For Those That Missed The Rally In Green Mountain Coffee, Look To TreeHouse Foods

Executive summary:

• TreeHouse Foods is poised to grow its single-serve coffee business from $180 million last year to $250 million this year.


• TreeHouse's lawsuit against Green Mountain has merit and I see a resolution favorable for TreeHouse, which is lead by an experienced litigation team.


• Look for further margin improvement this year as TreeHouse completes the integration of Cains Foods and Associated Brands.


• A debt refinancing next month will cut interest expense from $51.6 million to $41-$43 million.


• The company is also looking at M&A to continue growing its private label business.

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It's been a busy month for TreeHouse Foods (THS). First, the company filed suit against Green Mountain Coffee Roasters (GMCR) alleging anti-competitive practices in the K-Cup market. Second, the company reported EPS that beat estimates by $0.07. Revenues in the fourth quarter grew 11.4% year-over-year. I think Mr. Market is underestimating TreeHouse's market opportunity in the K-Cup business and I see its private label coffee business driving the top- and bottom-lines going forward. For investors that missed the move in Green Mountain, TreeHouse Foods is the stock to pay attention to.

Q4 results

The company posted strong results across the board. It was the first time in three years that the company posted growth in EPS, cash flow and sales. Net income increased by 14% as margins rose 130 basis points on the back of a 5% increase in sales. Adjusted EBITDA rose 12% to $95.5 million as the company benefited from strong sales and lower freight costs as the company's supply chain improvements appear to be paying off.

Sales rose 11.4% due to the acquisitions of Cains Foods and Associated Brands. Gross margins rose as well to 20.7% from 20.1% in Q4 of 2012. This was a positive since TreeHouse was integrating both Cains Foods and Associated Brands and there were costs associated with the acquisitions, integration, restructuring and facility consolidations.

TreeHouse's lawsuit against Green Mountain

TreeHouse has been quickly growing its presence in the single-serve coffee market. It's this growth that Green Mountain sees TreeHouse as a competitive threat, and why TreeHouse has in-turn sued Green Mountain.

In the lawsuit, TreeHouse alleges that Green Mountain's new Keurig 2.0 brewer, which will be launched later this year, contains anticompetitive lock-out technology that prevents cups from suppliers like TreeHouse from functioning. Basically, consumers are now able to use non-Green Mountain cups in their Keurig machines. Consumers have flocked to these cheaper cups and it is a threat to Green Mountain's business. Green Mountain wants consumers paying the higher prices for its Green Mountain cups.

Since TreeHouse entered the K-Cup market with its private label brands, it has grown from a zero revenue business to $180 millionat the end of Q4. It is obvious that Green Mountain sees upstarts like TreeHouse and its private label single-serve options as a competitive threat to its business. I do see the merit of the lawsuit and I think it will be favorable for TreeHouse and unfavorable in the long-run for Green Mountain. Leading the litigation team for TreeHouse is Winston & Strawn Chairman Dan Webb, who is one of the most respected litigation attorneys specializing in antitrust issues in the U.S.

Single-serve coffee still the main growth driver

TreeHouse's private label single-serve coffee and hot beverages posted $180 million in sales last year, which makes up roughly 8% of total sales. This also represented a 10% market share in the private label single-serve coffee and hot beverage market. This year, the forecast is for $250 million in sales for its single-serve coffee, or growth of almost 40% year over year.

TreeHouse is already the private label leader in the single-serve coffee market. This year I see TreeHouse continuing to grow its market share. The company plans to increase production capacity, ramp up promotions and invest in new products. Later this month, TreeHouse plans to introduce several new products and bring additional capacity online.

Plenty of growth ahead outside of single-serve coffee

The private label food business as a whole continues to thrive. Last year, sales of private label products across the board rose 2.7% compared to a drop of 6% in the mass merchant channel. For TreeHouse, the company saw the largest growth in its private label salsa business.

