Steeper Prices Aren't Damping Consumer Demand for Narrow-Moat Hostess' Products

Senior Equity Analyst

Rebecca Scheuneman

In the past five years, Hostess averaged 6% organic sales growth, materially outpacing the 2%-3% growth of the sweet treats categories per Euromonitor. Market share gains were driven by compelling innovations, as Hostess has developed an effective innovation process due to significant investments in talent and tools over the last few years. Hostess mines consumer data to better understand the factors that drive snacking occasions, analyzes where current offerings are not meeting consumer needs, and develops products that specifically target these needs. Hostess has identified five snacking occasions it will focus on that represent a collective market of $50 billion (in relation to the $15 billion market that it currently operates in), with each occasion growing at a mid-single-digit pace. These occasions are morning sweet start, lunchbox, afternoon reward, immediate consumption, and afternoon sharing.

We believe the Hostess brand’s demonstrated pricing power, selling at a consistent premium to its branded competitors, provides evidence of an intangible asset. In addition, we believe Hostess is a valued partner in the convenience store channel (supporting another facet of the firm’s intangible edge), where the sweet baked goods category drives a material portion of channel revenue and Hostess is the market share leader. These competitive advantages lead to our narrow moat rating.

Hostess has created significant shareholder value via its disciplined acquisition strategy. Although the 2018 Cloverhill acquisition initially depressed margins, the business is now generating healthy profits, and the deal provided a breakfast platform and access to the club channel, where the firm is expanding the Hostess brand. We think the January 2020 Voortman Cookies acquisition also adds material value, as the business' expected 5% long-term sales growth does not dilute the firm's sales trajectory, margins are comparable with those of the highly profitable Hostess brand, and as the top-selling brand of sugar free cookies, provides a brand to leverage in the growing better-for-you snacking segment.

Business Strategy & Outlook

The Hostess brand has exhibited impressive staying power, despite changing consumer dietary preferences over the brand’s 100-year history, and as such, we award Hostess a narrow economic moat rating based on the firm’s brand intangible assets. Although the previous owners of the Hostess brand filed for bankruptcy in 2004 and 2012, we contend it was due not to a lack of brand equity but rather highly inefficient manufacturing and distribution systems, a powerful unionized workforce, and a high debt load. Furthermore, a lack of financial flexibility limited the company’s ability to respond to consumers’ changing desires, resulting in declining sales as low-carb diets and clean eating movements swept the nation. Changes to the company’s cost structure were insufficient during its initial reorganization, which led to the second trip to bankruptcy court. However, the current company is not the result of another reorganization but the creation of an entirely new company. After the 2012 bankruptcy, investors purchased only the brand rights and recipes from the bankruptcy court, freeing them of employee benefits and other labor obligations that had weighed down the company in the past. 

Despite a broad move toward healthy and clean eating, consumers seem to feel nostalgic about the Hostess brand, generating a public outcry at the firm’s 2012 bankruptcy with many reports of consumers stocking their freezers with the sweet treats in fear of no longer having access to them. However, we think the most impressive and relevant evidence of the brand’s enduring intangible asset value is its demonstrated pricing power, with the Hostess brand selling at a consistent premium to its branded competitors across all products. Hostess is the second-largest brand in the sweet baked goods category, and its products sell at a material premium to the number-one brand, Little Debbie. 

The significant price premiums have not deterred consumers. Hostess has steadily increased market share of the sweet baked goods category since its July 2013 relaunch, from 7.4% in 2013 to 21.3% in 2021, according to Nielsen. The top three brands account for 65% of the category, while the rest of the category is fairly fragmented. Private label is only 9% of the category, compared with 16%-17% for overall packaged food per Euromonitor, implying that consumers show a strong preference for trusted brands in this category. 

We believe that a second source of Hostess’ brand intangible asset advantage is its status as a valued partner in the convenience store channel. We think the cakes, pastries, and sweet pies category is a significant category for c-stores, ranking as the channel’s 10th-largest category per GlobalData. The morning goods category, which Hostess also plays in, is a top 20 category. Hostess is the number-one player in the sweet baked goods category in this channel, with 30% share in 2021, according to Nielsen. It is the largest channel for Hostess, representing over 40% of the firm’s point-of-sale retail sales, or about 30% of company sales (as c-store products have a higher average retail markup). Hostess works closely with its retail partners to optimize revenue in this highly impulsive category, in which merchandising can have a large impact on sell-through. In fact, management has said display merchandising is a more significant driver of sales than price for the category. We believe that Hostess supports its retail relationships with the significant amount of data it has amassed on consumer purchasing patterns for sweet baked goods, and we anticipate that it will continue to harness these insights to optimize category shelf space for its retail partners. 

