Inventure Foods (NASDAQ:SNAK)
Inventure Foods is not a name you’d recognize at Costco while picking up some frozen berries or at Safeway getting some potato chips for game night. But their portfolio contains brands that you’d probably recognize: Boulder Canyon potato chips, Jamba frozen fruits, TGI Friday’s snacks, Burger King snack packs. They are not the most recognizable brands but they certainly command shelf space at big grocery chains and restaurants.
The Company (then operating as Poore Brothers) became public in 1996, and began reaching astronomical success gradually starting 2008. Without so much as a blink, the Company weathered the financial crisis in 2008 and started gaining momentum at the start of 2009, continuing its upward trajectory until the end of 2014.
First, what you should know about the Company.
Inventure Foods manufactures and markets both “healthy” and “indulgent” snacks under its own brands or licensed brands:
Over the last two decades, the Company has built national retail distribution channels across leading grocery, natural food store, super stores, convenience and foodservice channels:
Aligned With Health Food Trend (e.g. The Kale Craze)
Inventure Foods’ portfolio of branded products includes health foods, which they have been pushing to the forefront as the food industry trended toward healthy foods.
Since the turn of the millennium, the food industry has seen a higher growth rate of health and wellness foods than non-health and wellness foods (i.e. in the graph below, green line is higher than the grey line every year):
All it takes is Sales Growth and Margin Stability
From 2008 to the end of 2014, Inventure Foods’ stock price experienced a ~600% growth (stock chart below). During this period, the Company reported an overall growth in sales (blue bar graph) and stable profitability margins (gross profit indicated by green line; EBITDA margin by grey line).
Just as the Company was gaining unstoppable momentum, at the turn of 2015, the market proved that a growth in sales doesn’t mean much if the bottom line is not profitable. In Q1 2015, the Company’s cost of goods sold spiked, hurting both the gross profit margin and eventually the bottom line. As a result, Inventure Foods’ stock dipped even though the Company hit record sales. The stock continued to decline throughout 2015 as the margins never recovered to past levels.
2 questions emerge from this observation:
To answer the question of what they did right between 2008 – 2014 to command such a notable increase in their valuation during this period as well as what went wrong in 2015, below outlines key events and strategies implemented by Management:
2011 – 2012 –
2013 – 2014 –
As I dug deeper into Inventure Foods, a pattern of success factors emerged.
So far, similarities between Inventure Foods’ success and Crown Crafts’ (kids’ bedding company in my last post) success are striking. The 2 notable similarities are (1) in their respective industries, they both licensed with brands that were popular in their industry at the time; and (2) they constantly used feedback loop to update their portfolio of products. They discontinued products or divisions that were no longer forecasted to have potential growth and they designed, innovated and introduced new products that they found out to have potential in by assessing which existing products were contributing to their growth.
Crown Crafts (NASDAQ:CRWS) is the perfect example of how to turn around a company reporting losses every year into a company that not only survived the financial crisis but grew over 1300% in 10 years. The orange and red lines are the S&P small cap index and the Russell microcap index, respectively.
Before we get into the factors that drove the Company to succeed, a little overview of what the Company does:
Crown Crafts designs, licenses, manufactures and markets infant and toddler products – mostly in bedding, blankets and bibs and a smaller percentage of sales in plastic-related products.
Crown Crafts has an impressive distribution network of retailers:
Baby care market has increased overall since 2011.
However, it is a very competitive market. Crown Crafts has had to be strategic and disciplined. And that’s exactly what they’ve done.
How Did They Grow 1300%? Key Success Factors:
Upon a detailed analysis of Crown Crafts’ path reveals key success factors that contributed to the Company’s 1300% growth in 10 years. A more detailed analysis is below – with notes that point out significant events that caused the stock to reflect the value of the Company.
A lot happened in 2001. The Company IPO’ed, a new CEO was in charge, and they refinanced the debt from $106 million to $47 million. Management team vowed to turn the Company around. They started by selling off their unprofitable business in adult bedding products. This hurt their top line sales, but their focus was to cut costs and protect their profitability.
The next 5 years proved to be a difficult time, but throughout it all, the Management team continued to pay down debt every year and put in place a continuous feedback loop to determine which product divisions were working and which product divisions were not, i.e. they were ready to take appropriate risk measures in order to keep reinventing the Company.
2006 was a pivotal year. Crown Crafts refinanced their debt again, reducing the debt outstanding by more than 70% and just as importantly, extinguishing exercisable warrants that were attached to the debt, reducing the fully diluted shares by more than 70%. Overnight, the Company’s shareholders rewarded the Crown Crafts by more than 200% and the Company started gaining momentum. Crown Crafts’ CEO, Chestnut, also had a strategy to grow the company – to make meaningful acquisitions.
