Growth, Income, a Defensive Business -- This Stock Has it All

Think back to the last time you were on the road for business. You decided to drive because you were covering some of the outlying areas in the territory and it was much more cost effective. You skipped lunch so you could get to Slapback, Miss. to see your customer by 4:00 pm. When you made a pit stop at the Gas-n-Go or the Raceway, or wherever, you needed some kind of nosh.

What did you grab? That's right: a Coke and some peanut butter crackers. My guess is that there was a 70% chance those little crackers were made by Lance Inc. (Nasdaq: LNCE), the greatest little snack food company you've never heard of.

Lance isn't that little, actually. With a $1.3 billion market cap, the company has been manufacturing and distributing snack foods such as sandwich crackers and cookies since 1912. It serves most of the country and, thanks to the recent acquisition of pretzel peddler Snyder's of Hanover, they're poised to gain even more market share  in the tough, crowded, snack-food sector.

I stumbled onto Lance back in June of 2000. A client of mine was singing the blues thanks to the drubbing his tech-heavy portfolio was taking (who wasn't). He was looking for a long idea so I threw Lance out. It was trading around $9 and yielding 7%. "They make chips," I said. "The kind you eat." Luckily he had a good sense of humor. We bought a small position. We sold it a few years later at about $18.

Over the years, I've gone back and taken a look at the stock every so often. The story wasn't as exciting at $24 (it's 52-week high) as it was back then at $9. But, now at $20, I'm excited again.

A smart merger+ strong earnings growth + institutional buying = Recipe for success
In December 2010, Lance completed what was described as a merger of equals with Snyder's of Hanover. Snyder's was best known as the market leader in pretzels. Combined, the new company, billed as Snyder's-Lance Inc., boasts a portfolio of well-known snack-food brands that include Lance sandwich crackers (Lance's famous Toastchee cheese and peanut butter cracker sandwich was introduced during the Great Depression in 1938), Archway cookies and Cape Cod Potato chips. The company also has a strong foothold in vending machines throughout the country.

Pound for pound, the merger made a lot of sense. Lance now has a national, direct store delivery network and a national footprint, which  will help propel sales to north of $1 billion. That's a lot of Toasty crackers. Management projects that combined synergies are likely to generate around $30 million in annual savings.

The 2010 year-end revenue numbers were impressive given the disruption a merger could create: Revenue grew 6.6% year-over-year to $979 million. Snyder's of Hanover contributed $49 million to that effort the fourth-quarter of 2010.

The balance sheet passes muster as well. The merger grew Lance's assets by 172% year-over-year as well. Debt is quite manageable at just 20% of the company's $1.23 billion market cap. The dividend payout ratio is 58%, which makes me feel relatively comfortable about the 3.3% dividend yield.

Analyst forecasts call for 5% top line earnings growth for 2011 and earnings per share (EPS) of $0.99, putting the stock right at 20 times forward earnings. The 2012 estimate looks for 30% EPS growth to $1.29. Finally, institutions are interested in Lance. During the current calendar quarter, net institutional shares purchased equaled 814,500. That's an increase of 1,435% since the previous quarter.

Despite all the synergy and smarts the Snyder's-Lance merger generated, challenges remain. Nothing goes exactly as planned. Surprises always pop up after mergers. And at the macro level, everyone's operating margins are being squeezed by risingcommodity prices. The food business, no matter how junky, is always affected by this. Not to mention how tough the snack food space is anyway. The merger may have helped, but Lance still has to go toe-to-toe with the likes of PepsiCo's (NYSE: PEP) Frito Lay brands and Kraft (NYSE: KFT) every single day.

Action to Take --> Lance shares currently trade around $20. Considering the efficiencies created by the merger both internally and externally and a 17.5% average annual EPS growth rate in the next two years, $24 would be a realistic 12-month price target. That's 20% upside exclusive of yield.

Lance is a growth with income story. It's also a defensive, consumer staple name. During the structural low in March 2009, the stock was only off around 4.5% for the prior month compared with 9.4% for the S&P 500. That's about half the downside. Less volatility with 20%-plus potential? Sounds like a good idea to me.