Although the firm has opted to build out its mix through a handful of acquisitions to enhance its growth trajectory and diversify its category exposure, we continue to believe that its namesake brand is where its competitive edge is (which accounts for the vast majority of revenue and profits). In 2018, Hostess acquired Aryzta’s breakfast business, consisting of cinnamon rolls and Danish pastries sold under the brands Cloverhill and Big Texas, which have a strong presence in the value, vending, and club channels. This business also includes contracts to provide breakfast items for retailers to sell under their private-label brands. In 2020, Hostess acquired Voortman Cookies, the market leader in wafer cookies and sugar-free cookies. Despite these leading positions, the brand does not exhibit signs of strong equity, such as pricing power or even significant brand awareness. While these new offerings could further aid Hostess' sales prospects, we do not believe these additional businesses contribute to Hostess’ competitive advantage, given their smaller size and the fact that they have not demonstrated pricing power sufficient to imply the presence of a competitive advantage.

Further, we do not believe that Hostess has a scale-based cost advantage, even though profitability has improved as the new management team essentially built the company in its current form from scratch. It started by capitalizing on new extended shelf-life technology (which comes in the form of an enzyme provided by an ingredients partner) that increases shelf-life from 25-30 days to 60-65 days, enabling the firm to switch from the expensive direct-store-delivery model to the more cost-effective direct-to-warehouse model. Previously, the products had to be partially made in a central facility, then distributed to regional bakeries closer to the end customers to be baked and further distributed. With the new ESL technology, that is no longer necessary, and Hostess’ supply chain has been dramatically simplified (from 33 bakeries to 5, from 565 distribution centers to 3, from 18,500 employees to 1,350, and from an 80% unionized workforce to 30%). These improvements reduced transportation and distribution costs from 34% of revenue to less than 20%. In addition, the new company was launched with energy-efficient automated ovens and automated production lines. It simplified manufacturing by reducing the number of items it produces by 40% while improving capacity utilization from 50% to 80%. As a result, the firm’s manufacturing cost per case declined 17%. The financial impact of these changes has been significant, with operating margins for the old company averaging a low-single-digit loss while averaging a mid-20s profit for the new firm. We believe that Hostess’ direct-to-warehouse model provides certain cost advantages over its competitors’ direct-store-delivery models. However, as the DTW model as well as its automated and efficient ovens can be replicated, we do not consider it an enduring competitive advantage. In addition, Hostess does not have the same scale as its larger competitors: Flowers Foods (owner of the Tastykake brand), Grupo Bimbo (Entenmann's), and privately held McKee Foods (Little Debbie). In 2021, Hostess had $1 billion revenue in the U.S. and Canada to support its infrastructure in those regions, which pales in comparison to $4.4 billion for Flowers, $8.2 billion for Grupo Bimbo, and $2 billion for McKee, supporting our contention that it has failed to garner a cost-based edge. 

Hostess reports very healthy ROICs (including goodwill) of around 15% on average over the past three years, well above our 7% estimate of the firm’s cost of capital. We think this offers quantitative support for the presence of a competitive advantage. Further, we believe that it is poised to continue generating excess returns for the next decade.

Narrow

Economic Moat

Hostess Brands

Hostess Brands, Inc. engages in developing, manufacturing, marketing, selling and distributing baked goods. It operates through Snacking segment, which consists of sweet baked goods, cookies, bread and buns, and frozen retail products that are sold under the Hostess®, Dolly Madison®, Cloverhill®, Big Texas®, and Voortman® brands. The company was founded in 1919 and is headquartered in Lenexa, KS.

Earnings data Q2 2023

Revenue

Cost of revenue

Gross profit

Operating expenses

SG&A

Other

Operating income

EBITDA

Net income

Earnings per share

Total assets

Current assets

Cash & equivalents

Receivables

Inventory

Non-current assets

Net PPE

Intangibles

Total liabilities

Current liabilities

Short term debt

Income tax payable

Non-current liabilities

Long-term debt

Total equity

Stockholders equity

Minority interest

Total liabilities & equity

Total debt

Net debt

Book value per share

Cash from operations

Funds from operations

Change in working capital

Cash from investing

Capital expenditure

Purchase/sale of investments

Purchase/sale of business

Other sources

Cash from financing

Change in stock

Change in debt

Cash dividends paid

Cash from other sources

Net change in cash

Free cash flow

Hostess Brands, Inc. engages in developing, manufacturing, marketing, selling, and distributing baked goods. It operates through the Snacking segment, which consists of sweet baked goods, cookies, bread and buns, and frozen retail products that are sold under the Hostess, Dolly Madison, Cloverhill, Big Texas, and Voortman brands. The company was founded in 1919 and is headquartered in Lenexa, KS.

