Post Holdings: Positive Growth Tailwinds; Petfood Acquisitions Working Well (NYSE:POST)

Investment overview

I give a buy rating for Post Holdings (NYSE:POST) as I believe the business is going to see favorable growth tailwinds ahead in the snacks segment. Consumer behavior does not change easily, and the US population has a sticky habit of consuming snacks. Moreover, the change in working conditions (i.e., working from home) has increased the number of snacking occasions relative to the past. Notably, the growing penetration of private labels due to a growing mix of younger populations is also positive for POST. The venture in the petfood industry seemed puzzling initially but given how POST has executed over the past quarters, I believe the acquisitions were incremental to the business, and as POST continues to execute well, valuation should see a mean reversion.

Business description

POST manufactures and sells a variety of packaged foods across various categories and brands in its portfolio. The business is segmented into the following: Post-Consumer Brands [PCB], Weetabix, Foodservice, and Refrigerated Retail. Of the 4 segments, PCB is the largest segment, representing ~50% of FY23 revenue and ~44% of FY23 EBITDA. This segment is primarily comprised of cereal products and pet food. Following PCB is the foodservice segment, which accounts for around 35% of FY23 revenue and 39% of FY23 EBITDA. This segment focuses on value-added egg products and potatoes. POST is a serial acquiror that has conducted multiple acquisitions and divestures over the past two decades (I counted 31 transactions that were publicly known). The recent acquisitions were strategic decisions to venture into the petfood industry (discuss more below). Because of the nature of the POST growth strategy, it has been in a net debt position for a long time. As of 1Q24, POST has a net debt position of ~$6.2 billion, or near ~5.7x net debt to LTM EBITDA.

The US population loves to snack

The snacking industry in the US is a large and growing one, supported by multiple growth drivers that should continue to support growth over the foreseeable future. Based on Statista estimates, the US snack food industry is sized at around $110 billion in 2023 and is expected to grow at around low-to-mid-single digits through the latter half of this decade. I believe there are two main reasons that support this growth assumption. Firstly, it is a culture and behavior thing, and the US population really loves to snack. According to a study, 90% of all Americans eat one to three daily snacks, and some even consume calories equivalent to an entire meal every day. Secondly, I believe the pandemic has forced a change in eating habits due to the work-from-home situation. When we work in the office, mealtimes are pretty standard; you have breakfast before leaving for work, then lunch, followed by dinner at home (this is for more typical workers). With work from home, these timings have become a lot more flexible, especially at home, where one always has easy access to food. If you are hungry at 10:30 a.m., you can grab a snack bar from the fridge. In short, the probability of a “snacking occasion” has structurally increased compared to the past.

There is another layer of growth that is favorable for POST: the growing penetration of private-label snacks. This is an interesting trend that makes it hard to pinpoint the exact reason driving it since private labels have been on the market for a long time. My take is that this is due to demographic changes. The younger populations (Gen Z, millennials, etc.) behave very differently vs. the older generations (e.g., boomers). The younger crowd loves to experience new things, and private labels are “new things” that they have not experienced much when they were young (boomer parents buying the typical brands). Also, these younger populations are receiving more targeted marketing, which gives them more awareness of private label products. I believe this trend will continue, giving POST more pricing power and higher margins.

Entering the pet food industry

To give some background on the acquisition, on April 28, 2023, POST acquired a variety of pet food brands from J.M. Smucker Co. for a price tag of $1.2 billion. Based on the disclosure, the valuation was around 12x LTM EBITDA based on $100 million LTM EBITDA (7% margin) and $1.4 billion in sales. Also on December 1, 2023, POST acquired Perfection Pet Foods for $235 million, at a valuation of around 10x EBITDA (LTM EBITDA was $25 million).

Initially, I was very puzzled by this move, as POST has little to no experience in the petfood industry. Furthermore, the margins were not very fantastic either. POST’s snack businesses typically have mid-to-high-teens EBITDA margins, but the acquired pet food businesses have ~high single-digit EBITDA margins. However, as I thought further, I believe there is a bull case here. Firstly, POST pet food positioning is more value-oriented, which I see as a cushion to mitigate volatility in demand during a recession, given that consumers are likely to trade down. Secondly, while margins are lower, the pet food industry is expected to grow faster than the snack industry, enhancing POST’s ability to grow. Thirdly, based on the 1Q24 performance, it seems like management has put in place a plan that can successfully expand margin. In 1Q24, POST managed to generate ~$100 million in EBITDA over the last two quarters, which is equal to the initial outlook for EBITDA over a full year. Note that during the point of acquisition, the total LTM EBITDA was about $125 million, but POST managed to generate 80% of this in just 2 quarters. From a margin perspective, POST generated ~$830 million in petfood sales over the past 2 quarters, which implies ~12% EBITDA margin (this is already a >200bps improvement). While it is hard to pinpoint that exact exit margin that the petfood segment will achieve, I would not be surprised to see further margin expansion from here as POST can leverage its existing distribution capabilities to increase penetration for these acquired brands (thereby driving more volume that has high incremental margins given that the fixed cost is largely the same). If we look at Pets At Home pet food gross margin (its retail division), it has a gross margin in the range of 40+%, higher than POST’s snack food gross margin.

Pet Food exceeded our expectations as strong manufacturing performance supported growth in our value brands. Company 1Q24 earnings

Balance sheet leverage should come down

For bearish investors, the biggest concern is POST’s balance sheet. Having near 6x LTM EBITDA net debt is not a joking matter, especially for a business that sells to retail consumers. However, I argue that POST sells a re-occurring product (e.g., consumers frequently top up their cereal or snacks at home); hence, there is some form of visibility into upcoming cash flow. When we look at POST’s historical performance, indeed, POST has remained EBITDA and FCF positive for the entire past 13 years, even during COVID. In addition, POST has historically demonstrated that they were able to bring down leverage ratios (FY15 reached 7.5x but went down to 4x in FY16; FY18 reached 6.7x but went down to 5.2x in FY19).

Valuation

Based on my research and analysis, my expected target price for POST is $125. My model is built around forecasting post-EBITDA growth over the next 2 years, using management’s FY24 guidance as a yardstick. For FY24, management is guiding $1.31 billion in EBITDA (7% growth). I believe this growth is achievable as POST benefits from the acquired pet food acquisitions (easy comps), industry growth tailwinds, and further margin synergies from the acquired businesses. I expect lower EBITDA growth in FY25 as POST will not benefit from the same easy comps that it enjoyed in FY24.

I believe the main reason why POST is trading at the low end of its trading range (9.4x forward EBITDA) is because of the recent pet food acquisition that made many investors scratch their heads. As POST convinces the market that the acquisitions were the right decision, achieving margin synergies and improving the growth outlook (the petfood industry is growing faster), investor concern will abate, which should drive a mean reversion in multiples (back to 10x forward EBITDA).

Risk

There is a clear and growing trend for consumers to become more health-conscious. If this trend continues to snowball, there could be a scenario where consumers snack less than I expected. The improvement in petfood margins could be due to cost cutting (i.e., low-hanging fruits), and further improvement may not materialize.

Conclusion

Overall, I give a buy rating for POST. The strong demand for snacks in the US, coupled with changing consumer habits and the growing popularity of private-label snacks among younger demographics, are growth tailwinds for POST. While the decision to enter the petfood industry seems puzzling initially, execution and results so far have shown that it was a right decision – offering resilience during economic downturns and exposure to a faster growing industry. Regarding balance sheet, POST’s history of consistent EBITDA and free cash flow generation, along with a track record of reducing leverage ratios, should ease concerns.