The Long and Short
A Twinkie for SJM
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
SJM (Baa2/BBB (n)) recently closed on its acquisition of Hostess Brands Inc. (TWNK), adding both the Hostess and Voortman brands to its portfolio. On closing, SJM created a new business area, Sweet Baked Snacks, to focus on growing the brands. The company funded the deal with a combination of cash, stock and $3.5 billion of new debt, which increased net leverage above 4.0x. The acquisition not only broadens its snacking prowess, but helps replace lost revenues associated with the recent sale of certain pet food businesses. Management plans to focus on integrating the assets and delivering on $100 million of cost synergies while reducing leverage to its target range of 2.5x-3.0x.
With investors largely focused on both on-the-run bonds and duration, SJM is the only packaged food credit with a 30-year on-the-run (Exhibit 1). Its 2053 bond currently trades roughly 2 to 4 bp (g-spread) through Conagra Brands (CAG – Baa3/BBB-/BBB-) where the rest of SJM’s curve trades roughly 15 to 20 bp (g-spread) through CAG. With one notch higher ratings at SJM and a focus on debt reduction over the next two years, SJM’s 2053 bonds have the potential to move tighter and trade more in line with the rest of its curve. Furthermore, SJM’s EBITDA margin is set to expand as it realizes synergies over the next two years, where CAG’s margins are estimated to remain flat.
Exhibit 1. Packaged Food BBB Curve
Source: Company Reports; Bloomberg TRACE; Santander US Capital Markets
Commitment to Reduce Leverage
SJM’s net leverage stands at roughly 4.4x post close, which is up from 2.3x prior to the consummation of the acquisition. When factoring in $100 million of annual synergies that management has guided to, pro forma net leverage is closer to 4.1x. This compares to net leverage of 3.8x currently at CAG. SJM management is committed to maintaining strong investment grade ratings. That said, SJM has stated its intent to prioritize debt reduction in the near term and reduce net leverage to the 2.5x-3.0x range by fiscal 2026. SJM has maintained net leverage at or below 2.5x for the past three fiscal years.
Exhibit 2. SJM Debt Distribution
Source: Bloomberg; Santander US Capital Markets
The delevering path will likely require some sort of tender offer as SJM has only $1.0 billion of debt maturing over the next three years (Exhibit 2). Assuming that SJM repays the bond at maturity on March 15, 2025, net leverage is only likely to fall to the 3.7x area. SJM will likely need to repay an additional $1.0 billion of debt in order to hit the high end of its leverage target range. SJM currently has six bonds in its capital structure that trade below $90 which could all be potential tender candidates (Exhibit 3). These bonds account for $2.85 billion of notional outstanding.
Exhibit 3. SJM Debt Issuance
Source: Bloomberg; Santander US Capital Markets
Synergies Aid Margin Expansion
SJM noted that the Hostess acquisition will be immediately accretive to operating margins given Hostess’ best-in-class margin structure, which is largely derived from its efficient warehouse distribution model. Based on earnings estimates for fiscal 2023, Hostess’ EBITDA margin is anticipated to be roughly 23%, which is 200bp higher than SJM’s LTM EBITDA margin. That said, on a combined basis the EBITDA margin will likely improve to the 22% range. Once synergies are realized after year two, the EBITDA margin is estimated to expand to the 23% area. This compares favorably to CAG whose EBITDA margin has been hovering around 19.5% and is not forecasted to expand over the next two years.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
