B&G Foods (BGS): A High Yield Stock With Double-Digit Dividend Growth

Food stocks can often make excellent long-term dividend growth investments, thanks to the highly defensive nature of their businesses. After all, everyone has to eat no matter what the economy or interest rates are doing.

 

This is why many well-known food blue chips are among the list of dividend aristocrats and dividend kings, which have track records of 25+ and 50+ years of consecutive annual dividend growth, respectively.

 

Among food stocks, B&G Foods’ (BGS) 4.6% yield is one the highest dividends you can find. Even better, the company has grown its dividend at a double-digit pace in recent years and has potential for 7% to 8% annual dividend growth going forward.

 

However, in order to know whether B&G Foods is worthy of adding to your portfolio, especially if you’re a low risk investor looking to live off dividends during retirement, we need to get comfortable with B&G Foods’ business quality, current valuation, and the safety of its dividend.

 

Business Description

B&G Foods, including its predecessors, has been in business for more than 125 years. The company is the producer and marketer of numerous shelf-stable food products under dozens of independent, niche brands such as: Cream of Rice, Cream of Wheat, Don Pepino, Mrs. Dash, Ortega, Pirate’s Booty, and Green Giant.

 

The company’s many food brands have been steadily accumulated over time, including several recent acquisitions:

• Frozen-and-canned vegetable brand Green Giant, which the company bought from General Mills (GIS) in 2015 for $765 million. This deal marked B&G Foods’ first entry into frozen foods.
• Premium pasta and pasta sauce producer Victoria Fine Foods, bought for $70 million at the end of 2016.
• Premium spice brands: Spice Islands, Toney’s, Durkee, and Weber from ACH Food Companies for $365 million in November of 2016.

Business Analysis

The packaged food business is increasingly a tough one in which to build a durable competitive advantage, otherwise known as a moat. That’s especially true in today’s environment in which consumers are shifting their buying habits from packaged foods and towards fresh foods, especially of the organic variety. Many large brands are seeing their dominant market share positions gradually erode.

 

Packaged food brands are also facing increasing competition from generic store brands that make it hard to pass any increased production costs onto consumers. This means that the closest packaged food companies can come to a moat is maximizing economies of scale in order to cut costs and optimize their margins and returns on capital.

 

However, despite the challenges in the industry, in which most blue chip names such as General Mills, Hormel Foods (HRL), and Kellogg (K) are struggling with falling or flat sales, B&G has proven its long-term ability to buck the trend with very strong revenue, earnings, and free cash flow (FCF) growth.

 

 

Of course, that’s not because any of B&G’s brands have necessarily seen strong growth. Instead, the company continues to acquire new, under-loved brands at an impressive rate with a goal of investing more in marketing and new product development to reinvigorate them.

 

However, management’s track record of generating organic growth is mixed at best. For example, in the most recent quarter B&G Foods’ base business, meaning those brands it’s owned for at least a year, saw sales decline by 2.4%. Volume declined by 2.8%, but reported sales growth was helped by a price increase of 0.2% and beneficial currency effects of 0.2%.

 

In fact, just over half of B&G’s brands saw sales declines which management partially blamed for warmer-than-expected winter weather. Of course, the true reason is more likely the longer-term secular decline in packaged foods that numerous other companies have been experiencing for years.

 

However, just because B&G isn’t immune from flat to slightly falling sales doesn’t necessarily mean that it might not be a reasonable long-term investment. After all, with numerous acquisitions comes the potential for synergistic cost savings, in addition to growing economies of scale that can help B&G maintain strong and gradually improving margins over time.

 

 

In fact, given that B&G is such a small company (market cap of just $2.7 billion), the fact that it can generate above-average profitability and returns on shareholder capital is a testament to the historical success of its capital allocation strategy, especially since historically 87% of acquisitions end up destroying shareholder value.

