Flowers Foods, Inc.

Moat: 2/5

Understandability: 1/5

Balance Sheet Health: 4/5

Flowers Foods, Inc. is a large packaged bakery company, primarily operating in the US, and producing and marketing a variety of bakery products, including breads, buns, rolls, and snack cakes, with brands like Nature’s Own and Wonder.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Description

Flowers Foods (FLO) operates in the packaged bakery industry, producing and marketing a diverse range of bakery products. The company has two reportable segments:

  1. Retail: Sells products to grocery stores, supermarkets, and other retail outlets under brands like Nature’s Own, Wonder, and Dave’s Killer Bread.
  2. Foodservice: Sells products to foodservice distributors, restaurants, and institutions like schools and hospitals.

Flowers Foods has a clear focus on selling branded products, differentiating it from some competitors who offer generic private label goods.

Revenue Distribution

The company’s revenue can be segmented into branded and other products. Branded retail is more of their business (68%).

  • Branded Retail: 67.9%
  • Store Brand Retail: 16.6%
  • Other: 15.5%
  • The packaged bakery market is relatively mature with moderate growth, as it is a staple food category. However, consumer preferences are slowly shifting towards healthier options, specialty items, or even organic and gluten-free products
  • There is also increased consumer desire for premium and specialty items like sourdoughs, brioche, and artesinal breads.
  • Industry consolidation, both in production and retail, is an ongoing trend, potentially leading to greater pricing power for larger players.
  • High operating costs due to commodity price increases and supply chain disruptions are ongoing headwinds for the industry.
  • The packaged food industry, overall, has shown moderate growth due to increasing population and urbanization.
  • Consumers are demanding more transparency and information from food companies, a trend that could affect brand preferences and supply chain decisions.
  • Consumer awareness of the environmental and social impact of their food purchases, is increasing demand for sustainable products.

Margins and Financial Performance

  • Flowers Foods’ margins have fluctuated over the last few years. The company is facing pressure from higher raw materials prices, which are squeezing their gross margins. Inflation is an issue.
  • Gross margins have been around 50%.
  • Operating margin is around 8-11% with variability due to operating leverage and fuel costs.
  • Net profit margin, while positive, is low, around 3-6%, showing intense competition and low switching costs for customers.

Moat Evaluation

The “moat” concept, often popularized by Warren Buffett, refers to a company’s ability to maintain a competitive advantage over its rivals. These advantages can be structural (e.g., network effects or intellectual property) or be the results of efficient operational methods. Flowers Foods does not display strong or sustainable moat attributes.

  • Brands: Although they are present in many households, the popularity of bread brands tend to diminish over time and can easily be replaced or substituted. They do have some popular brands like “Nature’s Own” but there is nothing very special about the products. Also, brand strength does not make it particularly more profitable than others, as they are mostly commodities. They do have a niche with “Dave’s killer Bread” but it has low sales. Therefore, this does not confer a very large economic moat.
  • Switching Costs: There are very low switching costs. It is very easy for customers to switch to any other brand or even a private label brand without any hassle or significant cost.
  • Network Effects: There are no real network effects present in their industry.
  • Cost Advantages: The company does not have special proprietary production processes or unique resources, or a particularly advantageous geographical location that provide it with a meaningful cost advantage over its competition. It has a mix of regional and national production, distribution, and warehouses, which are readily accessible to most players.
  • Scale Advantage: Though it is a large company, it still faces many big competitors, such as Grupo Bimbo, who have the same or greater economies of scale.
    The company does have scale advantage in distribution, but that is not a very good advantage as most players have a similar infrastructure.

Moat Rating: 2/5

Flowers Foods has some brand recognition (especially “Nature’s Own” in their retail segment) and economies of scale (due to nationwide distribution), however, it is still highly susceptible to competition, and does not have a large and wide economic moat.

Risks to the Moat

  • Intensified Competition: Other packaged food companies, new smaller players or private labels could take away market share and reduce pricing power.
  • Commodity Cost Volatility: Increases in prices of wheat, flour, and other raw materials can squeeze margins.
  • Shifting Consumer Preferences: Trends towards organic, and other “healthy food” can reduce the appeal of their traditional bakery products. The industry is also shifting to high quality artisan bakery products.
  • Technology disruptions: Food delivery apps, and internet orders can threaten sales through traditional distribution channels.
  • Poor management and capital allocation: Capital allocation decisions or acquisition strategy may destroy value for the long-term.
  • High debt: This has been used in the past to fund acquisitions, and there is a risk of it growing too much and hurting the company in recessionary times or in high-interest rates times.

