Motley Fool Hidden Gems Investing - Twinkies Find A New Home

Episode Date: September 11, 2023

The acquisition of Hostess Brands by J.M. Smucker is the latest in a series of food mergers. (00:21) Jason Moser and Deidre Woollard discuss: - The synergies between Hostess and Smucker. - Why Instacart’s valuation dropped. - Kroger’s push to make the Albertsons deal happen. (16:09)  Deidre Woollard interviews Jesse Singh of home exteriors company Azek on competition in the decking space and what’s next for the brand. Companies discussed: TWNK, SJM, SOVO, AMZN, WMT, CPB, KR, AZEK Host: Deidre Woollard Guests: Jason Moser, Jesse Singh Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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Welcome to Motley Fool Money. I'm Deidre Willard here with Jason Moser for a food-centered Monday. How are you doing, Jason? I'm doing great. This is my kind of show, Deidre. How are you? I thought about that being your show too, because we've got some breaking M&A Monday news. We always like a good mergers and acquisitions Monday. It is Jelly and Uncrustables maker J.M. Smucker,

which I think everyone calls Smuckers. They're buying Hostess brands for $5.6 billion. Seems like a decent deal for Hostess. Works out to $34.25 per share in a cash and stock transactions. Stocks have been trading $25, $26 in recent months. It's been rumored a bit, but what do you think? Does this make sense? The Uncrustables and the jelly, you got the Twinkies and the cupcakes. What do you think? Yeah, I think it fits. I think these are two companies, I think these are two concepts that are fairly complementary. Host is clearly a brand with a bit of a checkered past as far as a company goes. They declared bankruptcy twice in its history. Recently IPO-ed again in 2015. Interestingly, it's been a very good investment

since that IPO. But this is a brand that makes, I think, a lot of us smile for nostalgic reasons and for nothing else. But when you look at the actual business, a compounded annual growth rate of 11.2% on the top line over the last five years, you compare that to something like a Smucker, over that same stretch, you're looking at 2.4% growth there. That's not surprising. Smucker is a very well-established and quote-unquote boring business, so to speak. You look at Smucker, the growth is nothing to write home about. It's not a tremendous performer there for investors over the last several years. Organic growth becomes a little bit of a concern. We've seen this story play out with several companies like this in the recent past. Sometimes they just need

to resort to smart acquisitions in order to keep that ball rolling and figure out ways to take that business to the next level. With Smucker, financially speaking, the company is well-profitable, well-established, coverage ratio of around eight. This is something that they clearly can afford. I think that it just really depends on what they actually do with this acquisition, but definitely a collection of strong brands to play around with. Yeah, the strong brands thing, when they did go bankrupt, I think it was in 2012, there was an outcry. People were so afraid that they were going to lose the Twinkie forever. It's a big concern. I mean, the Twinkie lasts forever. So, Smucker, they're forecasting a net

sale contribution of about $1.5 billion, based on seeing mid-single-digit annual growth rate. So, it looks like they're getting up around 3,000 employees, some distribution facilities. There's going to be cost-cutting at some point, right? We know that. They've already talked a little bit about some of the synergies there. But what are the things you think are going to happen as far as prepackaged smucker offerings? They've already been testing the shelf-stable, uncrustable, more Uncrustables, what other kinds of synergies you see in here? Well, it does feel like as time goes on, for the American consumer at least, convenience just becomes more and more of a consideration. I think that's likely to continue

with this deal. The headline here for Smucker, if you look at their investor relations page, the headline of this press announcement is that Smucker is acquiring Hostess Brands to accelerate focus on convenient consumer occasions. I'm not exactly sure what that means, but again, it goes back to convenient. There's nothing more convenient than this whole host of Hostess snacks. You're going to find them virtually anywhere and everywhere around the country. You can drive from South Carolina to California. I would imagine that any gas station you stop at along the way, you're going to find a nice assortment of those Hostess snacks. And so, from that perspective, it makes a lot of sense. And I think that with Smucker,

given the nature of their offerings, convenience fits very well into their strategy. You look at what Smucker is getting for this deal beyond just the brands. You mentioned there is distribution, there's manufacturing that comes into play. And when it comes to big-scale food, really, at the end of the day. Once you're making things that consumers want to buy, then it's just a matter of making sure you can make enough of it and get it as far and wide as you possibly can. I think that this deal certainly plays into that with the distribution of manufacturing that they're getting. Yeah. It is a favorite road trip snack. For some people, it's an everyday snack. But I was listening to the call about the acquisition,

and one of the analysts brought up a question about people on GLP-1 weight loss drugs, like an Ozempic or something like that, craving less sweet food. Is the rise of this existential threat for snacking? It doesn't seem like it yet, but could it be? Anything is possible. It certainly could be. I think there's still a lot to be learned about these weight loss drugs, the longer-term impacts, and exactly how they'll resonate with the broader consumer base. I think there's still a lot, we just don't know there. But ultimately, at the end of the day, when it comes to food, it's about giving consumers what they want. As long as you're giving consumers what they want, then that's the key. I think that

