Stock Mart: Earthgrains

Analysts and investors say the breadmaker is a standout in the generally beleaguered food industry.
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In the current tech-obsessed market, investing in a bakery stock sounds about as thrilling as watching bread rise.

But

Earthgrains

(EGR)

, a St. Louis-based baker and refrigerated-dough producer, looks exciting to analysts and investors, who say it's a standout in the beleaguered food industry.

"I wouldn't be surprised to see the stock double in the next year," says David Goldman, an analyst with

NationsBanc Montgomery Securities

, who rates the stock a buy. "It's the only company in my purview that can comfortably grow

earnings at 14% to 15% for the next couple of years with no acquisitions." (NationsBanc hasn't done underwriting for Earthgrains.)

Earthgrains, whose brands include

IronKids

and

Country Recipe

, has seen its shares fall 37% since late October, when rival

Interstate Bakeries

(IBC)

said earnings would be hit by price competition.

"What applied to Interstate doesn't apply to Earthgrains," says Goldman. "Interstate is very fragmented in terms of market share, and that allows for the emergence of maverick price-cutters. Earthgrains' operations are highly concentrated."

In addition, before the autumn decline, the stock had soared fivefold since its March 1996 spinoff from

Anheuser-Busch

(BUD) - Get Report

, so investors wanted to pocket at least part of their profits.

"The perception was that the easy money with this company had been made," says Jeffrey Kanter, an analyst with

Prudential Securities

, who this month initiated coverage of Earthgrains with an accumulate rating. "Now the valuation is so compelling and the visibility is so high, it makes sense for value investors," he says. (Prudential hasn't performed underwriting for the company.)

At its Friday close of 23 7/8 a share, Earthgrains trades at a P/E of just under 20 based on the fiscal 1999

First Call

earnings consensus of $1.20 a share. Its price-to-sales ratio is about 0.51, and price-to-book ratio is about 1.6.

That was enough to convince Robert Cummisford, portfolio manager of the

(KNEMX)

Kent Small Company Growth fund, to buy Earthgrains shares about two months ago. "It's a good company, but it's been beaten up for being in an unfavorable sector," Cummisford says.

Earthgrains is the third-largest baking company in the U.S., behind Interstate and

Flowers Industries

(FLO) - Get Report

, with a 6.1% national branded share of the $7.5 billion fresh bakery products market, according to Prudential's Kanter. But Earthgrains is highly focused: In its core markets in the South, Midwest and parts of California, it commands as much as 20% of the business. It also has European operations, provides breads and buns to fast-food chains like

Burger King

and

Pizza Hut

and is the only U.S. producer of private-label refrigerated-dough products like dinner rolls and cookie dough.

In January, the company posted a 30% gain in third-quarter per-share earnings, beating the Street's estimates yet again. Acquisitions have stoked growth. In recent years, it's bought the

CooperSmith

,

San Luis Sourdough

and

H&L Bagel Baking

bakeries. Earthgrains' Spanish subsidiary,

Bimbo S.A.

, just bought baker

Reposteria Martinez Group

, which had 1998 sales of about $80 million. (Earthgrains had 1998 European sales of $320 million, about 19% of its $1.72 billion in total revenue.) That purchase will be dilutive for the first 12 months but then will add to earnings.

"It was a quite good acquisition in Spain, but I don't think it was as fully understood as a lot of their acquisitions in the U.S.," says Chris Jakubik, an analyst with

Warburg Dillon Read

, who rates Earthgrains shares a strong buy and increased his target price to 46 from 44 following the acquisition. (His firm has done underwriting for Earthgrains.)

Still, "the market would like to see an accretive acquisition here in the U.S.," notes Dave Gilmore, an analyst at

Federated Investors

, which holds Earthgrains shares in its

(FEDEX)

Capital Appreciation fund.

But even if Earthgrains doesn't make any big U.S. bakery buys, its underlying growth is also strong. Analysts say that unlike many food companies, it's benefiting from consolidation among supermarkets, thanks to its agreements to supply private-label bread to chains like

Kroger

(KR) - Get Report

and

Lucky Stores

.

"They've found the business model that allows them to partner with growing supermarket chains to increase margins and profit," says NationsBanc's Goldman. The company also cut costs by consolidating accounting functions.

And Earthgrains has improved its sales mix, offering more of the branded sourdough and potato breads as well as bagels that have outpaced sales of the more mundane white and wheat varieties.

Analysts praise the company's quick adoption of new technology, including handheld computers used by route drivers to track inventory and sales trends, and direct-store delivery, both of which are being offered in some markets. "It allows them to basically run the bread departments for some of their customers, and it allows the Earthgrains truck to optimize its own schedule," says Ronald Sloan, portfolio manager of the

(GTAGX) - Get Report

AIM MidCap Equity fund, who bought about 110,000 Earthgrains shares in the past six weeks.

To be sure, like other food companies, it's dependent on the price of basic ingredients, which make up as much as one-fourth of total costs. Low grain prices have helped Earthgrains meet margin targets, but the recent run of falling commodity prices is probably over, says Kanter. Cost-cutting, which has lately helped margin improvement, won't last for the long term either, he says.

And unlike Interstate Bakeries, Earthgrains lacks a big snack-cake business. "It's a pure-play bread company," says Kanter at Prudential. "I'd like to see them getting into the snack-cake aisle," he says. (Earthgrains wouldn't comment on acquisition strategy or any other matters, citing the quiet period before the May 3 release of fiscal fourth-quarter earnings.)

When it reported fiscal third-quarter earnings in January, the company also said its European operations were below expectations. "That's certainly worrisome," says Kanter. A slowdown in the key Spanish children's bread market is secular, not cyclical, he says.

Still, analysts say Earthgrains should have no trouble making its earnings targets for 1999 and 2000. After that, progress will depend on continuing to add a little leavening to the otherwise flat U.S. bread market -- and on waiting for investors to get weary of tech and return to the hearth. "If people are thinking it's a tougher environment from a profit standpoint, these guys have some pretty steady results," says Sloan at AIM.