Boulder Brands: Does The Gluten-Free Opportunity Justify The Valuation

Gluten-free products are the growth engine for Boulder Brands (BDBD). Certain consumers require gluten-free products for medical reasons, but Boulder Brands believes that the potential for gluten-free products is much wider. Bulls argue that the benefits of gluten-free foods extend to the broader population and consumers will gravitate toward gluten-free over time. Bears argue that only a small segment of the population really requires gluten-free food and the much hyped gluten-free diet (for the broader population) is a fad. In the near term, the company has the potential to benefit from new gluten-free labeling as well as broader distribution and an expanded product offering. With the company trading at a high valuation, after a nice rally, is the optimism about gluten-free already priced-in or is there more upside?

Background

The company started as a SPAC in 2005. In 2007 it acquired GFA brands, which was known for the Smart Balance spreads and adopted the Smart Balance name following the acquisition.

In 2011, the company pivoted toward the gluten-free market with the acquisition of Glutino for $66 million. In 2012, it expanded the gluten-free platform with the acquisition of Udi's for $127 million.

In January 2013, the company changed its name to Boulder Brands.

Today, its main brands are:

Smart Balance - $208 million 2012 salesUdi's - $88 million 2012 salesGlutino - $76 million 2012 salesEarth Balance - $39 million 2012 sales

Boulder Brands is organized in two segments: Smart Balance and Natural (the gluten free products and Earth Balance).

As a result of the Udi's and Glutino deals, the company is now more focused on the gluten-free category and has a higher growth trajectory.

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(Source: BDBD presentation at Canaccord conference, August 15, 2013)

Gluten-free Market

According to Boulder Brands! , the gluten-free category is approaching $500 million.

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(Source: BDBD presentation at Canaccord conference, August 14, 2013)

On the recent Q2 earnings call, Boulder Brands' CEO, Stephen Hughes, said:

"I personally believe that over the next 3 to 5 years, 10% of all gluten-full categories either going to go away or they're going to go gluten-free." (Source: BDBD Q2 earnings call, Seeking Alpha)

Gluten-Free: Fad Or Not

For the 3 million people with celiac disease, gluten-free is a necessary part of life.

According to the company, another 85 million people are gluten intolerant or suffer from chronic conditions and may benefit from a gluten-free diet. I have no medical background and cannot asses this assumption.

Assuming that the target market includes these 85 million consumers, it is important to recognize that the company (and the medical community) would need to do a lot of market education to teach these people about the benefits of a gluten-free diet. This will take time.

Furthermore, it is possible to live a gluten-free lifestyle without consuming the products of Boulder Brands. The company's main products are gluten-free breads, pizzas and snacks. If you can't have gluten-based breads, pizzas and snacks, then the gluten-free option is attractive. But, you can be gluten-free without these products, especially if they are relatively expensive.

Similarly, the company includes 35 million "health seekers" as potential customers.

I am a "health seeker" that tries to maintain a "gluten-reduced" diet. I tried to be gluten-free, but it is very hard to maintain and there are lots of trade-offs (taste and price).

Over time, gluten-free products may improve (in terms of taste and price) and I may transition to more gluten-free breads, etc., but I am not there yet. I expect that many health seekers! (and aff! luent consumers) would spend a bit more for gluten-free products if there are no trade-offs in terms of taste.

It may seem odd that health seekers would be core customers for frozen pizzas and snacks. The hard-core health seekers may avoid frozen pizzas, even if they are gluten-free. But a large part of the health seeker population seems to be "incremental" health seekers. They don't have the time, energy or desire to go all the way, but are willing to take incremental measures toward a healthier lifestyle. This seems like the target market for Boulder Brands within the health seeker population.

There are many nuances to the debate about the gluten-free market. In the near-term, the potential for Boulder Brands will be determined by its execution and not the market size. It may also get a boost from new gluten-free labeling.

Labeling

On August 2, 2013, the FDA announced new rules for gluten-free labeling.

Gluten-free labels will bring more attention to gluten-free products and could boost demand.

