Flowers Foods (FLO) sells bread and cake products under the Nature’s Own, Wonder, Cobblestone, and Tastykake brands, among others.  The company has a market cap of $3.9 billion and a dividend yield of about 2.9%.  Excluding the impact of spin-offs and divestitures, Flowers Foods (formerly Flowers Industries) has paid steady or increasing dividends since 1987.  The company’s stability comes from its strong brands in the slow changing bread and cake industries.

Flowers Foods is a Dividend Achiever as it has increased its dividend payments for 10 consecutive years.  Flowers Foods was founded in 1919 and is currently headquartered in Thomasville, Georgia.  Despite its long history, the company’s distribution currently only covers 70% of the US.  Flowers Foods business, competitive advantage, and future growth prospects will be analyzed in this article.

Business Overview

Flowers Foods operates in two segments:  Direct Store Distribution, and Warehouse.  The Direct Store Distribution segment was responsible for 85% of the company’s sales in its most recent quarter.  The Warehouse segment was responsible for just 15% of total sales in the most recent quarter.

The Direct Store Distribution segment delivers the company’s bread products directly to retailers.  The Warehouse segment delivers products (primarily Tastykake and frozen goods) to retailer distribution centers.  Flowers Foods core bread brands and the majority of sales and profits come from its Direct Store Distribution segment.

Competitive Advantage

Flowers Foods competitive advantage comes from its strong bread brands.  The Nature’s Own brand reached over $1 billion in sales in full fiscal 2013, on 17.2% sales growth versus 2012.  The company is the second largest baker in the US, behind only Grupo Bimbo.  Flowers Foods has a 14% market share in the bread, buns, and rolls category.  The company has grown its market share from 7.7% in 2009 to 14% today as the bread industry slowly consolidates.  The image below shows the slow consolidation of the bread industry in the US:

Source:  Flowers Foods Investor’s Presentation

Unlike most businesses with strong brands, Flowers Foods spends very little on advertising.  The company’s advertising costs were less than 1% of revenues in its full fiscal 2013.  Compare this to fellow Dividend Achiever Church & Dwight (CHD), who spends over 12% of revenues on advertising its products which include Arm & Hammer baking soda and Trojan condoms, among others.  Rather, Flowers Foods brand is supported by its long history in the extremely slow changing bread industry.  The company’s continued market share growth in bread shows they are successfully outcompeting bread rivals.

In addition to its recognizable brands, Flowers Foods also has a strong distribution network and large number of bakeries spread throughout the South and East portions of the US.  In total, the company has 46 bakeries in 16 states.  New entrants into the market will be hard pressed to match Flowers Foods economies of scale.

Growth Prospects, Dividend, & Shareholder Return

Flowers Foods growth prospects are solid.  The company currently serves about 80% the US population.  The company has plans to continue expanding through bolt-on bakery acquisitions and targeted expansions.  Flowers Foods has expanded its geographic reach substantially over the last decade, and will continue to do so going forward.

The company’s growth plans through geographic expansion have rewarded shareholders over the last decade.  The company has grown revenue per share at about 8.5% a year over the last decade.  EPS have grown at 14% a year on margin improvements.  The company’s dividend payments have grown even faster, at about 19% a year over the same time period.

Going forward, I expect Flowers Foods to continue delivering strong EPS growth.  The company’s management plans to deliver double-digit EPS growth through a mix of organic growth, share repurchases, and margin improvements.  The company is expecting between 5% and 10% organic sales growth.  I believe 5% to 7% is more likely.  The company still has significant room for margin enhancement.  Rising margins should boost EPS growth by 1% to 3% a year for the next several years.  Finally, share repurchases should add another 1% to 2% a year to EPS growth.  In total, shareholders of Flowers Foods can expect EPS growth of between 7% and 12% a year over the next several years.

Flowers Foods currently has a dividend yield of about 2.9%, with a payout ratio of about 60%.  The company’s payout ratio is reasonable; going forward, I expect dividends to grow in line with EPS.  Total return for shareholders should be between 10% and 15% a year from dividends (~3%) and EPS growth (7% to 12%).

Valuation

Flowers Foods is currently trading at a P/E ratio of about 21.  This is slightly higher than the S&P 500’s P/E ratio of 19.4.  Flowers Foods has commanded a P/E ratio premium of about 1.2x above the S&P 500’s P/E ratio over the last 5 years.   At current market prices, I believe Flowers Foods to be trading at the low end of its fair value.

Recession Performance

Consumers need to buy bread regardless of the economic environment.  As a result, Flowers Foods managed to grow EPS each year of the Great Recession of 2007 to 2009.  The company’s strength during recessions gives it the stability necessary to raise its dividend payments each year.  Flowers Foods EPS over the Great Recession are shown below to illustrate how well the company performed during the last recession:

• 2007 EPS of $0.45
• 2008 EPS of $0.57 (27% growth)
• 2009 EPS of $0.63 (11% growth)

Final Thoughts

Flowers Foods growth through recessions and stable cash flows give it a fairly low long-term price standard deviation of about 27%.  Flowers Foods is a high quality business operating in a slow changing industry thanks to its competitive advantages in baking.  The company is ranked in the Top 30 based on The 8 Rules of Dividend Investing.