 

 

The reason that B&G has bucked the trend is that management has been very good at not overpaying for assets and taking advantage of record-low interest rates. In addition its record of executing on its planned synergies and other forms of cost cutting is solid.

 

This combination of good capital allocation and long-term cost cutting allows B&G’s acquisitions to be very profitable. This is especially true when it comes to growing the company’s FCF per share, which is ultimately what supports and grows the dividend.

 

This ability to convert its brand acquisitions into a strongly growing free cash flow stream is a key to the long-term, acquisition-happy business model. That’s because retained free cash flow is by far the lowest source of capital a company can have.

 

Thus, by mostly funding its growth internally, B&G Foods can keep its weighted average cost of capital, (WACC) much lower than its return on invested capital. This is very important because as with any company that is frequently tapping external debt and equity markets in order to grow through acquisition if a company can’t generate ROIC greater than cost of capital then it’s not actually growing shareholder value, but rather destroying it.

 

 

Key Risks

B&G’s biggest risks are caused by its acquisition-friendly business model and high financial leverage.

 

For example, when B&G Foods was younger and much smaller, needle-moving deals were much easier to come by. As CEO Robert Cantwell said during the most recent conference call, “the challenge is as brands get bigger, competition gets greater, and prices have seemed over the years to go up, and that doesn’t work in our model.”

 

In other words, for B&G to continue growing strongly it needs to be able to locate little-followed brands that other large food companies aren’t interested in. That allows B&G to buy them at a reasonable price and make a decent return on investment; one that’s far above its cost of capital.

 

Going forward, B&G may run out of attractive acquisition candidates because the brands it would be interested in buying might require a bidding war with larger and better capitalized rivals.

 

Which brings me to another major risk. In order to raise capital for acquisitions, B&G has been very aggressive in selling new shares with the share count growing by 7.5% annually over the past five years due to what’s known as secondary offerings.

 

Not only are such share sales dilutionary, but sometimes B&G has to offer a discount in order to obtain the capital.

 

B&G’s constant hunt for new brands means that It’s also taken on a lot of debt. This has resulted in a steadily-rising share count over time as well as a historically high debt/capital ratio which can harm its long-term dividend safety (more on this later).

 

 

As long as debt markets remain open and its share price high enough, the company has little problem raising acquisition capital to acquire new brands. However, when those external capital markets close, as occurred in 2008-2009, then B&G’s growth engine shuts down.

 

Which means that unlike larger food companies, which can internally fund their growth, B&G’s long-term growth thesis is at the whims of fickle debt and stock markets.

 

And with interest rates set to rise in the coming years (by 2.25% by the end of 2020 according to the Federal Reserve’s guidance), B&G Foods may see its cost of capital rise significantly in the coming years. Add to this the potential lack of large, undervalued brands to buy, and the company may be forced to rely more on retained free cash flow to fund its growth ambitions. That in turn could limit how much it can grow the dividend.

 

Finally, it’s worth noting that management’s acquisition strategy carries meaningful execution risk. B&G Foods’ acquisition of Green Giant put the company into a new category (frozen foods) and was its biggest deal ever. Green Giant’s performance has trailed management’s expectations thus far, although trends could eventually turnaround.

 

Regardless, acquiring struggling brands in very mature categories and trying to turn them around with marketing and product development investments is tough work, especially in today’s rapidly-changing packaged food industry.

 

Seeking Alpha contributor Crunching Numbers provides many quality insights into B&G Foods, and I recommend reading his latest article here for more on some of these risks.

 

B&G Foods’ Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

B&G Foods’ Dividend Safety Score of 71 indicates that the dividend is currently secure and dependable. That being said, be aware that due to its small size B&G’s dividend is far less safe than that of larger food companies. This was  seen during the financial crisis and Great Recession when B&G’s quarterly dividend was cut by approximately 20%.

 

 

Why the large cuts in what is supposed to be a recession-resistant industry? The answer lies in the small absolute size of the company’s earnings and free cash flow, as well as its heavy debt load. In non-recession years B&G’s FCF payout ratio has averaged 60%, which is a very safe level.

