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Lancaster Colony (NASDAQ:LANC) Misses Q2 Sales Targets


Full Report / February 01, 2024

Specialty food company Lancaster Colony (NASDAQ:LANC) missed analysts' expectations in Q2 FY2024, with revenue up 1.8% year on year to $485.9 million. It made a GAAP profit of $1.87 per share, improving from its profit of $1.45 per share in the same quarter last year.

Lancaster Colony (LANC) Q2 FY2024 Highlights:

  • Market Capitalization: $5.06 billion
  • Revenue: $485.9 million vs analyst estimates of $493.3 million (1.5% miss)
  • EPS: $1.87 vs analyst estimates of $1.65 (13.1% beat)
  • Gross Margin (GAAP): 25%, up from 21.4% in the same quarter last year
  • Sales Volumes were down 1.9% year on year

Known for its frozen garlic bread and Parkerhouse rolls, Lancaster Colony (NASDAQ:LANC) sells bread, dressing, and dips to the retail and food service channels.

The company was founded in 1961 as a glass and automotive products company. However, it quickly shifted focus towards specialty foods. Since its inception, Lancaster Colony has grown both organically and through a series of acquisitions, with its purchase of salad dressings giant Marzetti in 1969 as one of the most significant.

In addition to Marzetti dressings, Lancaster Colony goes to market with the Sister Schubert brand of rolls and the New York Brand Bakery brand of garlic breads, croutons, and toasts. The company sells to the retail channel, where its dressings and dips products can be found in grocery produce departments and where other products can be found in the shelf-stable sections. Lancaster Colony also sells private-label products to restaurants.

At retail, the core Lancaster Colony customer is likely someone who does the grocery shopping for his or her household. This customer values convenience, as he or she has little time between work, kids, and other commitments to make food from scratch. Those who buy the company’s dressings are likely also health conscious and use the products to add some pizzazz to their salads.

Packaged Food

As America industrialized and moved away from an agricultural economy, people faced more demands on their time. Packaged foods emerged as a solution offering convenience to the evolving American family, whether it be canned goods, prepared meals, or snacks. Today, Americans seek brands that are high in quality, reliable, and reasonably priced. Furthermore, there's a growing emphasis on health-conscious and sustainable food options. Packaged food stocks are considered resilient investments. People always need to eat, so these companies can enjoy consistent demand as long as they stay on top of changing consumer preferences.The industry spans from multinational corporations to smaller specialized firms and is subject to food safety and labeling regulations.

Competitors in specialty foods include Treehouse Foods (NYSE:THS), Flowers Foods (NYSE:FLO), and Clorox (NYSE;CLX), which owns the Hidden Valley dressing brand.

Sales Growth

Lancaster Colony carries some recognizable brands and products but is a mid-sized consumer staples company. Its size could bring disadvantages compared to larger competitors benefiting from better brand awareness and economies of scale. On the other hand, Lancaster Colony can still achieve high growth rates because its revenue base is not yet monstrous.

As you can see below, the company's annualized revenue growth rate of 11% over the last three years was decent for a consumer staples business.

Lancaster Colony Total Revenue

This quarter, Lancaster Colony's revenue grew 1.8% year on year to $485.9 million, falling short of Wall Street's estimates. Looking ahead, Wall Street expects sales to grow 4.3% over the next 12 months, an acceleration from this quarter.

Gross Margin & Pricing Power

All else equal, we prefer higher gross margins. They usually indicate that a company sells more differentiated products and commands stronger pricing power.

This quarter, Lancaster Colony's gross profit margin was 25%, up 3.6 percentage points year on year. That means for every $1 in revenue, a chunky $0.75 went towards paying for raw materials, production of goods, and distribution expenses. Lancaster Colony Gross Margin (GAAP)

Lancaster Colony has poor unit economics for a consumer staples company, leaving it with little room for error if things go awry. As you can see above, it's averaged a paltry 21.6% gross margin over the last two years. Its margin, however, has been trending up over the last 12 months, averaging 8% year-on-year increases each quarter. If this trend continues, it could suggest a less competitive environment.