LENEXA, Kan.--(BUSINESS WIRE)--Hostess Brands, Inc. (NASDAQ: TWNK, TWNKW) (“Hostess” or the “Company”), today reported its financial results for the fourth quarter and year ended December 31, 2020. “I am proud of the many accomplishments our team achieved during this unprecedented year. Hostess achieved our 12th consecutive quarter of net revenue growth with double-digit revenue and EBITDA growth in the fourth quarter. We remain informed, nimble and focused on our commitment to keeping our empl

Hostess Brands, Inc. Announces Strong Fourth Quarter and Full Year 2020 Financial Results

LENEXA, Kan.--(BUSINESS WIRE)--Hostess Brands, Inc. (Nasdaq: TWNK, TWNKW) (the “Company”), a leading manufacturer and marketer of snacks including Twinkies®, CupCakes, Ding Dongs®, Donettes®, Voortman® wafers and cookies and a variety of other new and classic treats, announced today it will report results for the fourth quarter and full year ended December 31, 2020 on Wednesday, February 24, 2021 after market close. The Company will host a conference call to discuss these results at 3:30 p.m. C

Hostess Brands, Inc. to Report Fourth Quarter and Full Year 2020 Financial Results on February 24, 2021

Adobe

Cannae Hlds

Dollar Tree

Lululemon Athletica

Hopes of a more significant stimulus and a quickening vaccine roll-out as Joe Biden preps to take office helped market sentiment as well. For investors looking to make the most of this market, the deep learning algorithms at Q.ai have crunched the data to give you a set of Top Buys.

Top Stocks To Buy Today As S&P And Nasdaq Hit Record Highs

B&G Foods

Hain Celestial Group

Sprouts Farmers Markets

Companies like BG Foods (BGS), Hain Celestial Group (HAIN) and Sprouts Farmers Market (SFM) are likely to gain on coronavirus fears.

4 Food Stocks to Buy as Coronavirus Takes a Worse Turn

Companies BG Foods (BGS), Hain Celestial Group (HAIN) and Sprouts Farmers Market (SFM) are likely to benefit in the near term given that the coronavirus fears might once again compel people to stockpile on food items.

4 Food Stocks to Buy as Coronavirus Fears Rise Again

JPMorgan on Wednesday added the bakery company Hostess Brands Inc (NASDAQ: TWNK) to its U.S. Analyst Focus list, reports CNBC. What Happened: The investment bank believes that Hostess' stock needs a price correction to reflect its growth.

Twinkies Maker Hostess Likely To Be A 'Strong Outperformer' In 2021, JPMorgan Says

Collection of iconic brands in the growing snack market. Positive financial results with recent strategic acquisition.

Hostess Brands, Inc.: Satisfy Your Sweet Tooth

LENEXA, Kan.--(BUSINESS WIRE)--Hostess® is serving up a whole new kind of treat as it launches the Hostess e-store, an e-commerce site with a growing selection of branded merchandise ranging from clothing and jewelry to bags and drinkware. The site comes just in time for the holidays, allowing Hostess to be part of the happiest season of all in a whole new way. For the first time, Hostess lovers have access to a wide array of merchandise designed with their passion and brand loyalty in mind. Th

Have Your Cake and Eat it Too: Hostess Brands Launches E-Store Stocked with Apparel, Accessories and Goodies Galore

One analysis firm thinks the Twinkie maker's stock has some tasty growth potential.

Hostess Brands Wins a Rare 40% Upside Endorsement

Hostess Brands, Inc. (TWNK) CEO Andy Callahan on Q3 2020 Results - Earnings Call Transcript

Hostess Brands (TWNK) delivered earnings and revenue surprises of 11.76% and 2.58%, respectively, for the quarter ended September 2020. Do the numbers hold clues to what lies ahead for the stock?

