Precious positioning at Hostess detailed

by Josh Sosland
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Hostess has leveraged the value of its brands through a business model predicated on warehouse, rather than direct-store delivery and extended shelf life.

ORLANDO, FLA. — A reestablished leadership position in the sweet goods category leaves Hostess Brands, Inc. ideally situated for further success, top Hostess Brands, Inc. executives said in a Jan. 10 presentation.

Speaking at ICR Conference 2017 at the Ritz Carlton Grande Lakes hotel and resort in Orlando, William D. Toler, president and chief executive officer of Hostess, said the company’s highly profitable approach would be difficult for two of its larger competitors to emulate. The presentation was one of the first by Mr. Toler since Hostess shares began trading publicly in November.

Explaining the success Hostess has achieved since the business was acquired in 2013, Mr. Toler distilled the strategy the company has pursued into three basic elements, beginning with the power of the Hostess brands.

William Toler, Hostess
William D. Toler, president and c.e.o. of Hostess

“The brands at Hostess mean the emotional connection with the American consumer, really, which has driven the power and speed and rate of success,” he said.

Hostess has leveraged the value of its brands through a business model predicated on warehouse, rather than direct-store delivery and extended shelf life.

“Our shelf life is 65 days from bake, and we guarantee 45 days to our customer,” Mr. Toler said. “So the first 20 days are us and the logistics team shipping it from our manufacturing plant to our distribution facility out to our customers so it has the length of time to allow it to go through a warehouse model, something our competitive D.S.D. products do not have.”

Mr. Toler and Tom Peterson, executive vice-president and chief financial officer, devoted time in the presentation to describe how the Hostess model has generated profit margins superior not only to other baking companies but also consumer packaged foods companies. For example, year-to-date Hostess EBITDA margins of 29% eclipse snack  businesses such as The Hershey Co., 24%; Snyder’s-Lance, Inc., 14%; and Flowers Foods, Inc., 12%; as well as mid-sized foods companies such as J.M. Smucker Co., 23%, and Post Holdings, Inc. 18%.

The executives offered considerable detail about how Hostess is positioned versus other snack cake businesses.

“We sell at premium per pound versus our competitor,” Mr. Toler said. “That’s a great place to be because that drives growth. So it’s simple math. Little Debbie, which is actually the category share leader, with 28% to 29%, they are a value brand. It is fairly unique in U.S. consumer products to have the value brand as the share leader, but in this category we do. This is one of the reasons our premium nature drives growth, because people shift up to the premium price point product. For example, in c-stores, our products sell for $1.79 to $1.89. The retailer will make probably 75c on that sale. That 75c is the same as the sale price of the items for Little Debbie, so the penny profit category margin (margin per unit) is driven by the pricing structure we offer. We are a huge trade up for retailers. That’s part of the reason they love us.”

Mr. Peterson offered further detail about how the Hostess business model underpins the company’s superior profit margins. Specifically, savings from the warehouse delivery model extend far beyond lower transportation and associated costs.

“The old company had 12 cake and combo bakeries, many of which had redundantly produced the same item,” Mr. Peterson said. “That means Twinkies were produced in six bakeries. We now have one fully automated line that makes all of our Twinkies. It takes 10 people to operate compared to a standard line of 38, and we sell more Twinkies than the old company did. So our margins are heavily impacted by this model.”

He said Hostess is continuing to pour significant sums into capital improvements, including $29 million in the 12 months ended Sept. 30.

“That included substantial automation of the cake line, consolidation of production lines and starting to enable Indianapolis to take our peanut butter items,” he said.

EBITDA margins are fairly secure going forward, Mr. Peterson said, helped by price stability and customer support of a pricing model that provides retailers with higher profits. The efficiency of the company’s production system helps sustain profitability as well, he said.

Responding to a question of whether competitors may choose to adopt the Hostess extended shelf life and warehouse delivery model since it is proving so profitable, Mr. Toler said such a shift was highly unlikely. He expressed confidence in this prediction even while acknowledging that the E.S.L. technology Hostess uses essentially would be available to anyone in the industry.

“(Our supplier) could sell other adaptations of (the E.S.L. ingredients),” he said. “And the answer is it doesn’t fit (other bakers’) business model, particularly our two largest competitors, Flowers and Bimbo. They’re tied to the bread business, and they are going to be in those stores three to four times a week for bread. Sweet goods are an important part of their company, but it doesn’t drive their infrastructure. Bread drives their infrastructure.”

Mr. Toler also cited a “cultural dynamic” at D.S.D. companies, saying he was very familiar with such a mindset from his time with Nabisco Brands.

“Culturally D.S.D. companies really love D.S.D.,” he said. “That’s who they are; that’s how they operate. And that’s fine, that’s how they work. And so culturally I will tell you Hostess would have never made the D.S.D.- to-warehouse switch if we hadn’t gone through something as dramatic as Chapter 7. So yes, it is a moat but it is a moat around culture and complexity and what really drives our competitors.”

Discussing market share, Mr. Toler said Hostess currently stands at about 16% of the snack cake market, versus 22% when the company ceased operations in November 2012. He said the company expects to continue gaining share since its current growth rate is higher than the market average overall. He cited donuts as a case study for how Hostess will gain share in the future, versus simply trying to reestablish its former position.

