Valuation a Thorn in Flowers Foods

NEW YORK ( TheStreet) -- For all of the talk about how slow-growing and boring companies in the consumer staples sector seem, tech investors in Microsoft ( MSFT), Cisco ( CSCO) and Intel ( INTC) are likely kicking themselves for not having picked Flowers Foods ( FLO), which has blossomed over the past decade into an incredible growth story.

Not only has the company's stock price posted gains of 70% in the past 12 months, but Flowers Foods, whose baked goods now serve more than 77% of the country (up from 33% in 2000), demonstrates what is possible when a strategically aggressive management team aligns great vision with pinpoint execution.

This performance, which has been the result of steady organic growth and market-expanding acquisitions, has not been lost on the Street. Flowers has doubled its stock price in the last 5 years, while shares have bloomed with 10-year gains of more than 500%, means that yeast is not the only thing rising from the company's ovens.

As impressive as the company's operating leverage has been, contributing as it has to double-digit compounded revenue growth (not to mention free-cash-flow growth of close to 15%), I do wonder how long Flowers' incredible run can last.

Don't confuse this with a sudden lack of confidence in management. There's no question that the maker of Wonder Bread knows how to make "bread" for its investors. But with Flowers having now scaled its market as far as the west coast due to recent brand acquisitions of Sara Lee and Earthgrains, the stock price presumes there is more territory and growth to conquer.

What's more, at a forward price-to-earnings ratio of 21, which is 7 points and 8 points higher than both Campbell Soup (CPB) and ConAgra Foods (CAG), respectively, Flowers is not cheap. Although Flowers outperformed both Campbell and ConAgra in terms of revenue growth, investors were nonetheless disappointed that Flowers' third-quarter earnings failed to beat expectations.

On the news, the stock shed almost 10%. Some have called this an overreaction and consider the dip a buying opportunity. That may very well be proven true. But the way I see it, that management also reduced fiscal 2013 guidance due to (among other things) higher costs, and declining margins in warehouse volumes, introduces doubt about Flowers' premium valuation.

As I've said, the company's brands of baked goods, which now includes Cobblestone Mill, Nature's Own, Tastykake, Sunbeam and so on, have scaled to close to 80% of the country's population. And with rivals like Grupo Bimbo (BIMBOA.MX), which has dominant brands such as Entenmann's, Thomas, Arnold, not to mention several other private-label brands, Flowers may have to venture beyond baked goods to grow. This doesn't even include Campbell Soup, which owns Pepperidge Farms.

Essentially, I believe it will be hard, if not impossible to for Flowers to duplicate the growth-rate management it was able to achieve a decade ago. To that end, given Flowers' well-established scale, for the company to grow long-term profits and earnings, management will have to now rely on efficiency and capacity improvements.

The good news is that with the company posting a 5% efficiency improvement in the last five years, management has shown that it can pull this off. With the recent $355 million acquisition of Hostess' bread business (not yet fully integrated), there is hope that Flowers can still deliver not only better margins, but also higher utilization, which is certain to boost earnings and cash flow.

In that regard, it all comes down to time. While I do believe Flowers' management deserves investors' patience, there is also something known as opportunity cost. Given the rate of growth, not to mention the stock gains Flowers has already enjoyed, I believe the greater opportunity lies elsewhere in relatively cheaper names like Campbell and, to a lesser extent ConAgra, that also pays a higher yield.

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.

If you liked this article you might like

Warren Buffett Is Sticking to His Strengths By Selling IBM and Buying More Apple

Warren Buffett Is Sticking to His Strengths By Selling IBM and Buying More Apple

Jim Cramer: Today Is Not Just About VIX, It Is About COMPANIES!

Jim Cramer: Today Is Not Just About VIX, It Is About COMPANIES!

24 Stocks Hedge Funds Are Loving Right Now

24 Stocks Hedge Funds Are Loving Right Now

It's Dumb to Think Amazon Will Be Able to Skirt Regulators Forever

It's Dumb to Think Amazon Will Be Able to Skirt Regulators Forever