PSTA’s Hot Growth, Cool Multiples Serve Up Opportunity

SALINAS, Calif.—The heat is on in the refrigerated section of grocery, club and natural foods stores, where robust sales of fresh, refrigerated pasta and sauce products by Monterey Pasta (PSTA) make this company one of the fastest-growing food companies traded on a major exchange.

Through its utilization of all-natural ingredients, PSTA straddles what it calls the high-growth niche markets of natural foods and refrigerated gourmet specialty foods. Founded in 1989 in Monterey, Calif., the company manufactures and distributes cut pasta, gnocchi, ravioli, tortellini, tortelloni, pizza, calzones, polenta and pasta sauces under the Monterey Pasta, Arthur’s and Nate’s brands, produces a line of fresh soups, and maintains a private-label business.

PSTA sells its products in grocery and club stores throughout the U.S., Puerto Rico, and Mexico and in two provinces in Canada, according to CFO Steve Brinkman. Conventional grocery-store customers include chains such as Safeway Inc. (SWY), Albertson’s (ABS) and Kroger (KR), as well as specialty stores such as Draeger’s, Lunardi’s and Andronico’s Markets. Club-store customers include Costco Cos. Inc. (COST) and Sam’s Club, a division of Wal-Mart Stores Inc. (WMT), which now represent 78 percent of PSTA’s sales. Natural foods store sales account for between 5 and 10 percent of PSTA’s business, and its products are sold in between 130 and 140 Whole Foods Market (WFMI) stores and in a number of Wild Oats Markets (OATS).

PSTA learned well its positioning lessons from attempts to grow too quickly in the early 1990s that included the opening of an unsuccessful line of mall restaurants and a rapid and problematical expansion into mainstream grocery distribution.

The company, which went public in 1993 and saw its stock rise from an initial share price of $6 to $19.25/share within two months, struggled with growth strategies over the next few years and watched its stock slide to a low of $.75/share by late 1997. To execute a turnaround, PSTA closed its food-service business and in 1997 hired the current management team, led by Lance Hewitt, to focus on its core strengths in refrigerated pasta products.

The company now focuses on its core business of fresh, refrigerated pastas and sauces and eschews the shotgun approach to mainstream distribution in favor of carefully picked stores that are aligned with its upscale product profile.

“Our products command a higher price and do better in upscale stores,” Brinkman says. “When we go into chains, we try to go into the higher-end stores.”

John Posteraro, an equity analyst with the New York-based research firm Sidoti & Company LLC, rates PSTA Buy, with a 12-month price target of $13 based on a 27x multiple of his calendar 2002 earnings estimate of $.50.

“In my opinion, the multiples on this company are not accurately reflecting the company’s growth potential,” Posteraro says.

PSTA has experienced 28 percent compound annual growth in the last year, according to Brinkman. For 2Q01, PSTA rolled out net revenues of $14 million and net income of $833,000 or $.06/diluted share. It also generated more than $4 million in EBITDA in 1H01 and remains debt-free. Brinkman says that for FY01 the company expects to grow its top line between 20 and 25 percent and its bottom line between 7 and 9 percent after taxes. In FY00, PSTA reported net revenues of $47.9 million and net income of $6.1 million or $.44/diluted share and posted a one-year sales-growth rate of 30.1 percent.

Posteraro thinks that PSTA can continue to grow its top line between 20 and 25 percent for the next three years, excluding acquisitions, and also thinks that the company can grow its earnings in the 30 percent range.

“One of their major advantages is that PSTA can focus on this niche market and move quickly; their main competitors are units of large multinational corporations, such as Kraft Foods and Nestlé,” Posteraro says.

PSTA plans to grow by adding chains and SKUs and making select acquisitions. According to Brinkman, while PSTA products are currently in approximately 5,500 of the 30,000 mainstream grocery stores in the U.S., he estimates that between 40 and 50 percent of the remaining stores fit the company’s upscale profile. PSTA’s latest new products include stuffed pizzas and calzones—introduced in fall 2000—which now account for between 7 and 10 percent of sales, and Borsellinis (“little purses” in Italian), introduced early this year, which involve a new technology for manufacturing “veil-thin” pastas, which could be adapted to many other pasta products.

In the realm of acquisitions, PSTA is actively looking within its core category at companies with sales of between $4 million and $20 million, with an emphasis on the upper end of that range, Brinkman says. Posteraro thinks PSTA is seeking acquisition targets east of the Mississippi to build its distribution presence in that region, which could also add capacity for existing product lines.

“The flip side is that one of the big guys could acquire Monterey Pasta,” Posteraro says. “Little companies seek national distribution, and big companies have it. Eventually I think that will happen.”