Value Investing IPO Lessons for Public Market Investors |
| IPO Lessons for Public Market Investors Posted: 11 Oct 2019 03:39 PM PDT |
| Posted: 11 Oct 2019 08:50 AM PDT |
| Posted: 11 Oct 2019 08:46 AM PDT This is a curious name I've been kicking around lately...I'm not quite sure what to do with it yet, but thought it'd make for an interesting discussion. I'm new to this industry and this is just about a days worth, so excuse any errors. UNFI is a leading distributor of organic / natural foods. They are the exclusive supplier to Whole Foods under a contract expiring in 2025. Whole Foods historically was about 1/3rd of the Company's revenue prior to the 2018 leveraged acquisition of Supervalu which diversified the Whole Foods exposure down to ~15%. Pro-forma for Supervalu, about 23% of sales are to independent markets, 17% to Whole Foods and Whole Foods-type retailers, 60% to conventional retailers, and the small balance to other vendors. Distributing organic foods used to be a pretty good business because 1) the organic foods industry has strong secular tailwinds and 2) organic foods did not fit the conventional food distribution logistics model for a variety of reasons that can somewhat be summarized as a combination of shelf life and de-centralized sourcing (farmers, local producers, etc., not traditional CPG suppliers) and as a result commanded a slight pricing premium over conventional distributors. The secular shift towards natural foods has been strong enough for conventional distributors to revamp their logistics and start to make inroads into the specialty market, and their large scale (Sysco, U.S. Foods, etc.) allows them to offer competitive pricing. So a race to the bottom is currently taking place. Gross margins on the organic side typically range around ~12% while more conventional is ~9%. Operating costs are mostly fixed - salaries, transportation, fuel, etc. - which is problematic particularly in low unemployment environments like today. This all comes together and gives you razor thin EBITDA margins in the LSD range. UNFI completed the acquisition of Supervalu in late 2018 and levered their balance sheet with $2.8 billion secured bank debt, plus another $1.3 billion operating leases capitalized at 7x. LTM EBITDA is $563 million against revenues of $21.4 billion for the same period. Net of interest, taxes, capital expenditures, and uses of working capital the Company burns free cash flow. Consensus estimates for the Company over the next several years call for modest cash generation, but this implies gross margin to only deteriorate by ~33bps driven by minor penetration of conventional retailers into the revenue base. I guess if I am starting to form a thesis in my head...that seems a little aggressive and it feels like these margins are going to continue contracting more to the ~9% I mentioned earlier. In fact, gross margins of ~10.5% will put the Company into negative EBITDA territory (!). Maybe ~11.5% is a more realistic goal post? That will get us $215 million EBITDA although the Company will still burn close to $200 million a year on that. Another interesting data point is the lean cash balance the Company runs with...around $40 million which is very small relative to their revenue base. Liquidity here primarily comes from availability on an asset based revolver secured by most of their inventory. If margins keep contracting, this may lead to a write-down of their inventory which makes me wonder how that may affect the ABL borrowing base calculation - it could squeeze liquidity real quick. As of the most recent 10-K they currently operating 63 distribution centers, and from what I understand there is a fair amount of overlap between legacy UNFI DCs and Supervalu DCs which will be consolidated. Since they own a lot of these the proceeds from consolidation will go towards debt pay down. The Company says they may get about $1 billion after they've completed selling assets...I just don't know if I believe that. I probably need to do more work on the total distribution foot print of all food distributors in the country to see if there is an overcapacity issue. If there is, they certainly won't get values high enough to total $1 billion. Given this context, it probably wouldn't surprise anyone to learn that their stock is trading at ~$7, down from $13 in September which is down from ~$50 in summer 2018. Their $1.8 billion term loan due 2025 trades at ~72 for a ~13.5% yield. I'm just not really sure what to do with this. These issues look pretty structural to me which I don't think they can reverse, so the stock is probably a short, yet I don't really see a good catalyst. For the same reason, I don't really want to buy the loan right now unless there is a way to force bankruptcy and preserve value. The debt is cov-lite so there aren't any maintenance covenants that can get the ball rolling here. One might suggest shorting the stock and going long the loan, which is a trade that doesn't necessarily disgust me, its just the catalyst issue. Asset sale cadence is probably the key here? Another issue with the loan relates to collateral, but that is a separate issue. I really don't know, but these are my thoughts. It'd be great to discuss if anyone else has thoughts on this or could point me in the direction of any good industry white papers on how food distribution works. [link] [comments]  |
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