“What A Difference A Difference A Day Makes!“
María Grever & Stanley Adams
What A Difference A Difference A Day Makes! was a hit song that won a Grammy for Dinah Washington back in 1959. In this case, substitute “year” for “day,” and we have one of the themes of this article. It was a year ago that Seeking Alpha published my article titled B&G Foods: A Double-Digit Yield With An Opportunity For Double-Digit Appreciation. Those choosing to follow the Very Bullish recommendation did far better than I anticipated, although it was far from a direct path higher. While the dividend was maintained as predicted, the price appreciation from less than $18 to an intra-day high of $30.95 early last week, a gain of more than 70%, was much more than I anticipated. The size of that share price appreciation is a major reason that I am reducing my rating.
As most followers of B&G Foods (BGS) know by now, the company generated record results in almost every major product category when it reported results after the bell on Thursday, July 30. Despite what many would consider stellar results, management has refused to give updated guidance or provide any significant future insights, attributing their uncertainty to the same pandemic that has driven the sales to record levels. As an investor in the company, I was disappointed with the silence, but was generally pleased with most of the rest of the results.
I first took a position in this equity because of the income it produced. The initial position was a hybrid security that was one share of Class A common stock and one part 12% note. The note was redeemed early, with the stock having had several significant moves up and down during my ownership. While that original hybrid equity is now a distant memory, the dividend income has remained a key attraction – an attraction that has remained a company priority. We see this regularly in the company SEC filings and hear it during the quarterly conference calls. On the most recent conference call, CEO Ken Romanzi stated:
Furthermore, on Tuesday of this week, our Board of Directors, declared our 64th consecutive quarterly dividend since going public in 2004. The B&G Foods team accomplished this, while remaining committed to the health and safety of all of our employees and to do our part to keep our nation supplied with food during this difficult time.
And, during the Q&A, CFO Bruce Wacha responded to a question as to whether there would be ” …any shift in the capital allocation priorities …” with the following:
I think from a capital allocation standpoint, we’ve always strived to do what we thought was best for shareholders, which is, one, returning excess cash in the form of a dividend, still high priority….
He followed with a statement about keeping the balance sheet healthy so that the company was ready for its next acquisition and other statements about reinvestment in the business, but returning cash to shareholders in the form of dividends continued to rank number one. The shares responded by increasing a bit the next day, and by moving to an intraday high of $30.95 the following Monday, August 3. It was the highest price since late 2018.
As I write this, the price has eased back a bit, but still remains in the high $20s, and that’s one of the reasons I am changing my rating to neutral. I still like the dividend, but the higher price has dropped the yield of that $1.90 dividend below 6.5%. That’s still more than double the yield of many other, much larger, major vendors that B&G competes with, but that gap is far less attractive than it has been in the past. Those major players include:
- PepsiCo (PEP) (3% dividend), which sells Quaker cereals, Stacy’s chips and Tostitos salsa that compete with B&G’s Cream of Wheat, New York Style and Ortega salsa.
- J.M. Smucker (SJM) (3.25% dividend), which sells fruit spreads that compete with B&G’s Polaner brand.
- Conagra (CAG) (2.25% dividend), which sells Birds-Eye frozen foods that compete with B&G’s Green Giant frozen brand.
- McCormick (MKC) (1.23% dividend), which sells a variety of spices that compete with B&G’s Tone’s, Spice Island, Dash, and Ac’cent brands.
Perhaps the Kraft Heinz (KHC) yield comes closest, with its 4.6% dividend and its Heinz Baked Beans and assorted pickles and relishes competing with the B&G relish and pickle line-up and B&M Baked Beans. Regardless of the narrowed gap, I currently intend to continue to hold my B&G positions. However, at any time, I may decide to sell out of the money covered call options against a portion of my holdings in order to boost the yield on the investment and/or sell in order to adhere to asset allocation limits.
