NEW YORK — While accretive merger and acquisition activity could add value, high leverage and competition for snacking assets may limit acquisition prospects at Hostess Brands, Inc., according to a Sept. 25 research report from Morgan Stanley & Co., L.L.C.
|Matthew Grainger, equity analyst with Morgan Stanley
“With limited margin expansion, (Hostess’) mid- to long-term growth appears dependent on M.&A., which the company has already pursued — with mixed success — via its expansion of Superior on Main in the fragmented $8 billion In-Store Bakery (I.S.B.) category,” wrote Matthew Grainger, equity analyst with Morgan Stanley. “We estimate that the company could fund a $250 (million) to $350 million acquisition, which could generate 8% to 10% accretion, but view the company’s M.&A. prospects as somewhat limited by its high leverage (4.1x) and heavy competition for snack-related assets.”
Digging deeper into the debate as to whether Hostess will be able to add meaningful value through whitespace expansion and M.&A., Mr. Grainger said the Kansas City-based company is looking at opportunities that enhance the scope of the business, with a focus on leveraging its brand and capabilities and increasing the company’s scale.
“As part of its M.&A. criteria, Hostess is looking for targets that can leverage the Hostess brand and/or its warehouse distribution model, can expand the company’s baking capabilities in either I.S.B. or adjacent categories and could provide a strong platform for growing within the snacking space,” he said.
The acquisition of Superior on Main in 2016 expanded Hostess Brands’ product offerings in the I.S.B. category, and while the category remains one avenue for growth, Mr. Grainger said the transaction also has highlighted the limitation of scale in the segment.
He said Hostess rationalized Superior on Main’s footprint by closing three of its five manufacturing facilities, and is now expanding the company’s geographic presence beyond the Northeast toward the Western United States. Hostess also is leveraging the I.S.B. footprint to launch Hostess branded Bakeshop products, he said.
“While this is a very fragmented category (~100+ suppliers), with consolidation potential, it has presented operational challenges given a less structured merchandising process and lower brand significance resulting in a softer-than-expected growth profile,” he said. “We forecast mid-term sales growth of ~8% in this segment, below the company’s low double-digit objective.”
Another challenge for Hostess is more heated competition for acquisitions in the snacking and confectionery segment.
“Hostess’s M.&A. prospects may be constrained by high competition for attractive snacking oriented assets as larger scale packaged food manufacturers are focused on snacking acquisitions due to weak center store growth,” Mr. Grainger said. “Within our large-cap coverage, (General Mills, Kellogg, Mondelez, J.M. Smucker and Hershey) have all discussed M.&A. in snacking as a strategic priority given evolving consumer preferences toward snacking, driving attractive category growth. This heightened interest is contributing to elevated valuations for snacking assets that could potentially price Hostess out of transactions or diminish its return profile.”Morgan Stanley has initiated a price target of $14 and a stock rating of equal-weight on Hostess Brands. An equal-weight rating means the stock’s total return is expected to be in line with the average total return of the analyst’s industry coverage universe, on a risk-adjusted basis, over the next 12 to 18 months.