Bob Evans Farms Inc. remained unmoved by new demands from an activist investor to sell off its real estate, spin off its packaged-foods division, or buy back significant amounts of stock, even though the shareholder announced Monday it would seek a consent solicitation.
Sandell Asset Management, which owns about 6.5 percent of Bob Evans Farms Inc.’s publicly traded shares, announced in an open letter to Bob Evans that it would intensify its efforts to drive change at the restaurant company through a consent solicitation. Under such a motion, a shareholder of any public company may put a proposal up for a vote of all shareholders without having to wait for the next annual meeting. Securities analyst Chris O’Cull of KeyBanc Capital Markets surmised in a research note that the solicitation would call for changes to Bob Evans’ board of directors and to the rules that dictate how often a director can be replaced.
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New York-based Sandell’s shareholder letter to Bob Evans expressed grievances with the restaurant company’s “abysmal” earnings reported last week for the second quarter of its 2014 fiscal year and management’s “near indifference” to the investor’s prior proposals to sell off real estate, spin off Bob Evans Foods, and buy back large amounts of stock.
Columbus, Ohio-based Bob Evans Farms said in a statement released the same day that its board of directors unanimously rejected Sandell’s proposals after careful consideration with its independent financial advisors at Lazard Ltd.
“Bob Evans Farms Inc. is always engaged with its shareholders and actively participates in discussions with current and potential investors,” chief executive Steve Davis said in the statement. “However, what we have not, and will not, undertake are financial-engineering tactics that place our company’s ability to deliver long-term shareholder value at unnecessary risk.”
Standing firm
Sandell expressed “serious doubts” about Bob Evans’ management’s ability to realize the full inherent value of the company, citing results for Bob Evans’ Oct. 25-ended second quarter of fiscal 2014.
Bob Evans’ net income fell 45.9 percent to $6.1 million, or 23 cents per share, compared with $11.3 million, or 40 cents per share, a year earlier. Impairment charges for restructuring the company’s restaurant and packaged-foods division weighed heavily on results for the quarter.
However, the restaurant division’s same-store sales declined 1.9 percent in the second quarter, and only 0.1 percent of that decrease could be attributed to the number of operating days lost to Bob Evans’ major “Farm Fresh Refresh” remodeling program. The chain completed the reimaging of 66 restaurants in the quarter, increasing the number of operating days lost to 411 from 290 lost days a year earlier.
Remodeled stores did perform better during the period, reporting an average same-store sales decrease of 1.5 percent, compared with a 3.6-percent decline for the restaurants remaining to be remodeled, which now account for 21 percent of the system.
“By our calculations, management will have spent close to $130 million on its remodeling initiative by the end of fiscal 2014,” Sandell wrote in its letter. “This costly initiative and the company’s recently constructed $48 million corporate headquarters are but two examples depicting what we believe are the misguided spending priorities of Steve Davis.”
Bob Evans has forecasted full-year systemwide same-store sales for fiscal 2014 to range between flat and a 1-percent increase, but KeyBanc’s O’Cull wrote in his research note that the guidance “could prove aggressive if same-store sales don’t show improvement” and accelerate from the 1.2-percent decline through the first half of the year.
The company’s leaders dismissed Sandell’s call for a major sale-leaseback transaction of the real estate parcels it owns beneath most of the chain’s 561 restaurants.
“Owning our real estate puts us in a better position to borrow on attractive terms now and in the future,” Davis said. He added that the proposed transaction would “be one of the most expensive forms of financing we could take on relative to other forms of debt that the strength of our balance sheet allows us to access.”
The sale-leaseback would also reduce Bob Evans’ flexibility to remodel its restaurants or close underperforming stores in a timely manner, Davis said. The company would reduce its free cash flow with such a transaction as well, he said, since new rent obligations — which could rise every year — would eat into earnings.
O’Cull concluded the same thing, even for a partial sale-leaseback of a portion of Bob Evans’ properties. “It would be accretive to earnings per share but dilutive to free cash flow due to the rent expense essentially replacing the depreciation expense,” O’Cull wrote. “Our view is unchanged, as a sale-leaseback transaction does not make sense, given the weak Bob Evans restaurant performance and low borrowing rates of funded debt.”
Facing headwinds
O’Cull cautioned that Bob Evans might not want to dismiss completely Sandell’s ideas about spinning off Bob Evans Foods, its packaged-goods division that accounted for much of the earnings shortfall in the second quarter.
During the period, Bob Evans encountered about $3.7 million in costs related to impairment charges for three manufacturing plant closures in Ohio and Texas, plant expansions to two more locations in those states, plus severance costs associated with the plant closures and the acquisition of side dish manufacturer Kettle Creations earlier this year.
Commodity costs were a bigger headwind, as a 79-percent increase in sow prices year-over-year led to a $9 million increase in Bob Evans’ cost of goods to produce its sausage products. The inflation in sow costs “had a dramatic negative impact on the operating results of Bob Evans Foods,” Sandell wrote, “further illustrating the strategic irrationality of combining a restaurant business and a packaged-foods business under one corporate umbrella.”
However, Bob Evans countered that “growing Bob Evans Farms Foods, rather than selling it or spinning it off, will create significantly more value for shareholders.”
The company expects the foods division to achieve positive synergies with the restaurant division over time, Davis said, and projections call for a 2.5-percent operating margin improvement in fiscal 2015 after this year’s restructuring, as well as a margin improvement of 3 percent to 3.5 percent by fiscal 2018.
O’Cull, however, wrote that Bob Evans ought to at least consider getting out of the business producing sausage and licensing its business to a third-party manufacturer, noting that sausage contributes roughly 25 percent to 30 percent of the packaged-food division’s sales but can drag down that division’s profit margins.
“Given the volatility in sow prices and the recent impact higher prices have had on profitability,” he continued, “we believe selling the sausage business … would help limit exposure to sow prices, could potentially result in other cost reductions at the segment … and licensing the products for retail sale would likely generate a high-margin revenue stream.”
Bob Evans’ company-owned family-dining restaurants operate in 19 states, mostly in the Midwest, Mid-Atlantic and Southeast regions.
Contact Mark Brandau at [email protected].
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