On the last conference call, CEO Stephen Hughes said:

"So I think that grocery is going to come quickly, but I think this is going to be the next 24 -- next 12 to 24 months is going to be pretty remarkable here. I think you're going to see ubiquity of gluten-free sections." (Source: BDBD Q2 2013 earnings call, Seeking Alpha, bold added by author)

Gluten-free labeling, and the attention it receives, may be a driver for the growth of gluten-free sections.

Market Share

The company believes that it has about 31% share of the gluten-free market with its Udi's and Glutino brands.

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(Source: BDBD presentation at Canaccord conference, August 14, 2013)

The CEO described the positioning of the brands as:

"Glutino is a brand that the hard-core celiac trust because it's been there for years. Udi's is a! product ! that is great tasting that happens to be gluten-free." (Source: BDBD Q2 earnings call, Seeking Alpha)

Execution

The company needs to execute successfully on two fronts: expanding the product offering and expanding the distribution channels.

Boulder brands places 18 of its products in conventional supermarkets, on average. The penetration of Udi's products has been growing rapidly, while Glutino's growth has been more modest.

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(Source: BDBD presentation at Canaccord conference, August 14, 2013)

Boulder Brands expects to expand its placement to 20 products by year end (source: BDBD Q2 earnings call, Seeking Alpha).

The company is also expanding its distribution channels. Its core is organic/natural supermarkets and it has been expanding into conventional supermarkets. It is also pursuing additional channels. CEO Stephen Hughes said on the recent conference call:

"In alternative channels, club and drug, we are in early stages of engagement, and these channels could potentially open to significant businesses in 2014 and 2015." (Source: BDBD Q2 earnings call, Seeking Alpha)

More products and more channels. Those are the near term opportunities.

On October 7, 2013, Boulder Brands appointed James Leighton to serve as COO. He had been on the board of directors and will continue in that role as well. His background is:

"James B. Leighton brings more than 35 years of operations, general management and manufacturing experience within foodservice, retail and international channels and has been a key contributor to Boulder Brands' board of directors since August 2007. Mr. Leighton comes from Perdue Foods, a large privately-held food and protein company, where he was President since 2009; and was the Senior Vice President of operations and supply chain from 2006 to 2009. From 2002 to 2006, Mr. Leighton served a! s the Sen! ior Vice President of Operations of ConAgra Foods, Inc., one of the largest food companies in the United States. He has also held senior level management, operations and executive positions with Celestial Seasonings, The Hain-Celestial Group, and Nabisco." (Source: BDBD press release, October 7, 2013)

The addition of a COO seems like a good move considering the execution challenges/opportunities ahead.

The company also appointed Benjamin Chereskin to its board of directors. Chereskin has a lot of private equity experience.

Competition

Boulder Brands' competitors are not ignoring the gluten-free opportunity.

General Mills offers more than 300 gluten-free products, including many snacks and many products under the Betty Crocker brand.

Even Barilla offers gluten-free pastas.

This seems like validation of the gluten-free category. But, it is also competition for Boulder Brands.

In a recent interview, CEO Stephen Hughes commented on the competition from larger companies:

"We don't really see any empirical evidence that it's impeding our growth at all. As more of these large guys get into it, they are going to do it somewhat defensively, to flank their current businesses. Given the uniqueness of the packing of these products, in many cases, when they launch a gluten-free product, it's going to be a lower-margin proposition than their gluten-full businesses. We're spending significant marketing dollars developing a good relationship with a gluten-sensitive and gluten-concerned consumers. I don't see anybody else focused that way. That could change in the next couple of years [but] if we get any competitive pressure in any particular channel, we have all kinds of white space opportunity. I don't lose sleep on that." (source: Interview: Boulder Brands CEO Stephen Hughes)

Boulder Brands vs. Annie's

There are many similarities between Boulder Brands and Annie's (BNNY). Annie's is best known for its Mac & Cheese products, but pizzas and snacks ar! e key pro! ducts for both companies.

While Boulder Brands focuses on gluten-free, Annie's is more skeptical about the category.

Annie's CEO John Foraker recently explained Annie's approach to gluten free (which highlights the difference between the two companies):

"Our strategy in gluten-free is to offer a limited assortment of great tasting products like giving consumers a gluten free choice in each of our key categories, those items are doing exceptionally well, they have been growing faster than the total business for quite some time. But, we also are cognisant that some consumers are in gluten free for diet reasons or other things which may be not as sustainable, so we want to make sure that we have products that taste great" (Annie's presentation at Barclays conference, September 4, 2013, no transcript available, but comments come around minute 30:00).

