LAURIE GORTON: What makes the baking industry a good place for Plaza Belmont to invest?

JOHN T. STOUT JR.: Our focus at Plaza Belmont is on acquiring manufacturing companies and businesses related to the food industry. We love the baking industry. Baking and its related industries provide consumers with low-cost, great-tasting products that are convenient and nutritious. Baked foods are excellent sources of fiber, complex carbohydrates and overall nutrition that taste good. They deliver great value.

The baking industry is one of the oldest industries on our planet and has survived and thrived for thousands of years through innovation and continuous improvement. The best-of-class companies in the industry provide excellent returns to investors and great employment opportunities. The baking industry has excellent management for the most part and the ability to lock in margins with various hedging tools. The baking industry thrives in times of recession. It has stood up well against the test of time.

What are the “basic values” that your group considers when looking at an acquisition or investment?

Basic values are harder to assess than the more objective financial criteria, but more often than not, such values and company cultures have more to do with success. We look for experienced, ethical and enthusiastic personnel; superior facilities; unique features in products, product development, processing, distribution or sales; and a high level of dedication to providing value to customers.

In reality, it is hard to find all of these values in businesses that are for sale. If one or more of our “basic values” are missing, we try to determine if we can find a solution without trying to change the overall culture of the company. The people are the most important attribute in any organization, and we like businesses that have enthusiastic and experienced personnel with an emphasis on ethical behavior.

A good example of the importance of basic values is our acquisition of MaMa Rosa’s Pizza from ConAgra. We acquired an extremely efficient but under-utilized plant with a very enthusiastic and entrepreneurial production, accounting, office and customer service personnel and several eager and experienced sales associates. We were fortunate to find Bill Mackin to run the business and guide the company through its transition.

MaMa Rosa’s had a number of great attributes. The company held the unique position as the No. 1 brand of refrigerated pizzas in the country. Although this category is smaller than the frozen category, it has a much greater growth rate. ConAgra had invested a great amount of time and capital installing high-speed lines and additional storage and putting in quality assurance and food safety programs that were second to none. The company also rationalized about 400 SKUs that left it with a stateof-the-art plant running at 40% of capacity. Normally, that would be a big gap to fill, but we were so impressed with the enthusiastic and entrepreneurial associates that were going to stay with the business, and Bill Mackin’s belief in his core team and the other attributes of MaMa Rosa’s Pizza, that we decided it was worth our investment of time and money.

In summary, we look for companies with good facilities, uniqueness, customer rapport and, most importantly, good people.

Your strategy is to work with acquired companies on a 3-to-5-year timeframe. What benchmarks do you establish to guide those efforts?

We begin every acquisition by learning the key metrics that drive that particular business, and we monitor those monthly at Plaza Belmont in our review with management. We have our own accounting and management information system that allows us to quickly identify potential problems.

Our financial format and management information system was originally developed by my father, John T. Stout, at Dixie Portland Flour Mills. It not only provides us with real-time data on key performance metrics within the companies, but it also provides us with a daily position report on all hedging operations within the portfolio companies. John Dalton, a partner at Plaza Belmont, worked with our lenders to develop a real-time, online program to monitor cash and credit availability that is crucial to our success. Bob Parnow selected an integrated software program that we own at Plaza Belmont and has developed a support system that we provide to our companies.

After immersing ourselves in the business, we start with the selection of a strategy development team that we take through a process to determine the key driver that will define the products offered and the markets served in order to allocate human and monetary capital in an effi cient manner. Our goal is to identify the key metrics, the key personnel, set up the management information system and to develop the strategy and mileposts within the first 90 days after the acquisition.

We review the strategy and strategic planning periodically to ensure we are meeting our milepost objectives both financially and in terms of improving our strategic framework and management team. We provide an incentive structure to management based on a targeted ratio of operating cash flow to invested capital, and management sets individual goals designed to exceed that targeted ratio. In addition, we encourage top managers to invest in the company and provide them with the opportunity to earn equity based on our internal rate of return to investors.

We assign a partner liaison to every company, and they visit the facility on a regular basis. As a group, we visit each facility at least once per year.

Then we do the best we can to get out of the way and let the operating management run the company. In an ideal situation, our job is to provide the capital, tools and environment necessary for the management team to succeed and to communicate with them regularly to make certain that we are providing the support they need and that they are on track with our mutual objectives.

Things do not always go according to plan, and there have been several situations where one of our partners at Plaza Belmont had to step in to run a portfolio company. But at least we have that ability when necessary.

Compared with other food manufacturing sectors, does the baking industry have special advantages for investors in this period of tightened consumer spending?

During recessionary times, most consumers tend to trade down on spending habits. Baked foods offer one of the best overall values in the food industry, providing great taste, convenience and nutrition at a much lower cost than other food alternatives. The baking industry provides consumers with value and investors with excellent and relatively low-risk returns.

During difficult financial times like these, food manufacturing companies in general, and the baking industry specifically, are thriving, providing good jobs and an array of healthy, low-cost, high-value products to the public. Let’s face it, people have to eat, and you cannot find a better value in diffi cult financial times than the most basic and nutritious of foods, and baked foods are high on that list.

What weaknesses endemic to the baking industry must bakery executives avoid to assure the success of their businesses?

I do not believe that there is any endemic weakness associated exclusively with the baking industry. If baking companies stick to their knitting and adhere to the same basic values that we talked about earlier, they will continue to succeed.

However, there are cyclical patterns that pose potential pitfalls. For instance, during each of the past four decades, we have experienced a dramatic increase in the cost of grain. The baking companies that maintain a healthy balance sheet and consistent hedging program have always weathered these cycles. Although these cycles of margin compression may be painful in the short run, the successful bakers usually exit such cycles stronger and more profitable than before.

There are some health issues and dietary concerns that are troubling to the baking industry. The growth in the number of patients diagnosed with either diabetes or celiac disease is a worry for the industry, as well as the general concerns surrounding obesity, consumption of salt, fat, sugar and simple carbohydrates.

The food industry in general and specifically the baking industry have been relatively quick to address health issues in the past and to provide healthy alternatives for those with a need for both gluten-free diets and diets low in carbohydrates, fat and sugar. The industry has also provided products that are high in fiber and deliver high levels of vitamins and other nutrients important to a healthy diet in general. As health care costs continue to increase, the baking industry must continue to address these real health issues, while still delivering great taste and value to our customers.

Some observers point to overcapacity as a problem for the baking industry. What are your thoughts about this?

There may be product-specific and regional issues of such, but with the numerous plant closings, I do not believe that excess capacity is an industrywide issue. Factors (such as extended shelf life and the Atkins diet fad) may have caused issues of overcapacity at the time, but since then, the industry has taken the opportunity to expand product offerings, increase consumption and to close less-efficient plants and reduce excess capacity.

What are you hearing about availability of credit to food industry companies?

In general, the availability of credit to the food industry, and especially to smaller food companies, has improved greatly from a year ago. Having said that, the availability of credit is still much tighter than it was three years ago, which may not be a bad thing.

We know of a number of firms that are starting to borrow and increase capital spending. You just have to pay a little more, borrow less and suffer with tighter terms than you did three years ago. Senior and subordinated lenders that are not faced with excessive write-downs on real estate and who have ample capital are excited to lend to good food manufacturing businesses. They just won’t loan as much on a business as they did three years ago.