CEO Mark Smucker on the call there, I think he answered the question pretty well there. and talking about the multiple ways that consumers will want to continue to snack, and they'll continue to pay attention to that. If they see some shift in consumer behavior, then they have the ability to pivot and change the makeup of their snack portfolio. If consumers are craving less sweet food, then they can ratchet that back a little bit. They can alter that, they can change things a little bit. I think still a lot to be learned from the ultimate impact of these weight loss drugs. But at the end of the day, I do believe that the company will have an answer regardless of what consumers actually want. Yeah, absolutely. A few weeks ago,

we had Campbell's buying Sovos, which is the maker of Rouse and some other things. Now we've got this. I know two deals isn't necessarily a trend, but one of the things I'm looking at is increase in private label consumption and do these brands have staying power? Are we going to see more of these acquisitions as maybe some of these brands face some economic pressure? Yeah. This was exactly what came to mind when I saw this headline this morning, when you and I started talking about it in pre-production. We did a show on the Campbell deal just a little while back and we talked about this even then. Yes, I do think this is another example of what we were thinking then in regard to consolidation in the industry. Food is tough.

Pricing can be exceptionally difficult, especially in inflationary times. It's not necessarily like a restaurant. A restaurant, they can realize pricing and growth more thanks to the experience, thanks to what they're actually doing with the food from a taste perspective. They can change menus up. There is obviously some brand power there. There's some loyalty levers they can pull their grocery, for lack of a better word, can be far more commoditized. To me, again, scale is something that really helps in this line of work. Whether they pursue the private label or the branded, I think we'll see, as time goes on, some of these brands that we were very familiar with growing up, some of them just fall off. Some of them, they don't live on forever. Some do seem

to have a little bit more longevity than others. But ultimately, I think scale is what helps these companies compete in this line of work. Yeah, absolutely. Let's keep the food train going. Let's talk a little bit about the Instacart IPO because we've got an offer price now. The company is going to set an offer price between $26 and $28. They're going to issue 22 million shares in total, which is 14.1 million new, 7.9 million existing being sold from shareholders. They want to raise $616 million. This valuation of $7.9 billion, it's below the original valuation when they were talking about the IPO a couple of years ago. What are you thinking about the valuation now? Well, yeah. You look at the

valuation today and let's just call it $9 billion. That's significantly down from the $39 billion valuation this company had garnered in 2021. I think it's fair. The mindset in 2021 was considerably different than it is today. It's worth remembering as we look at some of these companies that we still own and like, but the sentiment has shifted. It's not necessarily something fundamentally wrong with the business, but it's a reminder that valuation is something we need to keep in mind. You're looking at the numbers when it comes to Instacart. Last year, they recorded $428 million in net income. This year, $242 million the first six months of the year. Let's just say they're going to generate $480 million in net income this year.

That puts the company, if they IPO around this price, puts them around 20-ish times earnings, which I think is a little bit more interesting. To me, the growth question, I think, is still what is up in the air. We talked about, in regard to that Instacart IPO a couple of weeks back, I think one of the interesting parts about this particular market is that grocery is still so so immature. It's not a mature market. There's still so much untapped opportunity in the grocery delivery space. That's the argument. If you buy that argument, if you believe in that, then you're believing that growth will persist with a company like Instacart, and that makes this valuation look far more attractive than even just a couple of years ago. I think

the counter to that is, I look at these delivery companies and I put Instacart in the same category there is your DoorDashes and Grubhubs and whatnot, and Uber Eats even to an extent. They're very convenient, but I don't find them to be so compelling. The one thing I notice is the more and more that I look at these delivery apps, and I don't necessarily use them as much because I do start to notice some serious pricing disparities. That can only go so far. I think convenience is something the consumer values, but that doesn't mean price be damned. I just don't think they can push those prices up to infinity, and that is something that is going to play out on their model. Definitely a more attractive

looking opportunity, at least at today's valuation versus just a couple of years ago. But I'm not necessarily saying I give it the green light yet either. Well, let's wrap up by talking about traditional grocery. Kroger reported their results on Friday. They're the biggest pure play grocer. I wanted to talk a little bit about their merger with Albertsons because this has been going on for a long time. They announced a key step as part of their earnings. They're going to sell over 400 stores, some distribution centers. They're selling private label brands to CNS Wholesale. The part that I thought was really interesting was that they're selling the licensing rights to Albertsons

