The hot packaged food market has cooled a bit recently, but Annie's (NYSE:BNNY) continues to sport a rich multiple as a relatively rare high-quality play on consumer demand for natural and organic food. Annie's isn't just a healthy living play, though, as the company is still relatively young and can look forward to years of product introductions and further distribution leverage. I recognize that growth investors tend to emphasize opportunities more than multiples, but more value-conscious investors may not find Annie's so appealing today.
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Ongoing Growth To Close The Fiscal Year
Annie's is doing its part to keep the momentum going. Revenue rose more than 21% this quarter, a slight beat relative to the average sell-side estimate. Growth was led by the meals business, as revenue rose more than 35% and offset a nearly 8% contraction in the dressings/condiments category.
Margins were pretty good on balance. Gross margin did decline 50bp on a reported basis (and 30bp on an adjusted basis), but that was largely due to a year-ago trade spending adjustment and not a worsening of the company's intrinsic cost structure. Operating income rose 58% as reported and 35% adjusted, and Annie's showed solid operating leverage.
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Growing The Product Roster And The In-Store Presence
Annie's sells only a relatively limited number of products at this point, and that gives the company a long runway of potential organic growth opportunities. Pizza is the most obvious near-term opportunity as the company moves past the recall. Frozen pizza is a food category worth more than $4 billion in annual sales, with Nestle (OTC:NSRGY) holding almost 50% share and the top three (which includes General Mills (NYSE:GIS)) holding about 75% share. Nestle is well beyond Annie's weight class at present, but even 1% of the frozen pizza market would be material to the company.
Annie's is also gearing up for a bigger presence in snacks, where it will compete with the likes of Kellogg (NYSE:K) and Campbell Soup (NYSE:CPB) more directly. Snacks (and specifically snack crackers) is always a large and potentially lucrative category, but Annie's still has worthwhile opportunities to grow in markets like dressings and condiments – a market worth over $2 billion and where there is a history of natural/organic companies doing well (Newman's Own is the #4 salad dressing company by share and generates an estimated $100 million in revenue).
It's not just about getting new products on the shelf. Annie's is also working hard to get its products into more stores, and retail distribution points increased by 9% this quarter. Annie's is also working with stores to improve its product positioning – particularly in moving from the specialty kiosks or aisles to the regular center grocery aisles.
Don't Underestimate The Competition
While I realize that Annie's valuation is not so unusual for the sector nor for its growth profile, I do believe investors would be making a mistake to not at least consider the competitive threats to the business.
Annie's backed out of the cereal business due to poor customer acceptance, but the success of Kellogg's Kashi brand would suggest that it may have been competitive issues more than a lack of consumer interest in natural/organic cereals (though Kashi's claim to those labels is certainly debated by many consumers and industry-watchers). Were rivals like Nestle or Kraft (Nasdaq:KRFT) to seriously try to introduce competing products in the pizza and mac&cheese space, I do believe there would be a risk to Annie's growth trajectory.
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The Bottom Line
The market is already expecting pretty good success from Annie's in the coming years. A revenue growth estimate of 16% (a 10-year CAGR) and a free cash flow growth estimate of over 30% suggests a fair value in the mid-$30s today, which is not especially compelling relative to the stock price. It is certainly possible that Annie's could grow faster (particularly given the company's asset-light model), but likewise there is the risk that competitive product introductions compromise the growth opportunity. All in all, while I do believe Annie's is an interesting packaged food growth stock, buying an expensive growth stock in a sector where the investor sentiment may be petering out seems like a risky combination.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.