Summary

• The company will report earnings on 2-18-15.
• Specialty Brands acquisition should provide solid revenue.
• B&G’s recent push into snacks may prove to be a liability.

B&G Foods (NYSE:BGS ) will be reporting earnings after the bell on Wednesday, and I am not expecting a good report from the company. Last quarter the company came up short and reduced guidance. Even with the lowered guidance, I am expecting B&G to have a difficult time meeting the lower end of the revised adjusted EBITDA guidance of $202.0 million to $206.0 million.

Historical Perspective

For those unfamiliar with the company, B&G mostly sells a variety of food products with well-known brands. Up until late 2012 the company sold shelf-stable products, often referred to as center of the store products. It is a manufacturer and distributor of products typically sold through supermarkets in the US, Puerto Rico and Canada. Some of its better known brands include Cream of Wheat cereals, Mrs. Dash and Ac’cent flavorings and Ortega.

Instead of depending on organic growth, B&G’s strategy has been to use leverage to acquire orphan brands from other companies to increase its revenue, EBITDA and free cash flow. And, since many of those products are manufactured by co-packers, the company’s acquisitions typically required little in the way of incremental capital expenditures or adding personnel.

B&G began a diversification into snacks in late September 2012 with the purchase of New York Style and Old London brands from Chipita America, Inc. followed by three more snack food acquisitions in 2013. The acquisition from Chipita included a manufacturing facility and personnel, and more personnel were acquired in the subsequent snack food acquisitions. At a conference in early December of 2014, B&G estimated that snacks would be about 18% of sales for the recently concluded fiscal year.

More importantly to investors, these acquisitions were typically free cash flow positive. The cash thrown off by the acquisition was used to quickly reduce debt and increase the dividend. It is a strategy that has resulted in eight dividend increases since the end of 2010, with the most recent announcement having taken place at the beginning of 2014.

Upcoming Earnings Release

Although I am expecting disappointing earnings, it won’t be all bad news. The company should have strong sales from its latest acquisition — Specialty Brands. This acquisition was made in April of 2014 and is more in line with the traditional acquisitions by the company — products that it terms as center of the store. Most of the revenue will be from this acquisition’s dried soup mixes, although there will also likely be some contribution from its maple syrup products. Both of these product families should do well in the colder winter months.

There will also be some cost improvements. Not only does the company have a history of setting annual cost improvement goals, but it has been working to correct cost issues in warehousing and distribution that occurred following the series snack food acquisitions. The new CEO, Bob Cantwell, had been the CFO in charge of wringing excess costs out of B&G, so I expect the company will continue executing in this area.

Outweighing these positives will be the effect of a significant product recall in its largest brand, Ortega. The recall was due to contamination of some of its ingredients that could affect those with allergies to peanuts or almonds. In an 8K released during its 4th quarter the company stated that it

. initiated a voluntary recall of certain Ortega Taco Seasoning Mix, Ortega Taco Sauce, Ortega Enchilada Sauce and Ortega Taco Kit products and certain Las Palmas Taco Seasoning Mix and Las Palmas Taco Sauce products.

The total cost of the recall was not known, but B&G noted some of the potential impact, including costs of $12 million in Q4.

Although it is too early to ascertain the total cost of the recall, we currently expect to record costs associated with the recall of approximately $12 million in the fourth quarter of 2014. B&G Foods will also incur at least some additional costs in future quarters. We expect to reverse the charges for any portion of such costs that are recovered from our existing insurance policies and from the third-party supplier of the contaminated spice ingredients. Any such recovery will be recorded in the period in which such recovery is determined to be probable.

While it is too soon to predict the impact of this recall on B&G Foods’ net sales, net sales of the products affected by the recall will be reduced for the fourth quarter of fiscal 2014.

It is also possible that sales of other Ortega, as well as Las Palmas, products that were not subject to the recall could be affected as some cautious customers avoid the entire product lines.

Most of this information is known, and I believe that much of it has already been baked into the price of the stock. I am much more concerned about the impact of a change in buying patterns of shoppers in the US. While listening to a guest on Bloomberg Business Radio discuss an earnings shortfall at another food company, he noted that that particular company appeared to be hurt by the growing use of shop at home services. This includes not only home delivery, but the growing use of ordering on the Internet and then picking up the filled order at the store. A recent article at techcrunch.com notes:

Walmart today expanded its online grocery-shopping service, which allows customers to shop online then pick up at their local stores, to a new market: Huntsville, Ala. The move comes only days after Walmart brought the same service to a handful of stores in the Phoenix area, as well. The retailer is still describing the curbside pickup option as something it’s testing, though it notes that, so far, in markets where both pickup and delivery options are available, pickup is proving to be increasingly popular.

It’s not just Walmart (one of B&G’s customers); many of regional and national chains currently offer this type of service. This is fine for center of the store products — products that the consumer has on their shopping list. However, when it comes to impulse buys like snacks, I believe B&G will be negatively impacted from this increasingly popular shopping method.

The Dividend

I remain invested in B&G for the dividend, which is currently more than 4.5%, and believe that dividend is adequately covered for the foreseeable future. The dividend compares very favorably to other companies in the sectors where B&G competes. For instance, B&G’s Cream o’ Wheat cereals, snacks and Ortega salsa compete with PepsiCo (NYSE:PEP ) and cereal giants Kellogg (NYSE:K ) and General Mills (NYSE:GIS ), while its Polaner fruit products compete with J.M. Smucker (NYSE:SJM ). Those dividends are 3.1% for General Mills, 2.7% at PepsiCo, 3.0% as Kellogg and 2.3% at Smucker.

In addition, since this investment is in an IRA, I am indifferent as to whether the dividend is return of capital (as has frequently been the case with B&G, including this year where the $0.899097 of the annual payment of $1.35 was classified as return of capital) or dividend income. Also, in order to boost total return I will often write out-of-the-money covered calls.

I currently have the February 2015 calls with a strike price of $35 written against a position. When they expire next week, as I expect, I intend to sell the August $35 calls. For those interested in opening a new position in B&G for income, and with the shares trading below $30, both the August $30 (at $1.80 bid) and August $35 (at $0.50 bid) calls could be attractive for producing income.

Summary

Other than the unrelated product recall, B&G has had significant challenges in the snack food sector. One of these challenges was the reason the company was forced to invest in new distribution facilities. Clearly, the product recall will cause the company to miss guidance. When B&G reports, we can expect to see the results adjusted for one-time items, and it remains to be seen how the market reacts.

A larger question is whether the company will experience the loss of impulse buying caused by a move to shop-at-home services. I expect to see snack food sales disappoint, although I remain comfortable with its center of the store product sales. On balance, I expect the market to react unfavorably and send the shares lower, creating a buying opportunity for yield hungry investors.

Disclosure: The author is long BGS, PEP. (More. ) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.