in Arizona, California, Colorado, and Wyoming. That feels like a lot of concessions to me. It seems like they really want this deal to go through, right? Yeah. Well, this is really making me think just of something like Microsoft and Activision Blizzard. Obviously, two very different markets. We're talking about grocery versus tech essentially. But I do think that when you look at the bigger picture, there's just a lot of political will right now in certain pockets to fight big mergers. By the same token, you hear Kroger's rationale. They'll say that they really need this deal to go through in order to be able to compete with the likes of Amazon and Walmart. It goes to

show number one, the investments that Walmart has made all of these years into grocery, understanding that that is a fairly reliable, if not low-margin market. Amazon making the acquisition of Whole Foods back in the day. They did that before. It was really in a period of time where it'd be questioned so much. If they tried to push that deal through today, regulators would have taken a much closer look at it. But I think when it comes down to this deal, I feel like they're on the right track. I think it just boils down to the concessions and what ultimately constitutes enough in order to make this go through, but it does feel like leadership with Kroger is more than willing to make whatever concessions are needed to make this deal go

through. We're seeing consolidation again on the Aldi side too, I think, right? Aldi snapping up some of the Winn-Dixie franchises there. Yeah, absolutely. Going back to that consolidation theme, I don't think that's anything that's slowing down anytime soon in this space. No, absolutely not. You mentioned Amazon and Walmart. Those two companies are both doing something that Kroger is doing, which is getting deeper and deeper into healthcare. Kroger's got Kroger Health. They have about 225 clinics. They've got pharmacies in most of their stores. That's like 2,000 or so pharmacies. They ended their partnership with Express Scripts last year. I'm wondering, as I consider Walmart, Kroger, I think I'm starting

to have to consider the healthcare part of this business more and more. Yeah, I think it's something worth keeping an eye on. I think for something like Kroger, it's probably more incremental than anything else. It's definitely a value add for consumers. Like with any of these grocery concepts, you have your Kroger card or whatever it may be, any loyalty program that can help encourage consumers to come in there and do more of their shopping at the store. You look at Kroger, the footprint they have compared to something like a CVS, for example. You look at CVS with something close to 10,000 stores, or Kroger at the end of January of this year, they were operating somewhere in the neighborhood, just

over 2,700 stores total. If you look at the pharmacy division as a percentage of overall sales for Kroger. In 2020, it was 8.6% of overall revenue. Then in 2022, it bumped up a little bit to 9%. It's been 9% the last couple of years. It's worth noting there's some specialty pharma that makes up another small little bit of that revenue, and that's constituted in the other bucket. But generally speaking, it's essentially 9% of the business, so it's not insignificant. It's also not something that ultimately is going to make this business. I think it's a nice value add. I think it's a nice incremental boost,

but I don't know that it's something that they really need to over-invest in because of all of the different options that are out there today. Makes sense. Thank you for breaking this down for me today, Jason. Thank you. You just found out that your sales team

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Let's talk about ASIC and the business and your competition. So, you're a top competitor in decking with Trex, which is also in the composite decking space. I love this because it's sort of like Coke, Pepsi, or maybe more accurately, Lowe's and Home Depot. But I know one difference between you is that you're really focused on the pros relationship so far versus marketing to the consumers. So how does one market to the pros? Because that seems like a tougher market to reach sometimes. Yeah. So I'll just give you a couple of data points that might help put things in perspective. As you look at the two of us, as you point out, we're probably a bit more like Pepsi in that we have the brown water, but we also have a snack foods division, which is our

exteriors business. So, in that respect, we've got two platforms that play into the market. Exteriors is about a third of our residential business, and deck rail and accessories is about two-thirds. So, that gives us enormous strength in the market. And then, as you look at our progression, we talked about starting 25 years ago in this market. Over an extended period of time, we built up a really strong network of contractors, professional dealers, and channel partners that have allowed us to penetrate the market. And more specifically, we operate with 200 salespeople, direct salespeople that are working with contractors, working with architects, and working with our channel partners. And that's actually given some recent disclosure yesterday

about double the size of our competitors. So we are heavily focused on driving growth in the pro. And then if you just step back and you look at the differences in our share position, we're relatively equal on the composite decking side in the pro. As you mentioned, our main area that we are underpenetrated is in the retail side of the business, although that has been accretive growth. And then if you step back and say, what does it take to win in this market, you're marketing to millions of consumers that are buying from tens of thousands of contractors that are buying from thousands of channel partners. And for us, it's really, really important to cover the hole. And I'll leave you with one thing on the consumer side. As we have recently,

over the last five years, continue to invest on the consumer. The TimberTech brand has continued to show very, very strong elevation in the marketplace. And we continue to gain traction. I think there's only two of us that market aggressively to the consumer. We ran an ad during the NBA finals. We continue to invest on the consumer side. But as you say, that's on top of an enormous strength within the pro. And I'll leave you the other thing on the pro, as I highlighted earlier, by having these two divisions, exteriors and deck rail and accessories, it gives us enormous strength in that we're able to offer a contractor and a pro dealer and a retailer a broader offering that fits within what they need. So looking to the future, do you think