Since 2006, the Company continued to be profitable and it is evident that the Management team stayed disciplined. (Read through the detailed analysis of success key success factors below.)
To sum up the analysis, the key success factors that contributed to the Company’s success in the last 10 years (and continue to do so) are:
Detailed Company Analysis of Success Factors (and Failures)
Letter on the stock chart indicates key events discussed below in detail.
A. July 2006
B. November 2006
C. December 2006
D. February 2007
E. July 2008 – November 2008
F. June 2009
G. July 2009 – December 2009
H. February 2010
I. May 2010 – December 2010
July 2010 – December 2010
J. July/August 2011
Company’s value took a hit in 2011 as their gross profit remained in question due to rising costs for raw materials, labor, transportation, and currency translation. Along with decreased profitability and a losing “proxy”, throughout the year, there weren’t positive impacts that fueled the momentum they experience in 2010:
K. February 2012
L. March 2012
2012 – 2013
M. June 2013
N. June/July 2014
O. June 2015
P. February 2016
Q. November 2016
EnviroStar was founded in 1959. They started as a private distributor of laundry equipment and then went on to become a nation-wide distributor and provider of their own proprietary equipment. The Company was able to achieve success because of the founder’s innovative and entrepreneurial approach to business.
Their three business segments are very complementary to each other. They produce their own brand of products. They have a franchise business. And they’ve now added the nation’s largest distributor to their portfolio, from which they will have synergies through technician efficiency, inventory management, and exposure to clientele to market their products through the distribution business.
3 Complementary Operating Segments
Pricing & Customers
Steiner-Atlantic’s customers are primarily hotels, resorts, and correctional facilities that use industrial laundry and dry cleaning equipment everyday. In addition to their proprietary laundry and dry cleaning products and equipment, such as GreenJet – a dry wet cleaning machine that is energy efficient and environment friendly – their product offering has 12 brands which also include third party hot water boilers for industrial use. They believe their products attract their customers because it is a one-stop shop. Their prices for the products and machines range from $5,000 to $1,000,000.
DryClean USA’s customers are franchisees of the brand. Initial franchise fee can cost from $80k – $500k depending on location, size, and equipment. The franchise fee they collect from each location is $15k – $30k a year and the royalty fee is $5k a year. Terms of agreement are for 10 years with renewal fee of $5k. They don’t charge a fee for advertising. Other dry cleaning franchisors charge a percentage-based royalty fee around 6%. (Source: thefranchisemall) A profitable dry cleaner could be making $500k a year in sales, which translates to $30k a year in royalty fees at 6%. The fixed annual royalty fee could be their cost-leadership style. Although I can’t see what every franchise agreement looks like, there might be missed opportunity to structure the royalty fee as a fixed up to a certain amount of sales and then a fixed + percentage if they meet a certain target, provided that DryClean support advertising fees, etc.
Dry Cleaning Industry
Industry is Fragmented
The dry cleaning industry in the US is highly fragmented. The nation’s 50 largest firms only generate 10% of the revenue in the industry (Source: First Research, Dec 2016). In 2015, annual sales of the dry cleaning industry was $9 billion, brought in by more than 34,000 dry cleaners across the country (Source: IBIS, March 2016). In comparison, Walmart brought in $480 billion in revenue in 2015 alone from ~6,300 stores (Source: Statista). With the acquisition of Western State Design, they’ve now built a stronger presence in the coin-operated laundry industry. In the US, laundromat sales in the US was $5 billion, with almost 22,000 laundromats in the country (Source: IBIS, June 2016).
When the market is this fragmented, it means there is no loyalty from its customers, which makes sense since I am not going to drive 50 miles to my favorite brand of dry cleaners when I can go to the local dry cleaner’s down the street. There are advantages of a fragmented industry, which is that you are not competing against a Coca-Cola. There are also many pockets of niche that can be created to differentiate yourself.
EnviroStar’s Competitive Advantage
For EnviroStar, they’ve certainly been smart to brand their franchise business, DryClean USA. What they are missing in this business is the unique competitive advantage. Currently, their brand is known for average price, average service, average offerings. It neither caters to those who would pay extra for a reliable, high-quality job, nor the people who need it super fast and super cheap. Unless the company gobbles up other players in the industry to become the leading brand in terms of most recognized in customers’ minds, it’ll be hard to demand customer loyalty when there are dry cleaners that pop up down the street every year due to low barriers to entry.
