Ralcorp Turns Cereal to Cash: Under the Radar

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ST. LOUIS (TheStreet) -- Consumer spending, excluding car purchases, was stagnant in July. Investors who expected a spending revival because of a still-low national savings rate failed to recognize that Americans' disposable income is going toward debt payments, not discretionary purchases.

The recession may be over, but discounters are poised for further growth. After years of buying unnecessary items and building credit-card debt, Americans are realizing that fiscal prudence is more important than keeping up with their neighbors. A consequence of thrift is higher demand for generic brands.

St. Louis-based Ralcorp(RAH Quote), which makes store-brand food products, is benefitting from this trend. Its fiscal third-quarter net income rose 63% to $75 million, but earnings per share fell 32% to $1.31, hurt by a higher share count. Revenue surged 51% to $994 million.

Ralcorp purchased Post Cereals from Kraft Foods(KFT Quote) in late 2007. The addition of branded products has strengthened margins. During the latest quarter, Ralcorp's gross margin jumped from 21% to 31% and its operating margin rose from 7% to 13%.

The 31 million shares issued to fund the Post acquisition diluted shareholders, but the purchase was worthwhile. Quarterly sales in Ralcorp's cereals segment soared 145%. Three of its four other units also boosted revenue. All of them increased profits, a sign that Ralcorp is using the demand shift to nudge prices up.

Ralcorp's balance sheet is clean. Although liquidity is less than ideal, evident in a quick ratio of 0.9, its cash balance has grown 221% to $273 million since last year's third quarter, proof that management is addressing the problem. A debt-to-equity ratio of 0.6 is lower than the industry average, indicating conservative leverage.