Operating Margin

Operating margin is a key profitability metric for companies because it accounts for all expenses enabling a business to operate smoothly, including marketing and advertising, IT systems, wages, and other administrative costs.

In Q2, Lancaster Colony generated an operating profit margin of 13.5%, up 2.8 percentage points year on year. This increase was encouraging, and we can infer Lancaster Colony had stronger pricing power and lower raw materials/transportation costs because its gross margin expanded more than its operating margin.

Lancaster Colony Operating Margin (GAAP)

Zooming out, Lancaster Colony has done a decent job managing its expenses over the last eight quarters. The company has produced an average operating margin of 7.8%, higher than the broader consumer staples sector. On top of that, its margin has risen by 1.5 percentage points on average over the last year, showing the company is improving its fundamentals.

The company's operating profitability was particularly impressive because of its low gross margin, which is mostly a factor of what it sells and takes tectonic shifts to move meaningfully. Companies have more control over their operating margins, and it signals strength if they're high when gross margins are low (like for Lancaster Colony).

EPS

Earnings growth is a critical metric to track, but for long-term shareholders, earnings per share (EPS) is more telling because it accounts for dilution and share repurchases.

In Q2, Lancaster Colony reported EPS at $1.87, up from $1.45 in the same quarter a year ago. This print beat Wall Street's estimates by 13.1%.

Lancaster Colony EPS (GAAP)

Between FY2021 and FY2024, Lancaster Colony's EPS dropped 4%, translating into 1.4% annualized declines. We tend to steer our readers away from companies with falling EPS, especially in the consumer staples sector, where shrinking earnings could imply changing secular trends or consumer preferences. If there's no earnings growth, it's difficult to build confidence in a business's underlying fundamentals, leaving a low margin of safety around the company's valuation (making the stock susceptible to large downward swings).

On the bright side, Wall Street expects the company's earnings to grow over the next 12 months, with analysts projecting an average 33.8% year-on-year increase in EPS.

Return on Invested Capital (ROIC)

EPS and free cash flow tell us whether a company's revenue growth was profitable. But was it capital-efficient? If two companies had equal growth, we’d prefer the one with lower reinvestment requirements.

Understanding a company’s ROIC (return on invested capital) gives us insight into this because it factors the total debt and equity needed to generate operating profits. This metric is a proxy for not only the capital efficiency of a business but also a management team's ability to allocate limited resources.

Although Lancaster Colony hasn't been the highest-quality company lately, it historically did a solid job investing in profitable growth initiatives. Its five-year average ROIC was 19.4%, higher than most consumer staples companies.

The trend in its ROIC, however, is often what surprises the market and drives the stock price. Unfortunately, over the last two years, Lancaster Colony's ROIC has averaged a 9.8 percentage point decrease each year. We like Lancaster Colony's average ROIC but are concerned it has declined recently, perhaps a symptom of waning opportunities to invest profitably.

Key Takeaways from Lancaster Colony's Q2 Results

We were impressed by beats on the gross and operating margin lines, leading to a nice EPS beat. On the other hand, its revenue unfortunately missed analysts' expectations. Overall, we think this was a mixed but solid quarter that should satisfy shareholders. The stock is up 1.2% after reporting and currently trades at $185.9 per share.

Is Now The Time?

Lancaster Colony may have had a favorable quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

Lancaster Colony isn't a bad business, but it probably wouldn't be one of our picks. Although its revenue growth has been solid over the last three years, its gross margins make it more challenging to reach positive operating profits compared to other consumer staples businesses. And while its projected EPS growth for the next year implies the company's fundamentals will improve, the downside is its subpar brand reputation keeps it from exerting much influence over consumers.

Lancaster Colony's price-to-earnings ratio based on the next 12 months is 29.3x. In the end, beauty is in the eye of the beholder. While Lancaster Colony wouldn't be our first pick, if you like the business, the shares are trading at a pretty interesting price right now.

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