American Italian Pasta Company PLB
December 11, 2006 - 6:09pm EST by
2006 2007
Price: 10.98 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 208 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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Things are very different for American Italian Pasta (PLB) than they were 15 months ago (the time of the prior VIC write-up), and if things go as we expect, the stock should shortly trade up to $15-$18 as they get current on their financial statements (none filed since 3/05), refinance their debt, resume normal operations, and either hire new management or position themselves for a takeout.
What Has Changed
.Alvarez and Marsal is successfully navigating a turnaround in its operations and has released data demonstrating this.
.The Company not only negotiated a new credit facility, removing bankruptcy risk, but has since been paying some of this debt down and could refinance it at a meaningfully lower rate.
.Recent IRI data proves that both total pasta sales and private label pasta sales have stabilized.
.The Company has exited underperforming brands, is ending its exclusive foodservice contract with Sysco (at Sysco's request), and is refocusing on private label, where it has situational pricing power.
.The Audit Committee Investigation is coming to a close.
Company/Industry Overview
PLB is the number one producer of private label pasta in the US, with more than 50% of the market (some estimate greater than 60%). The Company is also a provider of branded pasta with a decent stable of regional brands such as Mueller's, Golden Grain, Ronco and Pennsylvania Dutch. The other players in the pasta industry include Barilla, a private Italian company and the #1 branded pasta company, New World Pasta (NWP), another brand-focused company (Ronzoni, San Giorgio, Skinner and Creamette), Dakota Growers, a former cooperative that is #2 in private label, and some smaller branded and regional private label players.
PLB was once a high flyer, trading as high as $50/share, with a market cap of nearly $1B in 2002 before falling on very hard times due to a major accounting scandal and the Atkins Diet, which hit volumes and given the high fixed cost nature of the business, crushed earnings. The stock bottomed at $3 early this year as investors grew worried that negative trends, the looming earnings restatements and a consolidated shareholder lawsuit would imply that the company could not be profitable going forward and may have to file for bankruptcy. At the time, the company was also in default of its credit agreement, which contributed to investor fears.
In March 2006, the company successfully negotiated a $295M new credit facility, which removed bankruptcy fears. The stock immediately popped to $6 and then traded between $7 and $9 for several months. Last week the stock popped to above $10 on an upgrade, though we believe it is worth $15-18 and there is a clear set of catalysts to get you there.
Alvarez & Marsal (A&M)
In December 2005, the company retained A&M to manage its turnaround effort. Jim Fogarty is the senior member of A&M who is currently President and CEO at PLB. Fogarty had previously led the restructuring at Warnaco (WRNC) and Levi's Jeans. He is well respected and considered to be a very good operator. A&M's first step was to get the new credit facility. Since then they have also supervised a major turnaround. The company has exited underperforming brands, shuttered excess capacity and accepted the resignation of several members of senior management who seem to be implicated in the alleged fraud at the company. The Company has also refocused itself on private label, and we believe (because of pricing surveys we have conducted), that the Company is selectively asserting pricing power in this market particularly with smaller and/or regional merchants.
In addition to their cash compensation (detailed below), A&M received nearly 500K warrants at close to $6. A&M does not communicate with the Street or provide any financial guidance. However, A&M has intermittently released cash flow data (in 6/06, 8/06 and 10/06) enabling investors to get to reasonable estimates of EBITDA and capex (detailed below).
Financial Statements
The Company has not filed financial statements since March '05 because it is in the midst of an Audit Committee investigation into accounting practices. To date this has revealed impairment charges and inventory write-downs and resulted in the company having to restate revenues and COGS because of how it accounted for certain promotional expenses. However, this is now largely behind the company. On 8/14/06, PLB announced that the investigation was in a late stage, that it plans to re-file the applicable historical financial statements by 12/31/06, and that it expects to be current on its delinquent filings by the end of the first calendar quarter of 2007. Subsequently, on 11/21/06, PLB issued a release detailing the likely revenue and expense restatement for FY9/05 and FY9/06, which also indicated that the company had concluded the fact finding portion of its investigation, lending credence to the thought that restated and current financials will come soon. We do not mean to minimize the investigation, but after reading the complaint in the shareholder lawsuit, we believe that the historical financials will be primarily adjusted for small and/or non-cash adjustments and with the old management team gone, the Company now has the opportunity to focus on operations for the first time in several years.
New Management & Growth Opportunities &/or a Takeout
After they get current on their filings, A&M will exit as they are not permanent managers and either the company will be sold or new permanent management will be brought in. NWP, a competitor that used to do private label and branded pasta but now does only branded, recently came out of bankruptcy and was acquired for 1.2x sales and 7.7x '06 EBITDA with EBITDA margins of 15%. The buyer was Ebro Puleva, a Spanish food company looking for a beachhead in the US. PLB has higher EBITDA margins and, because it is the #1 player in private label, some pricing power as well. (PLB charges different prices to different customers depending on their access to alternate sources of supply, given that some private label competitors can't supply throughout the country.) As such, we think it should go for at least a similar multiple and there are definitely murmurs of there being interested parties around.
