Hillshire Brands today (12 May) unveiled plans to acquire US peer Pinnacle Foods in a cash-and-shares deal worth US$6.6bn. The company argues the deal will bring operational benefits, competitive advantages and cross-selling opportunities. However, the high level of debt Hillshire will take on may raise some eyebrows. Katy Askew reports.
Shares in Hillshire Brands sank around 6% in morning trade today (12 May), after the maker of Jimmy Dean sausages announced plans to acquire Duncan Hines and Wish-Bone owner Pinnacle Foods.
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The share price drop is likely a reflection of concerns over the debt levels Hillshire will take on to fund the deal, coupled with confirmation it will freeze its dividend payment at 70 cents a share for the “foreseeable future” and cancel its share buyback programme.
Speaking to analysts during a conference call ahead of the bell today, Hillshire CFO Maria Henry said the deal would be funded by issuing 59m new shares and raising $4.8bn in debt. After the deal is completed, Hillshire’s debt-to-EBITDA ratio will stand at about five times, she revealed.
However, Henry was confident on the group’s ability to return the firm to investment grade within three years given the “strong cashflow” the enlarged entity will generate.
And, while Wall Street may not have been thrilled at the prospect of capped investor returns, the strategic rational behind the deal is sound when viewed through a long-term lens, Morningstar analyst Ken Perkins observed.
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By GlobalDataPerkins told just-food: “The strategy seems to make sense but they are taking on a lot of debt and that places limits on what they can do with their cash.”
The merger will create a “leading US food company”, Hillshire CEO Sean Connolly stressed today. The combined company will be the third-largest player in the frozen category, bring together the Jimmy Dean and Birds Eye brands. It will also boast a strong presence in chilled and significantly beef up Hillshire’s centre-store footprint with ambient brands including Wish-Bone salad dressings and Duncan Hines baking mixes.
It might seem ironic Hillshire – a company formed out of a desire for focus when Sara Lee sold off its various businesses including European coffee – is seeking to diversify its footprint. But Connolly insisted an enlarged Hillshire will remain focused while simultaneously benefiting from the greater scale the deal will bring.
“What we are now is a focused food company. We are not what you would call a pure-play meat company but we are a pure-play branded convenient food company in the United States.”
Increased might across categories will enable Hillshire to strengthen its relationship with retail customers, Connolly continued.
“What you can see right now in retailer landscape… they are looking for performance and want to work with companies who are performers… We have benefited from that in frozen… I anticipate that there will be a similar level of excitement from our customers for opportunities to generate growth in the centre of the store… I think our customers are looking for manufacturers that are going to drive innovation and help their brands remain strong.”
Hillshire expects its brands – such as recent addition Golden Island beef jerky – to profit from Pinnacle’s “experience and credibility” in the centre of the store. Meanwhile, Hillshire will drive the growth of Pinnacle’s business through “a disciplined approach to innovation”, the chief executive continued.
The company also plans to use the relationship it has built with consumers who buy products around “meal occasions” and can be fed through to the firm’s expanded and complementary brand profile.
Ernst and Young analyst Andrew Cosgrove suggested a a significant upside of Hillshire’s move to diversify is the reduced exposure to swings in commodity input prices.
Pork meat, one of Hillshire’s primary input costs, has jumped in price due to factors including the PED virus, drought and high feed prices.
“Hillshire’s focus around protein has made it one of the few firms able to post strong organic top line growth in this environment, but also left it vulnerable to margin pressure, especially with pork inflation rising. By shifting from a pure-play to a strong “centre of the store” player, Hillshire is effectively diversifying that risk,” he said today.
While Hillshire believes that scale can enable it to accelerate growth in the low-to no-growth environment of US retail, the firm maintains it can also strengthen margins.
Hillshire has predicted it will generate an estimated $140m in annual cost synergies by the end of the third year. This will be achieved on top of the group’s current efficiency initiatives, management stressed.
About half the savings will come from SG&A costs and half will be achieved by improving the gross margin, Henry revealed. “SG&A mostly relate to redundancies you would expect to have when you bring two companies together. On the supply chain side, the gross margin, most of that is related to procurement and savings on transportation.”
When the merger process is complete, Hillshire hopes to emerge a stronger, more efficient force in the food sector. Much will, however, depend on its ability to adopt a disciplined approach to capital management and reduce debt levels effectively in the coming years.