Hostess Brands (TWNK) Beats Q3 Earnings and Revenue Estimates

KANSAS CITY, Mo.--(BUSINESS WIRE)--Hostess Brands, Inc. (NASDAQ: TWNK, TWNKW) (the “Company”), today reported its financial results for the three and nine months ended September 30, 2020. “We are very pleased with the double-digit revenue growth and continued EBITDA margin expansion in the quarter driven by the strong profit accretion from our Voortman business and continued growth of the Hostess®-branded business. We are encouraged by the steady return of the convenience channel and our achiev

Hostess Brands, Inc. Announces Third Quarter 2020 Financial Results

LENEXA, Kan.--(BUSINESS WIRE)--Hostess Brands, Inc. (Nasdaq: TWNK, TWNKW) (the “Company), a leading manufacturer and marketer of sweet baked goods and cookies including Twinkies®, CupCakes, Ding Dongs®, Donettes®, Voortman and a variety of other new and classic treats, announced today it will report results for the third quarter ended September 30, 2020 on Thursday, November 5, 2020 after market close. The Company will host a conference call to discuss these results at 3:30 p.m. Central Time (4

Hostess Brands, Inc. to Report Third Quarter 2020 Financial Results on November 5, 2020

KANSAS CITY, Mo.--(BUSINESS WIRE)--Hostess Brands, Inc. (Nasdaq: TWNK, TWNKW) (“Hostess” or “the Company”), a leading manufacturer and marketer of sweet baked goods and cookies including Twinkies®, CupCakes, Ding Dongs®, Donettes®, Voortman® and a variety of other new and classic treats, announced today that Dean Metropoulos has notified the Company that he will resign from the Company’s Board of Directors at the end of 2020 in order to pursue other commitments. Current independent director Jer

Hostess Brands, Inc. Announces Changes to Board of Directors

LENEXA, Kan.--(BUSINESS WIRE)--As the leaves begin to turn and consumers seek out the comfort of warmer flavors packed with spice, Hostess Brands, LLC announces its most generous lineup of limited time-only products yet, filled with returning fall favorites and new flavors alike.

Hostess Spices Up Fall with Festive New Flavors and Returning Fan Favorites

LENEXA, Kan.--(BUSINESS WIRE)--Hostess Brands, LLC (“Hostess Brands”) is expanding its voluntary recall of certain Hostess® Raspberry Zingers® because the product may develop mold prior to the best by date.

Hostess Brands, LLC Expands Voluntary Recall of Certain Hostess® Raspberry Zingers® Due to the Potential for Mold

Hostess Brands, Inc.'s (TWNK) CEO Andy Callahan on Q2 2020 Results - Earnings Call Transcript

LENEXA, Kan.--(BUSINESS WIRE)--Amid evolving consumer taste preferences and an upward shift in snacking behaviors, Hostess Brands has opened a new, world-class Innovation Lab to support the Company’s ongoing commitment to crowd-pleasing product innovation.

Hostess Brands Invests in Future Product Development with New Innovation Lab

HOSTESS BRANDS (TWNK) delivered earnings and revenue surprises of 46.67% and 1.38%, respectively, for the quarter ended June 2020. Do the numbers hold clues to what lies ahead for the stock?

HOSTESS BRANDS (TWNK) Q2 Earnings and Revenues Surpass Estimates

KANSAS CITY, Mo.--(BUSINESS WIRE)--Hostess Brands, Inc.

Hostess Brands, Inc. Announces Second Quarter 2020 Financial Results

Verra Mobility Corp

The Gores Group is making a name for itself by becoming the King of SPACS.

Gores Group Launches Its Fifth SPAC. Should You Invest?

HOSTESS BRANDS (TWNK) doesn't possess the right combination of the two key ingredients for a likely earnings beat in its upcoming report. Get prepared with the key expectations.

Analysts Estimate HOSTESS BRANDS (TWNK) to Report a Decline in Earnings: What to Look Out for

Flowers Foods

Kraft Heinz

Stay-at-home orders had left people with no choice but to eat at home, which saw them buying everything from groceries to comfort food to packaged food.

At-Home Eating Habit Spurs Packaged Food Sales: 5 Winners

Hostess Brands, Inc. to Report Second Quarter 2020 Financial Results on August 5, 2020

LENEXA, Kan.--(BUSINESS WIRE)--Hostess Brands, LLC (“Hostess Brands”) is voluntarily recalling certain Hostess® Raspberry Zingers® because the product may develop mold prior to the best by date.

News for Hostess Brands Stock (TWNK)