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Stock Analyst Update

Hostess Flexes Its Brand Strength

We expect the new CEO to hew closely to Hostess' successful playbook as the firm rebuilds following its 2012 liquidation.

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With the shares up around 25% in the past month after a roughly 20% October-November dip after news of CEO Bill Toler’s retirement, narrow-moat  Hostess (TWNK) is trading near our $15 fair value estimate, validating our contention that the leadership change was obscuring the firm’s ongoing brand strength.

Executive chairman Dean Metropoulos is actively involved and taking a larger role until Toler’s replacement takes office, and we expect the new CEO to hew closely to Hostess’ successful playbook as the firm rebuilds following its 2012 liquidation. Prioritizing innovation and brand-building alongside distribution should allow Hostess to post category-beating 3% sales growth and low- to-mid-20s adjusted operating margins even as the sweet baked goods sector is held to sub-inflation expansion by health consciousness and snacking competition. Hostess has a history of premium pricing over its peers, elevating its standing with retailers as their profit on Hostess items is higher than it is for other products in the category.

Hostess’ indulgent positioning limits the extent to which it can alter its lineup to meet demand for health-oriented products, but we believe its new Bakery Petites line shows that innovation can address some trends. The premium lineup does not use high-fructose corn syrup or artificial colors or flavors, consistent with some trends in the culinary zeitgeist while preserving an indulgent profile. Before liquidation, the company’s exorbitant cost structure choked funding for innovation and brand development, but Hostess emerged with a lean production model, low-cost distribution architecture, and considerable flexibility. We believe it can use its newfound resources to capitalize on its brand strength and grow ahead of the category (albeit still at a low-single-digit clip) even after distribution recovers. The rally has reduced the margin of safety that Hostess shares offer, though we counsel investors to monitor the shares for future pullbacks.

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Zain Akbari does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.