Take a Bite of Pinnacle Foods

NEW YORK (TheStreet) -- It's not often that I discuss relatively unknown small-cap companies, much less those that have operated publicly for less than one year. But I do see a winning formula emerging with Pinnacle Foods (PF), whose stock has been up roughly 20% since the company went public this past April.

I'm not going to pretend that 20% gains in 18 months is something to write home about. But in the packaged food industry, where companies like ConAgra (CAG) and General Mills (GIS) have been ravaged by weak volumes and shrinking margins, I believe Pinnacle's relative performance has been top-shelf. And with Pinnacle's recent deal with Unilever (UN) to acquire salad dressing brand Wish-Bone for $580 million, Pinnacle should now be at the top of every investor's wish list. Not everyone agrees, however.

The deal, expected to finalize some time in 2015, is being dismissed by some analysts as being too expensive. But on what basis? Now, even if we were to get into all of the financial details and dissect the specifics of this deal line-item by line-item, we still won't find an exact apples-to-apples comparison.

Take, for instance, ConAgra, which paid a hefty 28% premium in a deal last year for Ralcorp at $90 per share. And given that this premium equated to roughly 11-times EBITDA, I questioned ConAgra's judgment, especially since the value of this deal was above what the industry average would pay (around 9.5 to 10 times EBITDA at the time). I felt ConAgra overpaid. The Street, meanwhile, felt differently.

While ConAgra hasn't exactly filled investors' appetites for growth, the company has shown modest fundamental improvements since the deal. Synergizing these deals doesn't happen overnight. But investors should nonetheless expect a leaner and more valuable company in the long term. This is assuming that management can continue to remove costs associated with Ralcorp, while also improving asset utilization.

Given that growth in this sector has been virtually non-existent, Wish-Bone, which has annual sales of $190 million, should help "dress up" Pinnacle's long-term revenue growth. What's more, management said it expects this deal will add not only $65 million to Pinnacle's EBITDA by fiscal year 2016, but Pinnacle will also realize $125 million in tax benefits on a net present value.

Essentially, while the growth is not going to happen overnight, it doesn't make a whole lot of sense to evaluate this deal solely on the basis of $580 million, which, by the way, will be financed by cash and debt. And from the standpoint of overall valuation, this deal, which is basically valued at 8.9 times EBITDA, falls in line with the industry average. Not to mention, the deal is cheaper than what ConAgra paid for Ralcorp.

Now, I'm not saying that this is a slam-dunk deal that will propel Pinnacle to higher heights. But when walking down grocery aisles, it's hard to miss the company's strong brands, which are said to be in 85% of American homes. These brands include (among others) Birds Eye, Duncan Hines, Mrs. Paul's and now Wish-Bone, which is -- behind Kraft (KRFT) -- the second leading salad-dressing brand with a 9.1% market share.

Since reaching a 52-week high of $28.52 a share in August, the stock has experienced a pullback by as much as 12%. But with earnings expected to grow by roughly 12% next year, I would be a buyer here on this small correction, which has now priced the stock at a forward P/E of just 15, which is in-line with General Mills and cheaper than Mondelez (MDLZ).

And given the expected value-add of Wish-Bone, Pinnacle's fair value can easily approach $35 in the next 18 months, especially with free cash flow recently growing at a compound annual growth rate of 25% above 2010 levels.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

More from Opinion

AAP Exclusive: Cramer Says The President is No Longer on the Side of the Bulls

AAP Exclusive: Cramer Says The President is No Longer on the Side of the Bulls

Why It Makes Perfect Sense for Netflix and Amazon to Buy Up Movie Theaters

Why It Makes Perfect Sense for Netflix and Amazon to Buy Up Movie Theaters

2 More Reasons to Sell All Your Stocks and Run Away

2 More Reasons to Sell All Your Stocks and Run Away

Sean Hannity's Link to Trump Lawyer Raises Questions: Doug Kass Insider

Sean Hannity's Link to Trump Lawyer Raises Questions: Doug Kass Insider

Netflix Blowout Earnings Remind Investors of One Thing: This Company Is a Beast

Netflix Blowout Earnings Remind Investors of One Thing: This Company Is a Beast