Alternatively, if the company brings in new management, there is an opportunity to grow the company. After spending the better part of the last 3 years righting the ship, new management will have the ability to truly focus on operations. Recent IRI data through October 2006 shows that pasta volumes have stabilized and in some cases are growing. For instance, for the 4 weeks through early November, industry wide private label pasta sales are up 5% year over year and year to date, overall pasta industry sales are up 0.3% year over year on a trailing 52 week basis. In addition, there is some evidence that when customers feel the pinch from gas prices, they trade down to foods like pasta. Lastly, with a more concentrated portfolio of brands, PLB has an opportunity to better support these brands and/or push product extensions and prepared foods through its distribution network.
Refinance the Debt
The Company currently pays more than 11% on its debt. It accepted these egregious terms because in the absence of audited financials, it had to. Now, with debt/EBITDA running at < 4x, the Company should be able to refinance its debt without large prepayment penalties at a much lower interest rate (probably 7-8%). (They do have this flexibility written into their loan documents.)
Sysco Contract
For FY9/05, sales to Sysco were approximately 11% of revenues (2nd largest customer behind WMT). The company had a contract to be the exclusive supplier of Sysco branded pasta, which expires at the end of this year and Sysco chose not to renew. However, the two companies will continue to do business with one another and PLB's release leads to the conclusion that the Company believes it will be able to offset any lost Sysco volumes by going after the 75% of the food service market that heretofore they were restricted from. Not to mention the fact that this has historically been a very low profitability business for PLB, so it is much less than 11% of income.
There are 3 main risks to consider.
a) Shareholder Lawsuit - there is a chance that the lawsuit results in massive settlements beyond what is expected. We estimate a potential settlement would be for about $50M and the company likely has D&O insurance coverage to handle the majority of this. If we are wrong, projected cash levels could be impaired.
b) Full Financials Reveal the Company is not As Profitable as We Think - there is a chance that some of this is year's projected cash flow is from working capital benefits that the company is unable to repeat. This is somewhat mitigated by the fact that implied EBITDA margins are within historical norms, but this is still a risk.
c) Durum Wheat - this is the main input in pasta and represented more than 30% of COGS in FY9/04. On 8/14/06, PLB stated that the rise in durum wheat prices is a headwind. Yet in their November release, cash flow generation was stronger than expected and the Company did not mention the risk again even though prices have climbed meaningfully since then. PLB does have price protection on an estimated 50% of their contracts. If wheat prices do not fall and PLB is not able to exert any pricing power, this could prove to be expensive for the company. Assuming they can pass through 50% of the non-protected rise in wheat prices due to pricing power, durum wheat could cost the company $2-$3M in additional expense this year versus last (using the current price versus what prices were at end of 9/06, which should mostly be reflected in current EBITDA).
B/S as of FYE 9/29/06
(in millions except per share data)
Current Price $ 10.98
FD s/o 18.9
Mkt. Cap. 207.6
Debt 262.3
Cash (22.9)
EV 447.0
Implied EBITDA from Data on Cash Outflows
12 months
(in millions except per share data) thru 9/06
Interest exp. $ 22.0
Capex 12.6
Professional Fees 8.4
Mngmt Consulting Fees 7.3
Cash Taxes 0.7
Debt Refinancing Costs 7.3
Reduction in Net Debt 28.2
Sub-total 86.5
Inventory Disposal (1.5)
Other Asset Divestitures (10.0)
Total Preliminary EBITDA 75.0
Less continuing impact of Durum Wheat (2.5)
Less continuing Mngmt Consulting Fees (2.5)
Annualized EBITDA 70.0
Based on 12 Mo. I/S and B/S for FY9/06
Revenues (in millions) $ 365.9 -Up 0.6% YoY. 4q revs were $95.6M up 3.2% YoY. Volume was down 0.4% YoY but up 4.7% 4q over 4q.
Implied EBITDA Margin 19.1% -Average EBITDA margins for 7 years thru 9/03 were 23%.
EV/(EBITDA - Capex) 7.8x
Target Valuation
@ EV/EBITDA multiple of 7.5x -None of these target valuations give the company any credit for potential revenue / EBITDA growth, wheat price reduction (as happened after a similar spike in 2002), or new food service business.
@ EV/(EBITDA-Capex) multiple of 9.0x
Implied Price $ 15.00
@ EV/(EBITDA - Capex) multiple of 10.0x
Implied Price $ 18.00
Average Target Price $ 16.50
% Upside from Current Market Price 50%
Our initial target valuation is based on 7.5x EBITDA and 9x EBITDA-capex. However, given the low capex needs in this business now (the Company had spent a lot of capex in developing its facilities, but now only needs to spend on maintenance), one could argue that it deserves a 10x multiple on EBITDA-capex, particularly because EBITDA is non-cyclical, it is coming off a somewhat depressed base, and the industry has been rationalized. Alternatively one could work backwards from $70M in EBITDA and get to a normalized EPS of a $1.25 (assuming a tax rate of 33%, normalized D&A of $16M, and interest on debt of 7.5%) and put a multiple on that.


1. Restating historical financials - expected by year-end. 2. Filing current financials - expected by 1q'07. 3. New management &/or takeout - one of the two must happen. 4. Sysco contract termination proves to be a positive not a negative. 5. Wheat prices moderate as expected by some. 6. End market growth post-Atkins diet. 7. Massive short covering rally highly possible -7M (>35% of the float) sold short.
This Idea was posted on 12/11/2006 4:56:39 PM.
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