you'll be doing more consumer marketing with the TimberTech brand? Absolutely. Absolutely. I mean, we've elevated it. We've got the TimberTech Championship, which is a golf event we've been sponsoring over the last few years. And as you look at, you know, digital metrics, brand metrics, what you would see is very aggressive step up on our side relative to consumer-oriented metrics. And we would expect that to continue to progress. Well, I think that everyone sort of understands the value of composite decking. But let's talk a little bit about the exteriors you mentioned, railings, cladding, siding, things like that. Are you expecting those areas to grow over time? Yeah, absolutely. So if you think about the macro

value proposition of our company, it's to take recycled materials and replace wood on the outside of the houses. There's a fundamental growth platform there. And of course, on the composite decking side and decking in general, by the way, we view it more as synthetic decking. We have two different decking lines. We've got a PVC decking line. We're the only player with substantial strength in two different lines that are both made out of recycled materials. So our definition of decking is broader, but however you define it, 75% of the market is wood. It is very similar in the exterior. So if you think about exterior trim, 40 plus percent of that market is wood. And every day that goes by, we are working with contractors and consumers to have them convert.

And if you think about the dynamic, it's the exact same issue, right? Where if you think about what makes a house look aged. It's the trim, paint peeling, not looking right. And I happen to be in an old house right now. And prior to us converting everything to ASAC, when it was wood, we had an annual budget of a painter that would come out and scrape and paint and fix it. And it's the exact same value proposition. Because of that, it gives us a very similar margin profile, a very similar growth profile. I think one of the differences that's a positive is there's actually more adjacent space in the exteriors business. So you think about trim, you can move into niche siding, you start thinking about other cladding on the outside of houses

where that value proposition works. And our strength in the market, the top two brands, AZAC and Versatech in the market, give us an opportunity to continue to really drive growth in that area. So, they are both equally growing and have equal margins and profitability. I love that you are using your own product in your home. That is fantastic. You mentioned two types of decking, though. Can you break that down for us a little bit? Yeah. So, if you think about the composite decking overall, typically, the solution has been a combination of recycled polyethylene and wood flour mixed and then wrapped with an outside that gives it the aesthetics. And that has been our competitors' growth trajectory and most of

our competitors' growth trajectory. We have that technology, and we continue to be the leader in the aesthetics on that technology. But we also have another technology, which is recycled PVC. We're the largest vertically integrated recycler in the U.S., perhaps in the planet, where we do our own PVC recycling. We take back siding. We take back a PVC pipe, anything that's out there that needs that's going to a landfill that's PVC. We take that. We process it. We make a deck goes into the inside of the PVC deck board and then it is wrapped again. there are significant benefits to this recycled PVC technology in that it is cooler. It is inherently cooler. It typically is 20 to 30 percent cooler than a composite board. And it is also inherently flame retardant. So we're you know, we're the major player in the market with a class

A flame spread product. And then lastly, we're able to get unique aesthetics that look a lot more like high-end products. So, if you look at the way our portfolio stacks up, we've got composite products and these PVC products. And in the premium part of the market, we define the market in decking as good, better, best premium. In that premium segment, right now, our PVC products, and in the market in general, are incredibly strong and have a really unique position. Last question for you. We're long-term investors at The Fool. What do you hope to see from ASIC in five years? Yeah, I'm really proud of the team over the last five-year journey that we've really been able to build out the company. From 2019 to now, we're 80% bigger,

78% bigger through 2022 on the residential side. So that's meaningful growth. We've given targets, So I can give you a financial view. We'll be at, you know, 27 plus percent EBITDA margins. You know, we'll be in the range of of generating 600 million of EBITDA. But I think more importantly for us as a company, you know, we want to be known as the company that uses recycled material and is the player that's using that material to replace wood to create a better aesthetic on the outside of homes. And and if I sit here in five years, there's going to be a number of product areas that we play in on the outside of homes that we are not communicating now where we are bigger players. So we love our core. You know, we're going to go from 25 percent composites to hopefully closer to 50 percent in decking. But but that'll be a part of the story. And I would expect us to continue to be the proud player that is the recycler that drives wood conversion on the outside of homes. And we've got a bunch of happy consumers because they don't have to paint, stain and and maintain.

So we're really excited about the future. And I'll tell you personally, there's very few places you can work where you make an impact by, you know, by taking stuff out of the landfill. And I'm excited by what that model might yield us. I love it. Thank you so much. Really appreciate it. Thanks for having me.

As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Deidre Bullard. Thanks for listening. We'll see you tomorrow.