I should also point out that many of the above competitors have increased their dividends significantly during the past few years. I am still expecting to see an increase by B&G before the end of the year, but considering the stellar results and the lack of an increase thus far, my confidence level in that prediction is waning. Consider the following…
The 64th consecutive quarterly dividend referenced by Romanzi was $0.475. It will also be the tenth straight quarter that the dividend remains at that level. That $0.475 quarterly dividend had followed six consecutive quarters at $0.465, indicating that it has been four years of a nearly flat dividend. By comparison, if we look back at the prior four-year period (from mid-2012 to mid-2016), the quarterly rate was increased seven times, growing from $0.27 to $0.465.
Let’s get some of the negatives out of the way. At the top of my list is the failure of management to be more forthcoming about forward guidance. The following statement is from the Q2 press release.
Full Year Fiscal 2020 Guidance
Although B&G Foods’ management continues to believe that B&G Foods’ net sales and adjusted EBITDA for full year fiscal 2020 will materially exceed the full year fiscal 2020 net sales and adjusted EBITDA guidance provided by management when the Company reported fiscal 2019 results in February 2020, the Company’s management is unable to fully estimate the impact the COVID-19 pandemic will have on the Company’s third quarter and full year fiscal 2020 results and therefore is unable at this time to provide guidance for the remainder of 2020.
Could it be more difficult to predict the future in the current environment? Certainly, but prior management had continued to issue guidance during the Great Recession when there was also a lack of visibility. If there’s uncertainty, widen the guidance range.
I also would have liked to know a lot more about the inventory levels, which were, as one analyst pointed out, “at the lowest level in three and a half years.” The dollar figure of the decline vs. 2019 was $115.4 million, or 24.4%, and the question was never really addressed as Romanzi’s answer went off on a tangent. Will B&G have issues addressing customer demand due to an inventory shortage? Management didn’t give us much to make an informed decision.
Back To Nature
A close second would be the continued bungling of the Back To Nature and Snackwell purchase. This was – and still is – supposed to be one of the seven major brands in the company’s move to emphasize healthier food, or its “Better For You” line-up. To state that it has performed miserably would be too kind.
When the transaction was announced, it was expected to cost $162.5 million and generate $17 million of Adjusted EBITDA on $80 million of revenue. The price paid was a high multiple on earnings compared to other recent transactions made by the company in that time frame. The transaction closed just after the start of the fourth quarter of 2017, generating slightly more than $20 million that year. That revenue was more or less in line with the annual revenue forecast, although since Q4 is the company’s strongest revenue quarter, it probably should have been a red flag. It has been all downhill from there, generating $69.7 million in 2018 and $60.9 million in 2019.
Year to date, with the pandemic driving record sales for B&G through the first half of the year, the carnage has continued. Q2 came in at a meager $14 million, and it’s the only one of its top nine brands to show a decline vs. Q2 of 2019. While the $14 million is up slightly from the $13.5 million in Q1, it is down from $16 million in Q2 of 2019. Year to date, the sales sit at just $27.6 million vs. $32.7 million in the first half 2019, and the sales seem unlikely to exceed $60 million.
Spices and Seasonings
Normally I wouldn’t pay too much attention to the Spices & Seasonings line items. It has been a solid performer, significantly exceeding the initial expectations of $220-225 million of revenue each year since it was acquired in late 2016. However, on the Q1 conference call Romanzi noted the following:
Net sales for our spices and seasonings business, inclusive of the business that we acquired in 2016 and our legacy brands, such as Dash and Ac’cent, were down significantly. Unlike the majority of our business, spices and seasonings has a significant foodservice weighting, and these sales were negatively impacted by the coronavirus and the resulting shutdown of large portions of the American economy. This is the one significant area of our portfolio where we have seen a negative drag on performance. And not surprisingly, net sales were down $12.9 million or 15%.
I had accepted that statement despite some nagging reservations that the stay-at-home orders that began in late March could exert such a large negative move. It became much more puzzling after CFO Bruce Wacha made this statement on the Q2 call:
Our spices and seasonings in the aggregate increased net sales by $17.4 million or 21.4%, with an acceleration in the second-half of the quarter, despite continued softness in food service.
