Hillshire’s doubtful growth may attract disrupter

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Hillshire Brands (NYSE:HSH) may face an activist investor or sale as it tries to become a growth story in a stagnant sector, industry sources said.

The Downers Grove, Illinois-based deli meat producer, formerly known as Sara Lee, attracted interest in 2011 from Brazilian food processor JBS and private equity firms prior to spinning off its tea and coffee unit into D.E. Master Blenders in June.

There has since been speculation that Hillshire could attract a bid as an independent company. Its stock has traded slightly down since the breakup to a valuation of around 7.3x EBITDA. Revenue has largely been flat since the spin.

Sara Lee pitched the breakup as a growth strategy, but so far Hillshire has not met expectations, said a trader following the situation. He suggested the situation may be ripe for an activist investor to prod the company to focus on returning cash to shareholders and consider other changes.

Seasoning capital

The company is conducting a long-range planning process to evaluate how it should deploy capital and expects to complete the review by early next year, CFO Maria Henry said on a 1 November conference call. She said Hillshire is “conservatively leveraged with a very strong balance sheet”.

Hillshire does not have a staggered board of directors. Ten directors were elected at its annual meeting on 25 October, and the company does not plan to hold another AGM until the latter part of 2013, said a person familiar with the matter.

Corvex Management recently pushed for Ralcorp Holdings (NYSE:RAH) to reach a deal with ConAgra Foods (NYSE:CAG) in November after the St. Louis, Missouri-based private label food company rebuffed ConAgra’s approaches in 2011. Ralcorp spun off its cereals business earlier this year.

At the same time, Hillshire Brands may need more time to season in the market before actual results from the spin become clear, the first and a fourth industry banker said.

As a newly independent management team, Hillshire’s leadership may want to create their own value, said the fourth banker. He agreed with the trader that Hillshire’s initial results are disappointing and said the company is not trading like a growth stock.

The company has told investors it expects to deliver 4.5% annual revenue growth by 2015 through innovation and increased support for its brands. Executives have downplayed near-term prospects for fiscal 2013 as the company transitions to its new growth strategy.

“We’re encouraged by our performance in the first quarter, but we expect year-over-year performance for the rest of the fiscal year to be more challenging, particularly in the second half,” CFO Henry said on the November call.

Limited growth?

Bankers said the case for a sale of Hillshire is the deli meat sector is a slow growth category, and consolidation in the packaged protein industry could help offset high costs and help raise capital to support growth.

To achieve the growth necessary to support the trading multiple of a regular food company, Hillshire has to spend cash generated from its boosted margins on marketing, the trader said. He called Hillshire’s growth “fake”.

The company’s largest hurdle remains pricing and how to effectively price its products to assume inflation costs while maintaining volume growth, said an equities analyst. Hillshire Brands’ management has been cautious on the company’s outlook, recognizing increased commodity costs and tighter supply, this analyst said.

With its product profile of processed packaged meats, Hillshire has higher margin stability than protein companies like Tyson Foods (NYSE:TSN), which offer commodity packaged meats, the equities analyst said.

Hillshire reported a 10.4% adjusted operating margin for the fiscal quarter ending 29 September and is targeting a long-term margin of 10%. Tyson reported a 4% margin for its most recent quarter.

Hillshire also has an advantage with its brands, this analyst said. “Hillshire and Oscar Mayer are the only two real national brands in the deli meat space,” said this analyst. Oscar Mayer is owned by Kraft Foods Group (NASDAQ:KRFT).

Hillshire still has room for additional household penetration to drive top line sales, this analyst said. The company built a successful business in the frozen breakfast meat niche category with its Jimmy Dean segment, the analyst and three industry bankers said.

Consolidation options

JBS could still be interested in pursuing Hillshire, said two of the bankers and the analyst, though CEO Wesley Batista told Bloomberg News in November he had not looked at Hillshire and was “not interested”. The Brazilian company was previously unable to line up enough financing in order to make a formal offer for all of Sara Lee that met the target’s price expectations.

Post the D.E. Master Blenders spin, JBS’ financing hurdles are now significantly reduced because Hillshire is much smaller, with a USD 3.4bn market cap and USD 940m in debt, said the first banker, the analyst and a fourth banker.

Though current debt markets are faulty, the conditions may not affect JBS’ ability to obtain financing for a potential deal, the first banker said. JBS did not return a request for comment.

Bankers said other potential suitors for Hillshire include Hormel Foods (NYSE:HRL) and Tyson Foods.

Hormel Foods, with a USD 8.2bn market cap, had USD 680m in cash and USD 250m in debt as of 28 October. The Austin, Minnesota-based food company trades at around 9x EBITDA.

Tyson Foods had USD 1.9bn in debt but total liquidity of USD 2bn, including USD 1.1bn in cash, for fiscal 4Q12.

The fourth banker said Tyson has the capability to buy Hillshire, but he said he wondered if there is a more valued focused buyer. Along with lower margins, the Springdale, Arkansas-based chicken company trades at a lower multiple than Hillshire.

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