Current Inflationary Environment Provides Demand Tailwinds for No-Moat TreeHouse Foods

Business Strategy and Outlook

Despite being the largest pure-play private-label food manufacturer in the U.S., TreeHouse’s performance has historically been stymied by poor execution, including lacklustre service levels and disjointed go-to-market efforts. Still, revamped leadership, strategy, and recent activist involvement have mostly remedied internal issues, and it is believed that the private label should continue to ascend, supported by secular trends across the U.S. retail and demographic landscape, once pandemic disruption subsides. While it is expected the windfalls from this rise to accrue disproportionately to retailers (who function as brand owners in this context), TreeHouse now has the right commercial and operational infrastructure in place to capture its fair share of growth and profitability. Management has reoriented the business strategy to align more with market dynamics instead of product categories. For categories that are either in early or mature stages of growth (snacking and beverages), the team is looking to grow the top line profitably through volume leverage and value-added innovation. For categories that are in stagnation or decline (typically centre-of-store wares), the goal is to maintain share and improve profitability through different manufacturing or order fulfilment processes. Ultimately, these mandates appropriately balance clarity with nuance and should allow it to optimize its asset base.

Portfolio optimization is also a core strategy pillar, and it has rationalized many underperforming areas of the assortment. It has also divested secularly challenged business lines like nuts and ready-to-eat cereal. The firm is expected to be more aggressive in discontinuing or monetizing suboptimal assets. In this context, in March 2022, management announced its exploring strategic alternatives to maximize shareholder value through divesting its stagnant businesses (meal preparation) and realigning operations around the high-growth snacking and beverages business. While recent deals executed under the current management team have been more favourable, it is viewed this strategy with some scepticism considering the firm’s mixed track record regarding acquisitions thus far.

Financial Strength

TreeHouse’s financial health looks reasonable to us, though it does leave a bit to be desired. The company has leveraged up meaningfully in the past to fund acquisitions (like Flagstone in 2014 and Ralcorp in 2016), constraining its ability in recent years to make value accretive investments. Leverage is quite high (project 4.5 times net debt/adjusted EBITDA for 2022), although its expected this will fall below 2.5 times by 2025. As management continues work to divest assets (it recently completed the RTE cereal business sale, and one shouldn’t be surprised to see more portfolio grooming), even more cash should be available for debt paydown. TreeHouse generates a good bit of free cash flow, averaging in the mid-single-digit range as a percent of sales in recent years. While the company will continue to invest a fair amount of capital in modernizing and streamlining its production/warehousing, it is believed margin improvement, along with process changes (like increasing made-to-order products, which reduces inventory requirements and waste) will allow free cash flow to normalize in the mid- to high-single-digit range. TreeHouse also has other cash flow levers, including its receivables sales program, whereby it monetizes its receivables more quickly in partnership with a financial intermediary. The company is still responsible for administering and collecting the receivables, but net-net, it is expected this program will continue to reduce its working capital funding needs during any given period. The firm’s debt covenants are fairly restrictive. Most of the debt is secured, and maximum allowable leverage is 4.5 times, although the firm received a temporary waiver to exceed this ratio in February, given pandemic-related headwinds. Some of its notes also inhibit dividend payments. Longer term, as business fundamentals improve, debt is paid down, and the firm’s credit rating improves, it is anticipated it will have more favourable access to capital markets

Bulls Say’s

The private label industry should continue to benefit from secular trends across the grocery retail landscape and demographic trends in the U.S.

If the coronavirus induces prolonged recessionary conditions in the U.S., private label will likely outperform, and TreeHouse would benefit disproportionately as a market leader.

Its massive manufacturing apparatus should allow the company to benefit from the secular shift toward small, niche brands, by way of co-packing arrangements.

Company Profile

Treehouse Foods, the largest private label manufacturer in the U.S., is the product of a slew of acquisitions, the most significant being the 2016 acquisition of Ralcorp, Conagra’s former private brands business. The firm plays in over 25 categories, including snacks like pretzels and cookies, meals like pasta and dry dinners, and single-serve beverages like pods and ready-to-drink coffee. Retailers represent its most significant end-market, where it sells products for resale under retailer brands, but it also serves foodservice customers (providing a similar service as its retail business), industrial (selling bulk food for repackaging and repurposing), and branded consumer goods firms (under co-packing arrangements). Over 90% of its revenue comes from the US.

(Source: MorningStar)

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