Post Is Anything but a Bargain

NEW YORK (TheStreet) -- It seems odd to discuss an expensive stock in an industry such as packaged foods that has been ravaged by poor volumes and weak margins. But Post Holdings (POST), whose stock is up 30% since October and now enjoys a P/E of 166, is hard to ignore.

I don't want to exaggerate the meaning of the P/E. But this isn't the tech sector where valuations are often ignored for future profits. Just to put things in more context, Post's valuation is seven times and eight times the valuation of market leaders Kellogg (K) and General Mills (GIS), respectively.

While it's true that Post has outperformed both Kellogg and General Mills in terms of revenue growth, this is also because Post is a much smaller company - one that operates (for better or worse) as an exciting startup following its 2012 spinoff from Ralcorp. But with only 10% of the ready-to-eat (RTE) cereal market, which trails both Kellogg and Post by roughly 20% each, I don't see the justification for this sort of optimism - not for a third-place company in a sector that is slowly fading.

I won't deny that Post, which Ralcorp acquired from what is now Kraft Foods (KRFT) in 2007, has some strong brands like Honey Bunches of Oats. And I will grant that management deserves credit for having maintained some decent volumes relative to the stale results in food industry. But that's the extent to which I could get excited about this valuation.

With Honey Bunches of Oats accounting for 40% of Post's RTE business, I don't believe the company is not as well diversified as its rivals. Quite frankly, I don't believe Ralcorp would have spun off this business if Ralcorp management was confident that Post can deliver the sort of growth necessary to boost long-term cash flow growth and earnings.

Truth be told, I had my doubts also because while under Ralcorp, Post delivered a collective 10% revenue decline over the past three-and-a-half years while management struggled to repair the company's underlying operational issues, which results in a 50% decline in operating income during that same span.

As it turns out, however, the spinoff has helped both companies. With Post shares now trading at around $50, the stock is up 86% since the January 2012 spinoff price of $26.89. With such strong gains following the company's recent $370 million deal for Dakota Growers Pasta, the Street has clearly bought in to the belief that management can turnaround what has been a fledging business, given Dakota's strong share in the pasta market.

The way I see it, though, with this $370 million deal -- which now raises Posts net debt position to $800 million -- the Street is placing too high of a bet at this current valuation. Again, as we've looked back over the past three-plus years and it's not as if management has a history of strong execution.

I'm not saying this deal won't work. I just don't believe that Dakota, even with its $5 billion market cap and leadership position in private label retail, materially changes Post's long-term growth outlook. Although the deal is expected to add $300 million in net revenue, I can't get excited about non-organic growth - not for a company that just reported 67% decline in net earnings for the first nine months of the year.

Investors will read this and accuse me of being overly bearish. But I don't believe I've been unfair. There are a lot of growth expectations that has been priced into this stock. But any company can put up gaudy growth numbers through acquisitions. The question, though, is how much of Post's fundamentals (good or bad) is the Street ignoring by slapping the stock with a P/E of 166?

Now I do realize that the spun-off company still has plenty to prove. Even so, I see very little upside potential and plenty of downside risk for an over-leveraged company that is aggressively entering new markets, while being led by a management team that has been at best substandard.

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.

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