Sunday 26 February 2012

Post Holdings – A Classic Case of Spin-off (continued)


A reader emailed us on the following, thought we share it over here.

"......they are already coming on the market with 716m in debt and they just issued another 775m, with the proceeds to go to Ralcorp. Am i reading this correctly that this means 716m old debt + 775m new debt =1.5billion in total debt?? With no cash?? This kind of debt dwarfs the 100+m free cash they are generating as it will take them more than a decade to pay off their debt and its not like they are a high-growth company.....
Although the cash flows look ok, their revenues are decreasing from 2009, 2010 and 2011. As much as i love their cereals, something else is catching peoples breakfast attention....."

Our reply as follow:

All the information that you need can actually be found in the Post fillings prior to the spin-off. In case you dont have the time to look through, below is an extract where they mentioned about the debt issuance:

"As part of the separation, we expect to incur approximately $950 million of new indebtedness, which we expect to consist of $175 million aggregate principal amount of borrowings under a senior secured term loan facility and $775 million in aggregate principal amount of senior notes. We will not receive any proceeds from the senior notes, which we expect to initially issue to Ralcorp in connection with the separation. We expect that approximately $125 million of the proceeds from the term loan facilities will be transferred to Ralcorp in connection with the separation and to directly or indirectly acquire the assets of the Canadian operations of the Post cereals business. Of the remaining $50 million in proceeds, we expect to retain approximately $25 million after payment of fees and expenses relating to the financing transactions."

In summary, the total debt they will incur is as follow:

Debt Interest expense
Senior Notes 775 7.38% 57.16
Term loan 175 8% 14
71.16

Hence, not a problem at all, using the above calculation, their yearly interest expense would only be about $71M.

For your concern on their decreasing revenue, bear in mind that all other cereal makers are also affected due to the weak economy. Furthermore, we believe it is over exaggerated as their market share only drops from 12% to 11% from 2009 to 2011 and this is due to their decreased spending in marketing and higher pricing of their cereals.

Hope this finds you well.

Buffet's 2011 Shareholder Letter!

It never fail to give us tremendous joy to read Buffet's shareholder letters. The 2011 letter is finally out and what can be compared to a day, sitting at our favourite Starbucks outlet, reading this piece of gem!

Enjoy.

http://www.berkshirehathaway.com/letters/2011ltr.pdf

Thursday 16 February 2012

Post Holdings – A Classic Case of Spin-off

Spin-offs are often great places to look at as value is often created from the underpricing of the business being spun off.

The most recent example is the spin-off of Post Holdings from its parent, Ralcorp Holdings. Post is the maker of branded cereals while Ralcorp basically does private-brand food products. A classic example of spin-off whereby the 2 businesses target different consumer segments.

As Post is more of a premium product player, they are more sensitive towards market conditions. Existing shareholders of Ralcorp would dump the shares of Post after spin-off in view of today’s recessionary-like environment. In addition, the newly spun-off Post would not be covered by most analysts and it would take a while before their value get realized.

Post was spun off at $26.89 and went down to $25.51 the next day. We managed to buy in at the cost price of $25.54, and now the stock is trading at $31.02! That's a nice return of almost 21%! Nothing to cheer about though, as we could have bought more but did not as we succumbed to being greedy and hoping the price would go down more. The good news is even at current price, Post is still a great buy.

The current enterprise value of Post at a stock price of $31.02 is about $2B. Ralcorp bought Post from Kraft a few years back at a price of $2.6B, that’s a difference of almost $600M. Of course, it might not be a fair comparison as they might have overpaid. But take a look at the numbers:


2009
2010
2011
Operating Profit
215.2
190.8
-305.6
Impairment

19.4
503.5
Adj. OP
215.2
210.2
197.9
Interest Expense
58.30
51.50
71.16

156.90
158.70
126.74
After Tax
101.99
103.16
82.38
EPS
2.96
2.99
2.39






Ave. EPS
2.78


Current P/E
11.17

After adjusting for goodwill impairment, their average EPS is about $2.78, which translates to a PE of about 11.17. As compared to the other cereal makers, they are trading at the lowest valuation for a consumer franchise business, which we believe, should be valued at a higher PE.


Kellog
General Mills
P/E
14.7
15.8
Valuation
40.84
43.89
Upside Potential
32%
41%
Margin of safety
24%
29%

At current price level, there is an upside of almost 32% to 41% if they move up to the valuation of their competitors. Furthermore, their earnings are depressed in the current environment.

Take a look also at their price to book ratio compared to the rest.


Post
Kellog
General Mills
P/B
0.81
10.2
3.6

Post is currently trading below their book value. They should be at least valued at price to book of 1 for a company that is still churning out positive cash flows. Adjusted EBITDA of $275M and $256M for 2010 and 2011 respectively.

Long Post Holdings.