NEW YORK — Above market growth in core sweet goods and strong growth in breakfast products at Hostess Brands, Inc., together with improved business with Walmart Stores Inc., leave the baking company poised to outperform current Wall Street expectations, said Steven Strycula, an analyst with UBS Global Research.
In connection with the UBS research report, Mr. Strycula raised the Hostess investment rating to a buy from neutral. With the upgrade, UBS has established a 12-month Hostess share price target of $17 per share, up from its most recent target of $14. In Nasdaq trading June 24 after the upgrade was announced, Hostess shares traded as high as $14.75, up 6% from $13.89 a day earlier. The shares closed June 24 at $14.26, up 2.7%.
Kansas City-based Hostess has gained market share steadily in recent years, a trend Mr. Strycula said is likely to continue. He forecasts 4.5% compound annual growth over the balance of this year and next, versus overall sweet baked foods category growth of 1%. Accounting for the outperformance will be 1.5% growth in the company’s core products market, a meaningful expansion into the breakfast category and improved business with Hostess’ largest customer — Walmart Inc.
The 1.5% growth for the core products represents a more moderate pace than the 2.7% CAGR Hostess has achieved the last three years, Mr. Strycula said.
In sweet baked foods, Hostess dominates the convenience store category, which accounts for 44% of the company’s retail sales. By contrast, UBS said the supermarket channel accounts for about 25% of Hostess retail sales and “remains an under-penetrated distribution channel for the company.”
Juicing up the company’s results going forward will be momentum in the breakfast category. A $1.4 billion opportunity, Hostess could gain $100 million in sales at retail. Noting that the Cloverhill baking plant Hostess uses to bake breakfast products has had sales as high as $150 million, the $100 million should be achievable, UBS said.
Mr. Strycula said Hostess has a 32% share of the $1.7 billion snack cake category and a 25% share of the $1.5 billion mini-donut category. The Chicago baking plant offers Hostess the opportunity for breakfast category growth three ways — producing Hostess breakfast products in new categories, baking breakfast products Hostess already sells that are produced by co-manufacturers and migrating volume mix from private label to value branded products, such as Cloverhill and Big Texas.
“Today, Hostess remains in the early innings of this multi-year category buildout,” Mr. Strycula said. “Hostess’ recent acquisition of the Chicago bakery provides Hostess new manufacturing capability for breakfast products. Previously, Hostess had outsourced breakfast pastry production to third-party co-manufacturers, which is a low-margin trade off.”
Mr. Strycula cited recent investor presentations in which Hostess executives offered details of how the company believes it will reach $100 million of incremental retail sales, equating to about $65 million to $70 million in wholesale sales.
“At present, Hostess has approximately $150 million in retail sales (in the breakfast category) but plans to launch new products and expand distribution for existing product lines to under-penetrated channels in the coming years,” he said.
Expected to rebound in the coming years is business with Walmart, following a difficult year in 2018, Mr. Strycula said. Hostess sustained significant shelf space loss last year, and UBS is forecasting 3% sales growth through next year as a projected moderate recovery. Walmart currently accounts for 21% of Hostess revenue, and last year’s problems “created a notable revenue drag for Hostess,” Mr. Strycula said.
“In the last few months, the merchandising and display issues between Hostess and Walmart have been resolved,” Mr. Strycula said. “As a result, better merchandising programs are in place following last year’s price investments. Hostess secured better planogram assortments for its 2019 distribution calendar. These distribution gains are now evident in Nielsen data, which show a clear trend improvement for Hostess sales.”
Current Wall Street forecasts for Hostess EBITDA in fiscal years 2019 and 2020 are too low, Mr. Strycula said. UBS is projecting EBITDA in 2020 of $230 million, versus $205 million to $220 million for this year and next by other analysts, he said.