The Long and Short
Flowers Foods as a defensive staple
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.
With tariffs at the top of investors’ minds and the threat of deeper economic weakness looming, Flowers Foods (FLO: Baa3/BBB/BBB-) presents a defensive staple and improving overall credit profile. Direct exposure to tariffs seems a manageable operating risk relative compared to other segments of the broader consumer sector. FLO intermediate bonds also trade at attractive levels compared to similarly rated food and beverage peers within consumer non-cyclicals. The market has been attempting to gauge where investors can find protection from trade war. Part of that process includes consideration of previous periods of elevated tariff uncertainty. Utilities, natural gas and consumer non-cyclicals remain at the top of those lists. And within that context, FLO appears a viable option with generous low-BBB spread compensation relative to peers.
FLO tapped the public US dolar debt markets in February of this year to raise $800 million in acquisition financing for Simple Mills, which closed later that month. Management priced 10- and 30-year bonds at spreads of 125 bp and 150 bp over the Treasury curve, respectively. The 10-year notes have drifted about 15 bp wider from launch while the 30-year notes have actually held in and trade relatively in-line with their debut. The curve consequently has flattened substantially to about 10 bp from the 25 bp at initial offering, favoring valuation in the intermediate part of the curve (Exhibit 2). Comparatively, the broad investment grade index is about 24 bp wider from that point in early February when the FLO bonds initially priced.
Exhibit 1: FLO longer maturities have flattened sharply to intermediate
Source: Santander US Capital Markets LLC, Bloomberg/TRACE g-spread indications
Overall, FLO appears attractively priced relative to its peer group, in part because leverage remains temporarily elevated following the closing of the Simple Foods acquisition. That puts intermediate bonds closely in-line with ‘BBB’ comps that include Grupo Bimbo SAB de CV and JBS Foods, both carrying significantly more tariff-related risk given their international footprints outside the US (Exhibit 2).
Exhibit 2: FLO intermediate bonds versus food and beverage peer group
Source: Santander US Capital Markets LLC, Bloomberg/TRACE g-spread indications
FLO presents an improving overall credit profile as it pays down leverage from the acquisition over the near-to-intermediate term. Management is likely to temper acquisition targets over the interim period, limiting activity to smaller bolt-on deals with limited impact to debt leverage. The rating agencies are giving FLO a reasonable runway to achieve their deleveraging goals. S&P did assign a negative outlook to its mid-‘BBB’ rating but expects management to get debt leverage back under 3x within the next two years. S&P appears to be giving them the flexibility to do so under its current rating. FLO typically operates in the 2.0x to 2.5x range over the past five years. Moody’s lowered the rating to ‘Baa3’ with a stable outlook. Using their metrics, leverage is currently expected in the mid-3x range throughout the remainder of this year, and they would consider bringing the rating back to the mid-‘BBB’ level if FLO can get consistently below 2.75x. Mexican peer Grupo Bimbo SAB de CV exited 2024 with leverage north of 3x as well and still maintains high-‘BBB’ ratings for the time being.
Generally speaking, FLO remains a defensively positioned consumer staple company that provides it insulation against ongoing and future tariff risks. Its portfolio of bakery, bread and snack products appear highly resistant to a weakening US consumer under the potential weight of a drawn-out trade war. While the company is undoubtedly subject to some higher input costs including grains, oils, eggs, transportation and so on, it is in a much more enviable place relative to other segments of the broader consumer sector. So far, the global impacts to input costs from the Ukraine-Russia conflict has had only marginal impact on their operating performance, and it does not appear to pose a major ongoing uncertainty for profitability. In their recent 10-K, management acknowledged uncertainty stemming from unknown tariff impacts, but again, manageable on a broader scale of consumer peers. The biggest long-term risk to a drawn-out economic downturn would appear to be consumers trading down from some of their premium, higher margin brands. FLO’s balance of branded retail to non-branded retail is about 64% to 36%, slightly higher over the past five years as they have shifted to higher margin growth areas. Nevertheless, the company still maintains a strong foothold in the bargain, lower-margin categories should the US consumer experience a lengthy downturn.
After terming out their bridge facility set up to fund the Simple Grains acquisition, FLO maintains a very solid overall liquidity profile. While the cash balance is extremely modest, the company has a $500 million revolving credit facility available to it through 2028. They also maintain an accounts receivable repurchase facility of $200 million that expires in 2026. They have a $400 million public debt maturity due next year, which likely gives them incentive to improve credit metrics over the interim. Cash flows have been extremely consistent over the past three years in the $500 to $600 million range with good free cash flow over those periods. The company’s relatively high dividend payout ratio could be curbed if management is struggling to hit its debt reduction targets.
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