DryClean USA’s franchise cost in upfront fees and annual franchise & royalty fees are in the middle of its peers (Source: Entrepreneur, thefranchisemall). So, the pricing they enforce or encourage their franchise stores to charge consumers depends on the profitability of the franchise stores and EnviroStar’s wiggle room to charge less royalty fees but with the strategy of putting more franchise stores across the nation.
One competitive advantage they have with their line of products that they sell directly to industrial and commercial customers, such as hotels, is that their products have been known for a long time as environmentally friendly and energy efficient. In this fragmented industry, if they continue to introduce new versions of products that are proven to be even more energy efficient and environmentally friendly, they’ll be able to position themselves to gain customer loyalty.
Surviving a Declining Industry
Unfortunately, what is working against them is the lack of growth in the industry. The annual growth of the last 5 years was -0.2% (Source: IBIS). Further adding to the decline of the industry is that clothing manufacturers are producing less clothes that require “dry cleaning only.” And there are more and more advanced washer and dryer for the home that will give you similar results from dry cleaning (Source: Capital, Jan 2016). Fortunately (but not really), the laundromat industry had a slightly better performance with 1.2% annual growth in the last 5 years (Source: IBIS).
EnviroStar – Last Man Standing?
On that note, Western State Design was a smart move – adding a portfolio of customers to its distribution network. Was it a fair price? We’ll find out in their next financials. But with a purchase price of $28 million, we should expect to see around ~$30 million of sales added every year, with an average multiple of about 1.0x sales (Source: Fulcrum). It has certainly helped with international expansion, i.e. to the Caribbeans and Latin America. Western Design is located in Calirofnia, which plays into the strategic location to reach into their distribution network since EnviroStar is located on the opposite side of the country in Miami, Florida.
We should be seeing more transactions involving international reach in the coming years if Management’s buy and build strategy is in full force.
The market really seemed to like the acquisition, helping the stock jump 225% in 3 months since their announcement of the acquisition in September and still 2 months after the completion of the acquisition.
As part of their buy and build strategy, in addition to businesses they are looking to acquire, they are exploring technological advancements to make their current operations better.
Currently, apart from the “technology” of their products, EnviroStar hasn’t implemented new faster, better, and smarter way of doing business that gives them a competitive advantage via technology. For example, with the network of franchisee partners, they are more suited to head a consumer-based pick-up/drop-off drycleaner service mobile app than Flycleaners, who has to cut a margin to their partnered facilities (Source: Business Insider).
EnviroStar could also be implementing technology into their advertising and sales. Are they doing any online targeted advertising for their franchisees? Are they doing any digital advertising to young people who are looking to become entrepreneurs via franchises? Do they have an enterprise software where franchise owners can use it to manage multiple locations?
There is a lot of room for improvement in technology.
The Management Team is currently comprised of:
Previously served as CEO of Chemstar Corp, a provider of food safety and sanitation solutions. Before becoming CEO, he held Executive Vice President and Strategy position at Chemstar. Prior to Chemstar, he served as Director of Corporate Development at Watsco, Inc, the largest distributor of heating, air conditioning and refrigerated products.
So, he’s a corp dev guy – no wonder as soon as he came on board EnviroStar, he’s implemented the buy and build strategy. Or conversely, the previous CEO, Michael Steiner, and the board may have been looking for new management to expand the business by way of acquisitions in his efforts to leave a legacy after his exit. In any case, for the buy & build strategy, he seems to have the right experience. However, after having servied as EVP for Chemstar since 2008, he left his CEO position not long after assuming the new role, which raises some questions. Although his experience has not directly been involved in laundry and dry cleaning, it has always been in industrial products and distribution, so it is somewhat aligned. A small, albeit, important finding is that the culture at Chemstar is such that employees did not approve of the CEO – most of the reviews are for after Nahmad left Chemstar, but there are some reviews for during Nahmad’s tenure as CEO there. And even if it is for after Nahmad had left, it does question the state of the company’s culture he had left it in (Source: Glassdoor).
Has been President of Steiner-Atlantic since 1988, and during his tenure, was involved in growing the business in many different facets. It’s reassuring to see that one of the company’s veterans is staying in Management after control of ownership.
Their financials ending Sep 30, 2016 is a bit cheeky. They had an outstanding revolving credit facility of about $2.2 million, which they wiped clean before September 30, so they declared debt to be $0 at the reporting date. But a week later, on October 6, they refinanced the debt into a $5 million term loan and a $15 million revolving credit facility. Of the $20 million available credit, the company took out $12.6 million to help pay for the acquisition of Western State Design. As a result, what is reported on their balance sheet looks ostensibly healthy, but their leverage ratios reveal otherwise.
