointing fourth quarter, Mr. Hundley wondered whether some unspecified “change” is needed.

Brett M. Hundley, an analyst with BB&T Capital Markets

“At the very least, a change in strategy is warranted, we think,” he said. “We wonder if legal issues are taking too much management time and attention, at present. We had understood that fundamental conditions were improving, alongside potential benefits related to recent M.&A. Its earnings call today — and guidance on 2016 — suggests otherwise, relative to these expectations. We are dropping forward estimates and maintaining our hold rating amongst a number of questions that are yet unanswered at this point.”

Laying blame at the feet of current Flowers leadership would be unwarranted, despite unattractive comparisons between the tenures of Mr. Shiver and his predecessor as c.e.o. George E. Deese, Mr. Hundley said.

“During the tenure of ex-c.e.o., George Deese, Flowers steadily grew e.p.s. by 13.5% annually, on average,” he said. “Thus far into the Shiver campaign, earnings have stagnated after a large step up in 2013 related to the Hostess market exit. We think recent year stagnation says less about Mr. Shiver’s abilities and more about a strategy that may need to be altered. We think Mr. Deese benefited greatly from obtainable white space and relative fragmentation within the competitive set. That is not afforded to Mr. Shiver anymore, yet the company continues to press on with a geographic growth mindset. The proof, we think, is in margin stagnation. Bimbo will defend market share. Further, we think recent year acquisitions have added too much complexity to the system. As we’ve written previously, we think this is what has led to the proliferation of driver lawsuits as of late. We wonder if legal issues and business complexity are affecting management execution. As we’ve written previously, we wonder if a pause in market share pursuit and focus on simplicity/operations is the right strategy at this point in time.”

In the April 13 investor’s day presentation, Mr. Shiver and his colleagues explained why they expect improved financial performance ahead and appeared to address some of the analysts’ concerns. Acquisitions are expected to remain an important part of the Flowers growth strategy longer term, he said.

“For now our primary management objective is to grow earnings by improving productivity, to increase margins across all of our operations,” Mr. Shiver said. “We expect these efforts along with dividends and share repurchases to grow earnings and cash flow, while increasing our market to capitalization.”

Bradley K. Alexander, chief operating officer of Flowers, offered a glimpse into ways the company believes profit margins will improve.

“From our bakeries, we are working to improve efficiencies to smart capital investments that we expect to improve quality and throughput from our people,” he said. “We are training team members in our newest bakeries and the best practices we have developed over the years to improve productivity.”

D. Keith Wheeler, president of the Flowers direct-store delivery operating segment, elaborated further on cost savings opportunities.

“We’ve begun to implement a trade promotion architecture that will allow us to be more surgical in our promotional spend,” he said. “We will continue to feature and promote our products but will do so by partnering with retailers to maximize sales and enhance margins. We’ve also improved our order forecasting.”

In connection with the presentation, Flowers revised several long-term goals that the company believes will deliver total shareholder returns of more than 10%, including revising its sales growth goal to a range of 2% to 4% (down from 3% to 5%); EBITDA margin to 12 % to 14% (up from 11% to 13%); and earnings per common share of 8% to 10% (down from double-digit growth).

In his presentation, Mr. Kinsey drilled deeper into the sales forecasts but didn’t shed light on the EBITDA or e.p.s. changes.

“To be more specific, we anticipate over the next three to five years, this (sales) growth to come from approximately 1% to 1.5% of the acquired organic business, 0.5% to 1% in expansion market and another 0.5% to 1.5% in price mix,” he said.

Overhanging the company in recent months has been the question of independent operator litigation, an issue addressed at some length by Mr. Wheeler.

“Flowers has operated an independent distributor model for over 30 years,” he said. “From the 1980s through today the model is intended to offer opportunities for distributors beyond that of company owned routes. Independent distributors are business partners to Flowers. Distributors have the exclusive right to sell and distribute our brands in their territories. They grow their income and their equity as they increase sales. They own their own business. They make decisions about how to operate for their products, for their customers, take responsibility for the management of their business, many hire their own employees. All make their own important decisions every day.

“Flowers benefits when distributors are successful and distributors benefit when Flowers invests in brands, new products, marketing support and improved technology. We believe this model creates an entrepreneur incentive that will deliver significant benefit for independent distributors, their customers and for Flowers.

“In the past few years, independent distributor models in general have been challenged. Those challenges have been across many industries, not just the baked foods industry. Flowers has some distributor lawsuits and so do others in the baking industry. We do not believe the lawsuits have merit and we’re vigorously defending our independent distributor model.”

While Flowers currently faces legal action taken against the company by 156 named plaintiffs in 20 different cases pending, Mr. Wheeler noted almost half are no longer working and the company currently has about 5,100 independent operators. To date, one class action suit has been certified and one has been denied.

“We are fully aware of the evolving environment in which we live,” he said. “Through the years, we’ve made significant changes to enhance our distributor model and we’ll continue to do so as needed.

“Finally, it’s important for you to know that our legal team is focused on handling the litigation and our management team is focused on running the business. It’s always been a pleasure for me to watch as distributors build up their businesses, these proud business owners are real entrepreneurs.

“They come to Flowers from all walks of life, but there’s a common thread with successful distributors. They all want to be their own boss. Through the years countless distributors have shared their success stories with us.”