THOMASVILLE, GA. — While the profitability of Flowers Foods, Inc. was under pressure in the second half of 2014, margins toward the high end of the company’s long-term objectives are highly achievable in the foreseeable future, even without an improvement in the competitive environment, said R. Steve Kinsey, executive vice-president and chief financial officer.
In an April 14 presentation at The New York Stock Exchange, Mr. Kinsey intimated that EBITDA margins above 13%, the high end of the company’s current target, were within the realm of possibility.
Flowers has long-term EBITDA margin objective of 11% to 13%, and margins were 11.4% in 2014. Still, margins were under pressure in the last half of the year, slumping to 10.6% in the fourth quarter, said Flowers executives.
Many factors pressuring margins will be disappearing in 2015 and beyond, especially in the second half, Mr. Kinsey said. By way of explanation, he offered a look back at the deteriorating profitability in 2014.
“Last year, we had a strong first quarter and began to feel pressure in the third quarter,” he said. “That pressure continued into the back half of the year. Some of that was because of increased promotional activity. Some was because we chose to exit certain private label business, and we also closed the company’s Leo’s tortilla plant and exited certain food service tortilla business.
“In 2015, we will begin to lap some of that in the second quarter, and then we’ll also lap some of the exited business in the back half.”
On the positive side, Mr. Kinsey cited certain “wins” in food service both with new customers and existing customers.
“You’ll start to see those contribute beginning in the second quarter,” he said. “That will continue in the back half as well. You’ll see improving comps as the year progresses. Looking at margins for the year and our earnings guidance, we’ll continue to focus on overall profitability. We’ve gotten things right in the tortilla business. We’ve seen those margins continue to come back. Brad (Alexander, executive vice-president and chief operating officer) and Allen (Shiver, president and chief executive officer) spoke about continued improvement at Lepage. That’s a longer term opportunity, but we are encouraged by the trends there and what’s been happening. In 2015 obviously we also will see some input cost tailwinds.”
Translating these improvements more directly into the company’s EBITDA margin objectives, Mr. Kinsey offered a slide showing about 240 basis points in margin opportunities, the number needed to bring margins back to the high side of the company’s long-term objectives. He noted the improvements are “exclusive of any sales growth or leveraging of the top line.”
“When you look at the Lepage turnaround and Leo’s, there is a 40-basis point opportunity, and we are starting to see that hit,” he said. “For 2015, we think we will be able to capture a good part of that.”
Another source of improved margins will be the reduced carrying cost of Hostess physical baking assets acquired in 2013. With the disposition or reopening of a number of these plants and depots, Mr. Kinsey estimated the carrying costs will decline to $14 million or $15 million in 2015, down from $20 million in 2014.
“We’re definitely very confident about capturing that margin improvement in 2015,” he said.
Perhaps Mr. Kinsey’s longest explanation for sources of improved margins related to a forecast of a reduction in stales. The 100 basis points of improvement he projected (without a precise timeline) represents half of what Mr. Kinsey said will be achieved over time.
“Over the longer term, we continue to focus on reducing our stales,” he said. “And we continue to focus on improving manufacturing and distribution efficiencies. For those who are new to the business: When we talk about stales, in our D.S.D. business, that’s product that doesn’t sell at retail. Most of our sales at D.S.D. are consignment, so anything that doesn’t sell is picked up. We use the term ‘stale’ in the industry.
“Over the last couple of years we have seen our stale rate pick up about 200 basis points. A lot of that was driven by the market dynamics. Hostess closed their doors and went into liquidation. We expanded to cover the market. We’re working on product mix. We’re seeing product mix drive improvement there as well. Then again Keith discussed expansion markets. We became more aggressive in expansion markets with the exit of Hostess, and we’re working on distribution efficiencies (to counter) some of the stale increase. It’s a longer term opportunity, but one we definitely think we can capture. We’ve done some things internally working on enhancing our ordering system. We’re starting to see some benefit there. The next 2-3 years you can expect to see the stale rate come in line with where it has been historically.”
What is the long-term upside for margins at Flowers if the initiatives Mr. Kinsey described are successful and if the company achieves its top-line growth objectives? He declined to offer specifics but suggested the potential was considerable.
“Long term, if we are able to lever the top line in addition to these cost opportunities, there is really great opportunity to expand EBITDA,” he said. “Right now we’re not willing to go above the 13% target, but I would say if the category stabilizes, I think there is there is opportunity to see good growth from an EBITDA perspective.”
R. Steve Kinsey offered a roadmap of the company’s path toward the high end of its margin objectives. In the fourth quarter of 2014, Flowers EBITDA margin was 10.6%.
