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Ralcorp makes Grape-Nuts but not a stock to go nuts over

Dear Mr. Berko: I have about $10,000 to invest, and I like food stocks because people always have to eat.

Since my family eats Grape-Nuts every morning, I was thinking of buying 100 shares of Ralcorp for my IRA.

I would appreciate your advice. –R.P., Aurora, Ill.

Dear R.P.: Years ago, when Ralcorp Holdings (RAH, 52-week high of $91.30 as of May 10) was trading at $13 per share, I bought 10 shares as a wedding gift.

The son of a friend of ours, a first lieutenant in the Army, was getting married to a former beauty queen. After the RAH shares were delivered, the bride (the groom a week following the nuptials was posted overseas) returned the certificate with a note saying: “The picture did not match the decor in our home.”

The husband, who is now a half-colonel and thankfully remarried, enjoys the telling of this story with great relish.

When I bought RAH in 2000, revenues were a measly billion dollars. Operating margins were 9.1 percent, net profits margins were 2.6 percent, book value was $12 a share, the average annual P/E ratio was 14.5 and RAH didn’t pay a dividend.

Eleven years later, revenues grew to $4.7 billion, operating margins improved to 17 percent, net profit margins increased to 6.3 percent, the P/E ratio is 16.2 percent and the stock still doesn’t pay crumb in dividends, which has helped the book value grow fivefold since to $59 a share today.

RAH is Post cereals (Grape-Nuts, Shredded Wheat, Raisin Bran, etc.), American Italian Pasta Co., Ralston Foods (more than 50 brands of mostly delectable private-label ready-to-eat cereals, cookies, crackers, organic specialty products, etc.), Ralcorp Frozen Bakery Products (breads, rolls, pancakes, waffles, desserts and prebaked gustables) and Ralcorp Snacks, Sauces & Spreads under the Carriage House, BFG and Nutcracker brands.

Revenues and earnings have grown consistently, aided by a spree of acquisitions. But though management has been aggressively cutting costs, the near term is going to be very challenging. Meanwhile, Kellogg’s and General Mills have been lowering prices to recapture some of the private-label business it lost to RAH.

Earnings for 2011 are supposed to come in at $5.32 and may be lowered as commodity prices continue to rise. There are five “strong” buys on the Street, which I find difficult to reconcile, as nine of the brokers who follow RAH have a median target price of $76, which is about where RAH should be trading.

But ConAgra (CAG, 52-week high of $25.82 as of May 4), a $12.3 billion packaged-food company that tried to buy RAH at $86, is still sniffing and may consider an offer in the high $90s.

The private-equity firm Apollo may also jump into the fray. Apollo seems more interested in RAH’s substantial free cash flow – 4 percent of sales – which they believe can be increased to 6 percent.

So on a buyout, there’s possibly six to 10 points left in the stock. However, without a buyout in the cards, RAH is overpriced, and the stock doesn’t butter my bagel at $90.

But in the meantime, if a market correction pulls the stock back to the high $70 range, I’d jump on the stock faster than a duck on a June bug.

Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775 or e-mail him at mjberko@yahoo.com.

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