Why General Mills Paid Too Much in Its Hunger for Annie's

NEW YORK (TheStreet) -- Over the past several quarters, shareholders of organic and natural food producer Annie's (BNNY) have enjoyed a higher premium than what others were willing to pay for rivals like Hain Celestial (HAIN) and Mondelez (MDLZ) .

This didn't matter to General Mills (GIS) , which decided to pick off Annie's for $46 per share, or roughly 31% premium above Annie's most recent closing price.

Known for its Cheerios, Bisquick and Yoplait yogurt, General Mills now wants to nibble on the growth potential that exists in natural and organic foods. It's a strategy tough to argue with. The likes of Kraft (KRFT) and Campbell Soup (CPB) are also heading in that direction.

Still, General Mills overspent on this deal, which is expected to close later this year.

Representatives from General Mills or Annie's were available for comment.

Prior to the announcement, shares of California-based Annie's were already trading at more than twice the price-to-earnings ratio of industry average (47 vs 19), according to Yahoo! Finance. After the stock's 37% jump, Annie's P/E has now ballooned to over 52, which is now 35 points higher than Mondelez. In other words, the rich just got richer. But did they?

Consider, with shares now trading around $46, Annie's investors are now (only) 7% richer in 2014 -- even after an almost 40% one-day jump. Prior to the deal, the stock was down 22% on the year. When factoring the 52-week low of $27.86 reached on June 5, investors had at one point lost more than 35% in 2014. Why do you suppose that is?

Annie's has been unable to feed Wall Street's appetite for growth. Although the company strung together some decent results, including 10% growth in the most recent quarter, this is still 15% below the industry average growth rate, according to Yahoo! Finance.

What's more, from an operational perspective, Annie's 35% gross margin trailed other top-notch packaged food producers like Nestle (NSRGY) and Kraft, which were operating at 48% and 36%, respectively. Investors could have owned both Nestle and Kraft at a fraction of the cost -- both are trading at P/Es of 21 and 12, respectively, and under the industry average.

For General Mills, the question is where is the value? What does the company believe it is buying? General Mills' organic business already delivers 61% more revenue annually than Annie's ($330 million vs. $204 million).

Although Annie's does focus more on natural and organic foods, which is still a growing segment, the company has been unable to deliver where it matters the most -- on the bottom line. The other thing is, unlike Kraft or Mondelez, the success of Annie's is too heavily tied on economic growth. This is because the company relies on the higher-earning demographic for its business. Although General Mills should have no problems bridging that divide, it's not going to happen overnight.

Natural and organic foods aren't cheap. Whole Foods (WFM) is now feeling the pressure from the likes of Wal-Mart (WMT) and Kroger (KRG) entering that space and offering cheaper alternatives. Annie's has begun to feel the same sort of pressure from Kraft.

To the extent that General Mills can leverage its reach to offset Annie's weak operating performance, this deal can work. But with Annie's limited number of products, it's going to be hard for General Mills to quickly fill that gap and extract value for a deal on which it overspent.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

Follow @Richard_WSPB

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


TheStreet Ratings team rates ANNIE'S INC as a Sell with a ratings score of D+. TheStreet Ratings Team has this to say about their recommendation:

"We rate ANNIE'S INC (BNNY) a SELL. This is driven by a number of negative factors, which we believe should have a greater impact than any strengths, and could make it more difficult for investors to achieve positive results compared to most of the stocks we cover. The company's weaknesses can be seen in multiple areas, such as its generally disappointing historical performance in the stock itself, unimpressive growth in net income, disappointing return on equity, premium valuation and poor profit margins." You can view the full analysis from the report here: BNNY Ratings Report

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