If the “significant foodservice weighting” was the reason that Q1 sales were “soft,” and if B&G had “continued softness in food service” for all of Q2, I wanted more detail explaining the 21.4% gain for “spices and seasonings in the aggregate” in Q2. Also, if I see swings like those above, I tend to take a closer look. In this case I decided to crunch a few numbers. From the 10Q for B&G’s Q1, we can identify 2020 and 2019 quarterly revenue for “Spices & Seasonings” and Dash and calculate their percentage declines:
- “Spices & Seasonings”: $51.8 million of sales in Q1 2020, down $11.4 million (-18.3%) from Q1 2019’s $63.2 million
- Dash: $14.5 million of sales in Q1 2020, down $0.7 million (-4.6%) from Q1 2019’s $15.2 million
More importantly, since we know the total Q1 decline from Romanzi’s comment, we can algebraically solve for Ac’cent sales (the other significant brand included in the “aggregate,” even though those are no longer listed separately in the 10Q. The decline of “$12.9 million or 15%” would mean the total for the three items is:
$12.9 / 15% = $86 million in revenue for the three items in Q1 2019
And, since the Q1 2019 total for the two known items is:
$63.2 million + $15.2 million = $78.4 million, we are left with
$86 million-78.4 million, or $7.6 million for Q1 2019 sales of Ac’cent.
Next, using the Q2 sales for “Spices & Seasonings” and Dash from the current 10Q, along with the above statement by Wacha on the Q2 call, both the Q2 revenues “in the aggregate” for “spices and seasonings” and the Q2 sales for Ac’cent can be determined.
Since $17.4 million represents a 21.4% gain for the total sales for the three items in Q2 of 2020, the aggregate spices and seasonings sales can be determined for Q2 2020 as follow:
$17.4 million / 21.4% = $81.3 million of Q2 2019 sales
And, $81.3 million +$17.4 million in incremental sales = $98.7 million of Q2 2020 aggregate spice sales.
From the current 10Q we know that Q2 Spices and Seasonings revenue was $68.5 million, and the Dash sales were $20.8 million, leaving Ac’cent at $98.7 million – $68.5 million – $20.8 million = $9.4 million for Q2 sales. For those that are interested, the last time the sales of Ac’cent were broken out separately was 2014 when annual sales for the period 2012-2014 had averaged ~$19 million/year. Mrs. Dash (which was acquired in late 2011) had sales during that time period that averaged $62 million/per year. More recently, Mrs. Dash sales had been closer to $60 million, although with a new revenue recognition standard adopted in 2017, the figures were retroactively adjusted, and have been below $60 million since 2016 and fell below $59 million in 2019.
Why so much focus on spices and seasonings? Over the past two years, only the sales of the Green Giant – frozen line-up have exceeded the aggregate sales of the category. Also, as with Back to Nature, the Dash and Spices businesses are part of the Better for You suite of B&G products.
With Dash sales year to date in excess of $35 million, there is no evidence to suggest that the business has suffered a significant reduction in sales due to weakness in the Food Service sector. It’s a bit different for the sales of the Spices & Seasonings line-up that includes Spice Islands and Tone’s. Those sales are down significantly, even with the snapback in Q2.
YTD 2020, Spices & Seasonings generated $120.3 million, an amount that would annualize to just over $240 million, ignoring some of the seasonality. Over the past three years those figures have steadily deteriorated from $259.2 million to $256.0 million to $249.4 million in 2019. Even though those figures are still well above the $220-225 million initially projected, it’s a segment that bears keeping an eye on.
The positives are easy to identify. Management is always happy to point them out, and this quarter was no different: From the top of the press release:
Second Quarter 2020 Financial Summary (vs. Second Quarter 2019 where applicable):
- Net sales increased 38.1% to $512.5 million
- Base business net sales increased 33.9% to $496.9 million
- Diluted earnings per share increased 150.0% to $0.70
- Adjusted diluted earnings per share increased 86.8% to $0.71
- Net income increased 146.1% to $44.9 million
- Adjusted net income increased 87.6% to $46.0 million
- Adjusted EBITDA increased 44.6% to $102.6 million
- Net cash provided by operating activities for the first two quarters of 2020 increased to $246.4 million
Sounds great, but it wasn’t good enough for the management to increase guidance or get the board to raise the dividend.
