Overhill Farms: Riding the prepared-foods craze
Americans love their food, especially, it seems, when they’re not cooking it.
If dining out was once the stuff of special occasions, people today are so busy, or at least so eager to stay busy outside of the kitchen that they eat restaurant food all the time. Even when they are eating in.
It’s now possible to buy warm take-out sandwiches at convenience stores, prepared soups at Safeway and gourmet chicken salad at Whole Foods. Weight watchers have developed a preference for idiot-proof diets based on reduced calorie meals prepared by The Zone or Jenny Craig. And even food banks that once ladled out basic broths are shifting away from the soup kitchen model to pre-packaged meals that low-income families can take home and warm up.
Into this rapidly expanding market for easy food comes Overhill Farms Inc. (AMEX: OFI), a Vernon, Calif., company that makes a variety of frozen foods, prepared or so-called plated entrees, soups and sauces, as well as meals for the airline industry and for the Jenny Craig diet program. Along with Jenny Craig and a couple major airlines, some of its customers include Costco, Sam’s Club and Safeway.
Overhill Farms is actually a 12-year-old company, but its stock has recently enjoyed intense investor interest thanks to some very aggressive internal expansion plans.
Overhill’s shares have more than doubled this year, closing Monday at $5.95 per share, up from $2.92 at the start of the year. That surge can loosely be traced to mid-March, when Overhill officially announced a $7 million expansion plan, adding everything from industrial sized refrigerators to pasta-cooking machines to its main plant in Vernon, which it said would enable it to produce enough food to generate annual revenues of $250 million.
That level of annual sales would be an increase of almost 50% over fiscal 2006 revenues of $168.3 million. And, the company is not just bulking up in a hoped-for surge in business. It says it has already won multiple new contracts that will bring it to an annual run rate of $200 million by the third quarter of this year, a roughly 20% increase in revenues from last year.
Until this recent surge, Overhill has grown at a steady – if unremarkable – rate for the past several years. Its fiscal 2006 revenues of $168.3 million compared with $162.6 million in 2005 and $138.9 million in fiscal 2002. Growth in net income has been more robust, thanks partly to improved expense controls. The company’s earnings totaled $5.1 million last year, up from $3.7 million the year before and $1 million in 2002.
So are these new and improved growth projections really enough to make the company the small cap wonder du jour that so many investors believe it to be?
Maybe not. Investors have already responded to the company’s recent good news, including its accelerating sales growth, its internal expansion, and the health of the prepared food industry to which any shopper of Safeway’s convenience aisle can attest. However, they may be less aware of some of the challenges.
If demand for prepared food is robust, competition is fierce and little Overhill Farms, with a market cap of about $99 million, must compete with some much bigger and much better established players like Sysco Corp. (NYSE: SYY) of Houston, which generated revenues last year of $32.6 billion. There’s also a host of tiny, local prepared-food producers to contend with on the other end of the competition spectrum – companies that are often the preferred food providers for chains like Whole Foods Market (Nasdaq: WFMI), which seek out locally-produced, organic food.
Overhill has built up a smattering of customers, but it does not seem to have a defined niche that will protect it from all this competition.
And if it were to lose a contract to one of its competitors, Overhill could be very hard hit, due to the fact that so much of its business is concentrated among just a few customers. Last year it said that more than half its revenue came from just two customers: the Panda Restaurant Group, which accounted for 35% of its sales, and Jenny Craig, whose business made up 28% of Overhill’s 2006 revenues.
Another 12.8% of its business last year came from sales to airline customers, a group that is somewhat unstable due to the shaky conditions throughout the airline industry. In a recent regulatory filing, Overhill cited the bankruptcies in 2005 of two of its airline customers, Delta Airlines (NYSE: DAL) and Northwest Airlines (OTC: NWACQ), as a risk factor in its growth going forward. Even airlines that do not file for Chapter 11 are always looking for ways to save costs, and in-flight meals are often the first to go.
On Monday, Overhill showed how vulnerable its stock could be to hiccups in its expansion plans. Shares closed down 12.5% to $5.95 after the company’s second-quarter earnings report showed a drop in earnings during the three months ended April 1 (see Overhill Farms rebounds in after-hours trading after earnings dip, May 7).
Overhill said its second-quarter net income fell to $875,000, or $0.06 per share, from $1.2 million or $0.08 per share, in the year-ago quarter. It blamed the decline on inefficiencies in the launch of several new products.
Overhill said that revenues during the quarter rose to $46 million from $43.7 million the year before. CEO James Rudis said in a statement that most of the problems encountered during the quarter were one-time costs related to its planned expansion, such as the recruiting of 100 additional production line workers.
“With production lines now fully staffed, and with the increased efficiency that comes with more experienced employees and sustained production of these new items, we expect to see improved productivity and cost efficiencies,” Rudis said in a statement.
Even with Monday’s stock price drop, Overhill’s shares remained more than double their price at the start of the year.
Overhill seems to be well aware of the intense competition that it faces, and is working hard to expand to a point where it is not so dependent on the whims of a few key customers. Those expansion plans look encouraging and may well catapult the company into a new phase of growth that will justify current stock values.
But with so much of that future growth still speculative, the stock price may have gotten a little ahead of itself. Investors may want to take a wait-and-see approach rather than rushing in.