The company has also expanded its distribution to enter new markets. This year, TreeHouse will see sales gains from its recently added specialty tea and mayonnaise items. Perhaps most importantly, the recent acquisitions and new product introductions allow TreeHouse to continue its one truck, one invoice sales path.

By having many products within its portfolio, it allows grocers and merchants to look at TreeHouse as a one-stop shop. The sales teams are actively promoting this strategy and the supply chain efficiencies are already helping boost margins. I see further margin improvement later this year as the company continues to integrate both Cains Foods and Associated Brands on to this network.

Debt refinancing will lower interest expense

Next month, TreeHouse will refinance its high-yield notes that bear an interest rate of 7.75%. I see the company being able to refinance those notes in the low 5% range. This should bring interest expense for this year to $41 million to $43 million, down from $51.6 million last year.

The other interesting thing to note is that TreeHouse Foods is working with its bankers to expand its borrowing capabilities. This tells me that the company has its eye on an acquisition target. Management has shown prudence in making the right acquisitions and in growing the top- and bottom-lines. I really liked the Cains Foods and Associated Brands acquisitions and other similar acquisitions will set the company up for its next leg of growth.

CEO Sam Reed addressed his outlook for TreeHouse's M&A plans on the company's earnings call.

"Lastly, we anticipate that the M&A market for private label assets will be quite active in the months ahead. Sellers have at long last returned to the marketplace while credit remains plentiful and as the general business outlook improves. Accordingly, we have expanded our corporate development team, reviewed our capital structure and initiated discussions with our private label counterparts across the industry. As always, our priorities will continue to be strategy first and foremost, followed closely by value and fit."

2014 outlook

This year, the company is forecasting EPS of $3.50 to $3.60 a share. Consensus is for the company to earn $3.57. Over the last four quarters, TreeHouse has beaten EPS estimates by a cumulative total of 18 cents. That is why I think the range of $3.50 to $3.60 is on the low end and see company posting EPS of $3.65, which is still below the highest estimate of $3.67. Either way, this is a considerable jump from the $3.19 a share earned last year.

If we look at the private label coffee market for TreeHouse, it is growing in the double-digits. Last year, the hot beverage business grew 18% and the forecast is for the same growth rate this year. A good part of this is coming as more and more coffee machines make their way into not only homes, but businesses and restaurants as well.

For TreeHouse, the company has been adding capacity to meet market demand. The key to TreeHouse's success is that the company has perfected its rollout for its customers. Matter of fact, the company is now manufacturing product for branded coffee companies. On the earnings call, CEO Sam Reed laid out the company's go-to plan.

"And the fascinating thing about private label is that we can actually order a new machine, have it delivered and installed, test run, go into full-scale production in a shorter period of time than many of our customers and go through the internal decision process to not only select the product, but also importantly focus on the consumer testing and package design and all of those matters."

Look for further margin improvement this year

A big driver of margin expansion this year will be the completed integration of the two recent acquisitions, Cains Foods and Associated Brands. The key is that both are now in TreeHouse's distribution network. Now, TreeHouse can see the added benefits from transportation efficiencies. This all stems to ingredient sourcing and supply-chain efficiencies. I see margin improvement by about 150 basis points on the back of acquisition integration.

Bottom line

Green Mountain's new machine is just the latest effort for the company to try and get consumers to trade up and spend more. Ever since its patents expired in 2012 and TreeHouse started grabbing market share in the single-serve coffee market, Green Mountain has been looking to shut companies out of the market if they don't have a licensing deal with Green Mountain.

Unfortunately for Green Mountain, it is like the big pharma companies when the generics come along. Market share deterioration is inevitable. For investors looking to play the single-serve space, I'd look to TreeHouse Foods as it offers a better value than Green Mountain. TreeHouse Foods trades at an EV/EBITDA multiple of 11.05, compared to Green Mountain's multiple of 17.49.

Source: For Those That Missed The Rally In Green Mountain Coffee, Look To TreeHouse Foods

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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