 

 

However, during recessions that figure can jump significantly because the lack of access to external capital means it has to fund growth internally, which decreases FCF. That can result in an unsustainable dividend and thus the need to choose between the current payout, growing the company, and protecting the balance sheet.

 

At some point B&G’s cash flows should grow large enough to make the dividend truly recession resistant but at least for now the heavy acquisition-fueled business model makes the payout only safe when cheap debt and equity capital are abundant.

 

Another reason that B&G has, at least until now, been a “fair weather” dividend friend is its high debt levels. The company’s overall balance sheet is far more leveraged than most of its peers.

 

 

As you can see, B&G’s leverage ratio is far above the sector average, as is its debt/capital ratio. This, plus the small size of the company, explain why B&G Foods has a sub-investment grade credit rating, forcing it to borrow and refinance debt in the higher interest rate junk bond market.

 

During a time of historically low interest rates, when the bond market is flush with yield-starved investors, this isn’t a problem as the company’s fast growth over the past six years has shown.

 

However, just be aware that B&G’s high debt levels mean that during the next economic downturn, when credit markets tighten, B&G could be forced to cut the dividend in order to strengthen its balance sheet.

 

B&G Foods’ Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

B&G Foods’ Dividend Growth Score is 68, supported by management’s very dividend-friendly policy of returning about 60% of its fast-growing FCF each year as dividends. You can see that the company’s dividend has increased by 14.9% per year over the last five years, which is among the fastest payout growth in the entire industry.

 

 

Given its still-small size and interest rates that, despite likely increasing in the coming years, should still remain low by historical levels, B&G Foods should still be able to find plenty of acquisitions to make.

 

The company could grow its FCF per share about 10% per year, depending on the deals that are completed. B&G Foods could grow the payout at a similar pace; however, I think that management may take a more conservative approach and choose to lower the FCF payout ratio, which would result in 7% to 8% long-term dividend growth.

 

Why be more conservative with payout growth?  Because by growing the dividend slower than FCF per share, this will create a much stronger safety buffer for the next economic downturn, when B&G is likely to have to fund more growth internally and its FCF is likely to fall.

 

In other words, this level of dividend growth should allow B&G Foods to sustain the current dividend through the next recession, as opposed to cutting it as it did in the past.

 

Valuation

Over the past year the market hasn’t been kind to packaged food companies, B&G Foods included. In fact, shares have underperformed the S&P 500 by about 20%.

 

That has left the trailing 12 month P/E ratio at 24.5, which is slightly below the 26.2 median P/E ratio of the entire group of dividend-paying consumer staples companies. BGS’ multiple is also a little below its long-term median P/E ratio of 25.7.

 

The stock’s 4.6% dividend yield is slightly higher than its median historical payout of 4.4%, too. Based purely on historical valuation metrics, BGS’ stock appears to be trading at a modest discount. However, any investor considering B&G Foods must be aware of and comfortable with the risks inherent in a small and highly leveraged company such as this.

 

Concluding Thoughts on B&G Foods

Just because B&G Foods is in the consumer staples sector doesn’t mean its payout is dependable in all economic environments or that its stock is likely to be a defensive holding during the next market downturn.

 

As we’ve seen, the company’s small size and acquisition-happy business model mean that, until it achieves a much larger scale, the payout could be at risk during the next recession. That’s especially true given B&G Foods’ highly-leveraged balance sheet, junk bond credit rating, and dependence on raising external growth capital.

 

While B&G Foods has a lot to offer a high-yield dividend growth investor and its payout appears secure in today’s low interest rate environment, this shouldn’t be thought of as a low risk stock.

 

Rather I would consider it a medium risk company, one that could appeal to investors with a longer time horizon but perhaps less so for a very conservative retirement portfolio. Investors might consider some of the best high dividend stocks instead.