Smart Balance: It's Like Buttah…Maybe

I’ll start by saying that this is not a post that contains any investment advice.  I do not make specific recommendations or market calls to anyone through The Reformed Broker.

In this piece, I’ll be discussing the merits of one small cap company that I consider to have a very interesting story.  It could double from it’s current price or go to zero, that’s not for me to say.  I will, however, endeavor to give you some background information as a basis for the start of your own research.

Please do not trade or invest based on my below overview, I have enough responsibilities on my plate and I write this having no idea about the individual suitability situations of all of my readers.

The company we’re going to learn about today is Smart Balance (SMBL).

I first took notice of this stock more than a year ago when Barron’s wrote about the company and it’s incredible butter substitute (which has a permanent spot in my own fridge).  I was wondering why I hadn’t heard about the company having come public, but then I learned the reason:  It was a Special Purpose Acquisition Corporation.

A quick word on SPACs: in general, they suck.  I immediately put any thought of this company out of my mind, as I’ve basically only seen a trail of tears following stocks that have come public through the SPAC backdoor and I wasn’t interested in shedding any more of my own.  The stock has been almost cut in half since then (now trading at 7.50), so I’m glad I laid off it at the time (September of 2007).

That said, as a primer, Smart Balance began life as a breakthrough in the labs at Brandeis University.  It is a specific blend of vegetable oils that’s actually been shown to raise the good type of cholesterol (HDL) in the blood stream.  Licensed to Robert Harris (developer of Weight Watchers food line), this compound became a line of heart-healthy dairy alternatives, with the buttery spread being the most popular.

Harris sold the company to a SPAC run by ConAgra/ Tropicana veteran Stephen Hughes in a deal that was consummated in 2007.  Smart Balance was purchased by the Hughes team for about 490 million and it’s enterprise value (market cap + outstanding debt – minus cash) currently stands at about $700 million.

Many of the hurdles that most SPACs face in the early stages have been cleared, like having expectations that are set too high or dealing with a horrible hedge fund shareholder base that will dump their stock with reckless abandon at the worst possible times.  I feel that enough time has passed since it’s formation that we can now look at this company based on it’s own merits rather than on the basis of it’s stock’s mechanics.

Why do I feel this story is worth following?  Here are a few reasons I’m interested:

Products: As previously mentioned, I am a big fan of the buttery spread product, and I’ve also gotten into some of the product extensions, like the version fortified with Omega 3 fatty acids.  Smart Balance is reported to have about 13.5% of the margarine market where it competes with two offerings from Unilever (like I Can’t Believe It’s Not Butter).

This stuff is better than any other product I’ve tried over the years, in my opinion.  Start using Smart Balance instead of butter for a week in your home, I bet you don’t switch back.

Lest anyone think we’re talking about a narrow market opportunity, Smart Balance is carried everywhere from Krogers to Trader Joe’s to 7-11 to Wal-Mart to Whole Foods.

Management: All SPAC management teams have fancy pedigrees, but in the case of Stephen Hughes, the man who now runs SMBL, he’s a product guy, plain and simple.  Some of Hughes past successes include his star turn at Healthy Choice, a line he launched at ConAgra Foods which became a billion dollar brand in it’s first 4 years.

He’s also done well building other healthy brands like Silk soy milk, Celestial Seasonings tea and a very successful turnaround at then-struggling Tropicana orange juice.  The man knows the business from the big brands to small ones.

Growth: Smart Balance has proven it’s concept has legs outside of the butter arena with the launch of it’s peanut butter product and several other offerings like cooking oil and popcorn.

The supermarket is as hyper-competitive as it gets, so I will be watching very carefully to see how it’s newest push into the branded milk space does.  Hughes believes his skim milk product tastes as good as 2% and is more loaded with protein (10 grams) and vitamins than any other milk carton on the shelf.  Horizion Organic, a Dean Foods branded milk has carved out quite a niche for itself in the $11 billion market, so the Smart Balance offering does have a shot, although it’s still rather early in the game.

Hughes think’s that Smart Balance will be a $500 billion brand by 2012 and ultimately a billion dollar brand in it’s own right by 2014.  Even analysts that are skeptical about this prediction have admitted that if any brand out there can achieve this, it would have to be Smart Balance.

Valuation: We don’t look for dirt-cheap valuations in our growth stocks and one certainly couldn’t call SMBL a screaming bargain based on traditional metrics like price/earnings ratios.  That said, estimates from the few analysts that cover the story (including Citigroup) are calling for margin expansion this year and about 28 cents a share to the bottom line.

There aren’t many public comps that make sense to look at, but I look at Lifeway Foods (LWAY) as a somewhat similar animal.  Lifeway has a line of Kefir, a Russian yogurt drink that also has natural health benefits and It trades at a forward P/E of 35 right now.  SMBL is doing about 40% more than LWAY in annual sales (estimates for 2010 are around $325 million), but Lifeway has reached profitability sooner.  The median analyst target (there are 7 of them) is 10 bucks a share, a 25% return from these levels if achieved (which would be about 35 times the .28 cent eps estimates).

Bottom Line: Smart Balance has set some pretty lofty goals for itself, but as several recent profiles of the company mention, they have been notably conservative in their staffing structure so as to leave themselves enough room to get their money’s worth out of a ramped-up workforce without too much fixed spending.

I like this conservative approach to growth and I’ve got to admit, it’s in marked contrast to the management of many other post-SPAC firms where they can’t wait to blow through their new-found cash hoard.  Combine this with the fact that the products kick ass in the stores, and I feel that Smart Balance has a lot of potential.  We’ll have to see if Hughes and the gang can live up to it.

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I am not recommending that anyone go out and buy this or any other stock without pursuing their own course of homework, especially in light of the fact that Smart balance has only been public a short time.  I would start by looking at the following recent articles I’ve listed as sources below…

Next Stop: Fat City – Barron’s September 2007

Food’s Next Billion Dollar Brand? – Fortune June 2008

Smart Balance Keeps Tight Focus on Creativity – Wall Street Journal June 2009

A Smart Balance of Staff and Contractors – BusinessWeek June 2009

Full Disclosure: As of the date of this writing, I do not have any personal or client money invested in shares of SMBL.

I may choose to trade this security in the future.  Please do not make any trades or investments based on anything you read here as my commentary above does not constitute a research product.  I am strictly relaying publicly available information, not offering an invitation to buy or sell any securities.  For a full disclaimer, visit my Terms & Conditions page.

Analyst Estimates in this piece are from Yahoo Finance, I am not responsible for the veracity of the information presented on any third-party website.