Business Resilience

  • Diversified Product Portfolio: It produces a wide range of goods, which provides some insulation against changes in consumer preferences in specific sub-categories.
  • Established Distribution: The established and vast distribution network is very hard to copy and this gives some operational scale.
  • Geographical Presence: Their wide-reaching operations in the US reduces the impact of regional factors.
  • Food Staples: Being in the food space, their goods are staple products, people always need it.

Financial Analysis

A thorough look into a company’s financials is crucial for determining its strength, stability, and growth potential.

Key Metrics

  • Revenue: Flowers Foods’ revenue has shown a consistent upward trend over the years.
    • Revenues have increased by approximately 7% in fiscal year 2023.
    • A 15% increase is expected in 2024 as they expect the pricing power to remain. This is quite aggressive and this revenue increase is not very likely.
  • Profitability: The company has a consistent but low profitability with net profit margins usually falling under 5%.
  • Return on Capital: The company has a mediocre return on capital, which is currently between 10 and 14%.
  • Debt: The company has a considerable amount of debt, which is mainly used for acquisitions.

In-Depth Review of Financials

  • Income Statement: The company’s revenue is highly dependent on pricing increases, and volume increases. As the pricing pressure is easing, and volume is mostly stagnant, revenue has not shown a large increase. They are trying to increase margins and achieve higher profitability, but commodity cost inflation pressures are a challenge to them and will be a focus. Due to higher volumes in 2023, they have increased the selling, distribution, and administration expense significantly.
    • They have done very well on reducing SG&A expenses
    • They are trying to reduce commodity costs by using alternate ingredients and optimizing routes. They are also hedging against volatility in commodity prices.
  • Balance Sheet: Flowers Foods has a considerable amount of debt, but a healthy amount of current assets. Given the large assets, this gives it the strength to continue business during unforeseen economic conditions. Their short-term liabilities are well controlled, but long-term debt is a point of risk. They are trying to reduce leverage, which is a good sign.
  • They have a good amount of cash on hand.
  • Cash Flow Statement: The company has maintained a relatively stable positive cash flow from operations for the past few years. The cash flow statement shows a high dependence on their core business operations and it reflects the company’s ability to maintain its current financial obligations. However, after acquisitions and capital expenses, free cash flow is a bit on the lower side.
    • As they increase capital allocation towards share buyback, their cash flow will be further reduced

Recent Concerns & Management Response

  • Pricing pressures - Flowers Food has shown a good performance, mainly by increasing prices for their products. This is not likely to be sustainable in the long term and is reducing volume growth.
  • Inflation: Management acknowledges that inflationary pressures, particularly in raw materials, labor and other transportation costs are challenges to profitability. They are working to find ways to mitigate costs through improving efficiency. They are also hedging against volatility in raw material costs.
  • Acquisitions - Recent acquisitions might not result in value creation as they struggle with integrating them. However, they claim that it is only a matter of time, and they are learning better ways to integrate acquisitions.
  • Share buybacks - The management in the recent past has increasingly allocated capital towards share buybacks. Although share repurchases increase the price per share, it does not directly improve the underlying economics of the business. The management needs to be careful about excessive share repurchases, even when a stock is undervalued.
  • Debt - The company is trying to deleverage, reduce its debt, and become more financially stable and flexible. The company has been making great progress in this respect.
  • The management is trying to reduce reliance on acquisitions for growth.

Understandability Rating: 1/5

The packaged food space is one of the most easiest businesses to understand, there is nothing much complicated to understand. It is very easy to understand where the company derives its revenues and where their expenses are located. The products and services that the company offers is very understandable, as well. They sell staple bakery items such as breads, buns, rolls and snacks. The financial statements are also quite easy to understand and analyze. So I will give it a rating of 1.

Balance Sheet Health Rating: 4/5

Overall, the company has a healthy balance sheet, with plenty of current assets and a good debt-to-equity ratio. They have plenty of cash on hand. They are also working to lower the company’s debt burden. Given this, it’s a low to moderate financial risk company and its financial obligations are well covered.

  • Therefore, rating of 4 is applicable.
  • Further improvement of debt levels will improve this rating to a 5.