“When we left the category we had about a 50 share in donut,” he said. “Of course that went to zero when we were off the shelves. Now we’ve rebuilt that to about a 38 share. But our competitors are still there, so it will be very difficult to get all the way back to 50. You’ve got to get back there with other innovations, other channels, like going into food service, in-store bakeries, dollar stores and drug stores where Hostess didn’t have great presence before. So our channel product mix will be change, but we fully expect to achieve that 22 share over the next several years.”

He said Hostess describes as “everyday grind growth” conventional steps to regain share such as rebuilding distribution and increasing the numbers of items customers carry in their stores, principally through innovation. At present, Hostess offers four fewer stock-keeping units than before the 2012 liquidation. Included in the mix though are bread varieties, including the recent introduction of bagels with 65 day shelf life, Mr. Toler said.

“It’s a nice analog to add on that will go primarily to the drug channel and some c-stores as well,” he said.

Mr. Toler devoted considerable attention to the new product pipeline at Hostess, including the launch this year of a chocolate cake Twinkie.

“It’s the first time we’ve done chocolate cake Twinkie with a regular creme filling,” Mr. Toler said.

Other pending new products he described as perhaps even more ground-breaking.

“We’re launching white fudge covered Ding Dongs right now,” he said. “It’s the first line extension for the Ding Dongs business, and we’re very excited about it. And we just announced a couple weeks ago we are doing peanut butter Ho Hos. You’ll see other peanut butter offerings later this year. That also will be the first line extension of Ho Hos. So that is some big news for us on — our 50-year-old icons like Ho Hos and Ding Dongs, our first line extensions on those brands ever.”

Deep Fried Twinkies were introduced last summer, and Hostess is introducing Dolly Madison Zingers in Canada.

“So there is lots of activity,” he said.

In another first, Hostess has reached a licensing agreement with Nestle USA, and in the coming weeks six s.k.u.s (stock-keeping units) of Hostess co-branded ice cream will be introduced. In addition to a Ding Dongs ice cream sandwich, rolling out in stores presently, Mr. Toler said four or five other items will be launched in the spring when retailers “reset their ice cream set.” Under the agreement, Nestle will handle production, sales and logistics of the ice cream business.

The partnership helps Hostess “leverage our icons like Twinkies, CupCakes, Sno Balls and other things,” Mr. Toler said. “We’re pleased with our partnership with them. We think it extends the brand, gives the brand presence in more parts of the store and will add great value to us and to the overall trademark going forward.”

Longer term, looking to “white space areas,” seeking opportunities beyond the company’s “core aisle” is key, Mr. Toler said. He cited the freezer section as an example and the company’s migration there last year with deep fried Twinkies, first at Wal-Mart and then at supermarkets. Other opportunities include food service and international. He clarified what is meant by international expansion for Hostess.

“For us, international is North America,” he said. “Nearby markets we can manage tightly and efficiently. And we’re going into Canada with our Dolly Madison brand because we don’t own Hostess in Canada. We’ve moved into Mexico with OXXO (a convenience store chain there). And now other retailers. That’s international. We aren’t talking about some far flung international strategies — close in things that are very executable with our current distribution system and our current capabilities.”

In food service, Hostess is working with McCain USA Foodservice, Lisle, Ill. Initially, McCain’s Hostess product line has been limited to deep fried Twinkies, but more items will be added beginning this month, Mr. Toler said. Progress also has been made in breaking into the club store business, historically an area of weakness for Hostess he said.

Mr. Toler also expanded on earlier remarks he has made about better-for-you opportunities at Hostess. While holding true to the company’s position principally as an indulgent snack maker, he said the company continues to explore ways to clean labels, including the removal of hydrogenated oils, simplifying labels and descriptions and considering removal of artificial flavors and colors.

“So we’re trying to remove the negatives where we can do that without compromising taste,” he said. “We’re also thinking of adding positives such as adding whole grains into our muffins, which we’ve done. Since we’ve done that the muffin business is up double digits. So we’ve turned a small business that was negative into a positive. We think that’s a way to approach nutrition.”

He said whole grain content and nutritional makeup of the muffins allow the products to qualify under the Smart Snacks in School regulations of the U.S. Department of Agriculture, giving a new generation of consumers exposure to the Hostess brand.

While Hostess has stepped forward only gingerly in the realm of acquisitions, with its relatively modest purchase of Massachusetts-based Superior Cake Products, Inc., Mr. Toler said the company is poised for significant further steps.

“Right now we’re a sweet-baked goods company business inside of shelf-stable and I.S.B. (in-store bakery) company with a little frozen with deep fried Twinkies,” he said. “If you think of us as a snacking platform it gets much broader, both with how we might use the Hostess brand and how we might use other brands or other products. So we think of it as the broadest platform is snacking and then it goes immediately to sweet then it goes to shelf-stable I.S.B. and frozen. The pipeline is pretty long. There have been a number of businesses that sold last year in the I.S.B. space and that is a $7 billion dollar category doing really well, highly, highly fragmented. So there’s lots of roll up opportunities inside of that. We think there are other places to be in the store. There’s more things to do in frozen, there’s more things to do in shelf stable and some of our channels we have unique competitors who only compete in one or two channels. There may be great opportunities to pick up as well.  So we think the m.&a. potential here is very rich. We think there’s already has been a good bit of activity in those spaces.”
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