BOSTON — Berenberg Capital Markets L.L.C. Has initiated insurance of Flowers Foods Inc. With a “maintain” score.

While Thomasville, Ga.-based Flowers has been gaining proportion inside the baked meals category in current years, Berenberg warned that the income growth has been driven by means of much less profitable products, inclusive of Dave’s Killer Bread.

Based in Boston, Berenberg is a subsidiary of Joh. Berenberg, Gossler & Co. KG, Hamburg, Germany. Berenberg has a charge goal for Flowers of $22 according to proportion, about $1.50 in step with proportion lower than where the company’s stocks have been buying and selling at mid-day July 19.

Donald McLee, a Berenberg analyst, summarized the baking category as large ($36 billion in annual income) and “fragmented.”

“The bulk of that low growth is pushed by way of the conventional bread loaf, which is reasonably commoditized,” Mr. McLee said. “However, there are numerous pockets of elevated client call for for area of expertise items. Flowers is the market leader for organic baked items, that is a primary underlying growth phase and has ended up a key differentiator in recent years. The fulfillment of its Dave’s Killer Bread logo has helped guide almost 100 basis factors of 12 months-over-yr growth for Flowers’ marketplace share within the broader category to 17% inside the first zone of 2019. We anticipate the strength of the natural class to support similarly marketplace share gains in the intermediate-term.”

Describing baking as “fiercely aggressive,” Mr. McLee stated lots of regional bakers, neighborhood bakers, and store-owned bakers vie for marketplace percentage.

The 3 biggest baking groups — Grupo Bimbo S.A.B. De C.V., Flowers and Pepperidge Farm, Inc. — account for approximately 50% of the marketplace, which Mr. McLee mentioned has been developing very slowly.

“Given the commoditized nature of the conventional bread loaf, the charge is regularly the biggest determining aspect for purchasing customers,” Mr. McLee stated. “This generally makes the traditional bread loaf a decrease-margin product, with confined rate elasticity.

Against this backdrop, the area of expertise bread has been a desired street for growth.

Mr. McLee stated gluten-free bread might be one of the quickest developing segments in coming years, noting that increase due to the fact that 2015 has compounded annually at a 6.6% charge, well outpacing the overall marketplace. Flowers entered this market with the December 2018 acquisition of Canyon Bakehouse, Johnstown, Colo.

“Canyon Bakehouse gives Flowers a strong foothold into that attractive boom profile through a leading logo,” Mr. McLee stated.

The upside for Canyon stems from the broadening patron base for gluten-free merchandise and due to the fact ninety% of Canyon Bakehouse sales are from frozen merchandise.

“While gluten-unfastened ingesting is generally considered as being within the ‘mature’ degree of the healthful claims lifestyle, we assume there may be nevertheless solid future increase ability,” Mr. McLee stated.

He cited Technomic records indicating 52% of respondents to a 2018 survey trust gluten-loose foods are healthier. The variety of customers on gluten-free diets without a gluten disorder or sensitivity doubled between 2009 and 2014.

“We also see untapped boom potential for Canyon’s merchandise inside the clean baked items segment,” Mr. McLee stated. “As previously cited, 90% of Canyon Bakehouse income are derived from frozen merchandise. We accept as true with that is because of the fantastically short shelf-life of bread and Canyon’s confined distribution skills. We assume Flowers to make use of its superior distribution competencies and retail partnerships to enlarge the network for Canyon products and growth income of its fresh-baked items.”

Berenberg defined results from Project Centennial as “combined at fine so far.”

“While Flowers has been capable of hitting its target of flat-to-2% income growth in 2018, it has fallen quick of its EBITDA margin objectives,” Mr. McLee stated.

He stated the corporation’s EBITDA margin dropped to 10.4% in 2018, down 110 basis points from two years earlier.

“We assume this decline changed into driven by using Flowers’ product blend, indicating that a number of its quicker increase products (like Dave’s Killer Bread) are likely lower margin,” he stated.

Also pressuring margins have been rising enter charges, up to $40 million in 2018.

“While this becomes largely as a consequence of rising component expenses (as wheat and flour expenses moved higher), control mentioned that a tight labor market and growing freight prices have been additionally headwinds throughout the year,” Mr. McLee stated. “Despite a subsequent enter fee decline in the first area of 2019, we count on the headwinds from freight, hard work and elements to keep in 2019. While factor fee is a quarter extensive trouble, we word that Flowers most effective has a tendency to hedge its ingredients over a four to seven-month time horizon (compared to the competition inside the 12-month variety), which leaves it greater prone to charge inflation for its elements.”

Berenberg stated the decrease margins of better-growth products create “a vicious cycle wherein its income boom and EBITDA margins are possibly in opposition at this point.”

Flowers’ stocks ought to experience considerable upside if it could obtain better margins, Mr. McLee stated.

“Our bull-case analysis assumes Flowers is able to reach its intermediate-time period performance objectives including thirteen% EBITDA margin and modest volume acceleration,” he said. “Based on our estimates, we calculate a bull case valuation of $34, or about 31% capability upside to the present day share price.”