However, all that cash coming into the company has allowed it to reduce leverage by more than one full turn. The following is part of Wacha’s comment during the conference call that addressed leverage:
…During the first six months of the year, we have reduced our net debt by approximately $170 million to $1.7 billion at the end of the second quarter. We have reduced our net debt to pro forma adjusted EBITDA from 6.1 at the start of the year to just under 5 times today.
We are now well within our stated target range of 4.5 to 5.5 times net debt to pro forma adjusted EBITDA, and we expect continued strong financial performance throughout the back-half of the year to further reduce our net leverage in 2020.
The sharp decline in the leverage ratio is mostly the result of the increase in Adjusted EBITDA and cash rather than debt repayment, but it does give the company the opportunity to hunt for another acquisition. I am all for accretive acquisitions, but it might not be prudent to be too aggressive. If others are doing as well as B&G in this environment, there is a danger of paying too high a price.
The relatively recent acquisition of Clabber Girl appears to be one of those products that B&G manages very well. Steady annual revenues under $100 million (it was initially projected to generate annual revenue of $70-75 million), number one or two in its product category or region, and most importantly, expected to be immediately accretive to earnings per share and immediately accretive to free cash flow.
It was acquired on May 15, 2019, and generated $53.6 million for the last seven and a half months of the year. Ignoring any seasonality during 2019, that would have projected a total of more than $85 million, significantly more than the $70-75 million expected for the full year. So far this year, Q1 came in at $18.7 million, and was followed by $26.5 million in Q2, totaling $45.1 million for the first half. It would seem to be well on its way to becoming the company’s fifth-largest brand. (Note that even if the lower Q1 2020 figure is annualized, it would still be the company’s fifth-largest brand).
The Share Buyback
For the past couple of years I had been heavily in favor of an aggressive share repurchase program. The $1.90 dividend yield was in double-digits as the shares were heavily shorted and the company’s leverage ratio was questioned. That was great for income investors, but not so much for the company that has to pay the dividend. It even made financial sense for B&G to borrow money at mid-single-digit percentages and purchase shares to save on dividend payments. And, of course, the interest on the debt is tax deductible, while the cash paid for dividends provides no such benefit, widening the impact on cash flow.
With the share price rallying, much of that attraction is gone, and I wasn’t unhappy that no shares were purchased during the first seven months of the year.
Buy, Sell or Hold?
So, should investors buy sell or hold? A lot depends on what they expect from the investment. With the shares currently trading near $30, and the dividend yield falling below 6.5%, income investors may be much less likely to push the price higher. And, since the company has not only let the dividend stagnate for the past eight years, but also refused to commit to guidance figures, the attraction of a growing dividend has become a distant memory.
The lack of transparency with respect to forward guidance also does little to attract investors. Even the drop in the leverage ratio may prove to be ephemeral. If the company needs to build inventory back up, cash will drop, the “net debt” numerator will increase and the leverage will rise – a set of events that will almost certainly bring out the bears.
With these negatives, why am I not bearish? Simply because the dividend yield – even at 6.5% – could still be attractive to certain income investors. It is the reason that I have continued to maintain a slightly overweight position, although that position has been greatly reduced during the last few months. I am also comfortable selling covered calls against the position, sacrificing some potential upside in share price appreciation for significant additional income today.
For instance, the January 2022 calls with a $30 strike price are currently selling for ~$4. Even the $32.50 and $35 strike prices with the same expiration are selling for ~$3 and ~$2. The closer call options offer far less of a premium, and I expect that I will sell calls against a portion of my position in the near future.
Disclosure: I am/we are long PEP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I currently reinvest dividends on both B&G and Pepsico, and have covered calls written against parts of these positions. I may cease DRIP or write additional calls at any time.