For more about Annie's please see my article: Annie's: A Healthy Valuation For Natural Foods Growth.

Smart Balance

Smart Balance contributed approximately 48% of Boulder Brand's LTM revenue.

Smart Balance sales have been in decline and the key patents for Smart Balance's products are due to expire in 2015 (source: BDBD 2012 10-K).

However, even if competitors start to produce similar products, consumers may stick with the Smart Balance brand because they are used to it.

The patent expiration is a headwind, but it is too soon gauge its impact. The decline in Smart Balance, even before the patent expiration, is also a cause for concern.

Financials

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Valuation

Boulder Brands is trading at a high valuation: 17.5x TEV / LTM Adj. EBITDA and 51.4x 2013 P/E.

This valuation may be justified if you believe in the growth opportunities, but it means that a lot of optimism is already priced-in at these levels.

Furthermore, the company has $237 mi! llion of ! debt. It refinanced its credit facility earlier this summer. The new credit facility gives the company more balance sheet flexibility and removes some of the concerns about its liquidity.

Considering the debt balance and the high equity valuation, I wonder if the company would take advantage of the increase in the stock price to do an equity offering to raise more capital for growth. Shareholders should, at least, consider the possibility of dilution from an equity offering.

A clean balance sheet would give the company more flexibility to pursue growth, especially if it expects some headwinds from the Smart Balance business.

Comparable Company Analysis

I compare Boulder Brands to two sets of comps:

Organic / Health Foods companies:

Hain Celestial (HAIN)WhiteWave (WWAV)Annie's

Best In Class Food Companies:

Coca-Cola (KO)Pepsico (PEP)Mondelez (MDLZ)Kraft Foods (KRFT)General Mills (GIS)Kellogg (K)ConAgra Foods (CAG)Hershey (HSY)J.M. Smucker (SJM)McCormick (MKC)Dean Foods (DF)

A few comments about this analysis:

Boulder Brands is trading a big premium to the Best In Class food companies as well as the larger organic/natural foods companies (Hain and WhiteWave). It is trading in-line with Annie's, another small organic/natural company.The short interest for the organic/natural foods companies is high, but declined in the most recent period.Boulder Brands' leverage is at the high end of the comps.Earnings estimates for the Best In Food companies have been declining. This seems normal as earnings season is beginning. Nonetheless, the stock prices of many of these companies have been weak over the last few months. Weakness in this segment may impact the organic/natural foods companies too.

Please note that the following data is from Yahoo Finance and may differ slightly from my calculations above.

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Short Interest

The short case has received a lot of attention recently, especially from Herb Greenberg (here and here).

Short interest in Boulder Brands is high, but has declined from the peak a few months ago.

Stock Price

Boulder Brands is trading near record highs and rebounded nicely off the dip earlier in the year.

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(Source: FreeStockCharts.com)

Conclusions

I don't think that gluten-free is a fad. For a small part of the population, gluten-free is a necessary part of life. A larger part of the population may gravitate toward gluten-free for a variety of medical, diet and lifestyle reasons. In the near term, gluten-free labeling as well as broader distribution channels should provide tailwinds for the gluten-free industry.

However, I don't expect mass adoption of gluten-free diets. Furthermore, people that go gluten-free (by necessity or choice) may n! ot create! as much demand as expected for gluten-free breads, pizzas and snacks because of taste and price trade-offs.

Boulder Brands is trading at a premium valuation and the stock price experienced a strong rally over the last few months. There is a lot of optimism already priced-in at these levels. Although the company has several near term opportunities (especially greater product penetration and new distribution channels), there are also some headwinds. The Smart Balance segment may continue to be a drag on the company's financials.

I prefer to take a wait-and-see approach to Boulder Brands. I am not inclined to chase the stock price at these levels. There are reasons to be optimistic about the gluten-free market, but a lot of optimism is already priced-in at this valuation.

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Source: Boulder Brands: Does The Gluten-Free Opportunity Justify The Valuation

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BDBD over 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...)

Additional disclosure: I may trade any of the securities mentioned in this article at any time, including in the next 72 hours.