Again, the median of its peer multiples was in line with EnviroStar’s implied trading multiples before the inflation of its stock price following the announcement of WSD acquisition announcement. However, in the last 3.5 months, the stock price became way too inflated and now it is extremely overvalued.
|Positioned themselves to provide complementary products/services within their space. They target the commercial and industrial customers, which is easier to reach with their salesforce than individual customers. However, it is still a highly competitive industry.|
|Declining industry, i.e. -0.2% annual decline in the last 5 years; highly fragmented – no customer loyalty. Competitive forces come from outside its direct competitors such as consumer-based washer and dryer products that can replace dry cleaning. Opportunity lies in international expansion and implementing its buy-and-build strategy until its captured most of the demand that it could.|
|EnviroStar’s had a long history of innovation, not so much reinvention. When the company started out as a distributor of laundry and dry cleaning products, the founder, Bill Steiner, saw the opportunity to fill the gap in the market with more energy-efficient and environmentally friendly products. Henceforth they started providing their own products to industrial and commercial customers. EnviroStar saw the opportunity to enter the franchise market and now boasts ~400 stores. Since then, they have been building their distribution network and franchise segment, both organically and with the acquisition of Western State Design under the new CEO, Henry Nahmad. Their innovation and reinventing strategy will be more important than ever going forward with competitive forces at play in this declining and fragmented industry.|
|They don’t currently have technology implemented into the way they do business. A part of their buy and build strategy does mention that technological capabilities is one area they will explore in potential investments.|
|The company has the right mix of old and new. Steiner, the veteran of EnviroStar who grew the company to what it is today continues to assume leadership of Steiner-Atlantic. Meanwhile, Western State Design’s founder and EVP have now joined the team to build the distribution network, which in this highly fragmented business and where sales depends on distribution, is key. Furthermore, although the new CEO, Nahmad is young and lacks experience in the CEO role, his previous roles were aligned in a similar industry and his experience in corporate development/M&A could be what EnviroStar needs to expand.|
|Strength of Financials||
|High leverage ratios, but we are not sure how Western Design is going to contribute to working capital. It is a loose grade of C for now until the next 10Q.|
|Right now, the stock is overvalued. However, that is not to say that the company does not have potential to be strong. I believe the company has a robust intrinsic valuation. It appears the stock is overvalued (but we will have to see WSD’s financials to comment further).|
|Strong company but currently overvalued. Wait to see WSD’s contribution to the consolidated financials in the next 10Q.|
I am impressed by the level of detail Neonode’s 10K goes into in terms of its customers, the market it operates in, and the very relevant risks to the business. One of the key criteria that Buffet looked for in his fundamental valuation of companies was whether the company’s management gave detail on the drivers for the industry and their company. So, I was excited to see that Neonode was asking and answering the right questions preemptively.
My hope was then shattered when I dove deeper into their numbers. The company is clearly trading on its future potential. But this is not a discussion of stock price, but a stripped down analysis of whether the company has substantial value. Let’s begin with who Neonode is and what they do.
Brief Company History
Products & Solutions
Core Business: Touch Technology Licensing
AirBar: Neonode’s First Hardware Product
A lot of heavy hitters for partnerships, but that isn’t reflected in their financials.
Risks & Opportunities
First of all, the Company operates in a very competitive space, as evidenced by them losing Amazon as a customer for the Kindle e-readers, which affected the business by a -48% decline year over year.
Revenues from engineering consulting fees have been about ~$800,000 a year. It’s not a bad idea to build this division out as it relates to optical technology implementation and vision consulting. It would be a more robust way to secure sales
The launch of their first consumer product, AirBar, is very timely as it coincides with Apple’s new “touch bar” on their Macbooks, so they’re riding the coat tails of Apple’s marketing as an introduction to the product. But it is still not widely known, so they need to be doing some more online marketing of their product. As they stated in their filing, they’ve never mass manufactured products before, and they’re about to find out how good they are at it.
Neonode has put themselves in a very interesting position. If they’re successful at marketing AirBar and PC users adopt this in lieu of Macbook with touchbar functionality, they can leverage their presence in the consumer market to launch new products using their optical technology, especially in the augmented reality/virtual reality space. It’s promising that they’re developing a human interface product with tier 1 automotive OEMs at the moment, but this will take 4-5 years as they said. If they’re smart, they’re probably working on an AR/VR product development as well, but this is also going to take at least a few years. So, the company can go down a few paths from this point on as I see it:
Regardless of their path, I don’t see this company failing anytime soon. Even though they’re operating in a highly competitive space, they’ve positioned themselves very well in the market with OEM partnerships and there are ample opportunities for their technology to be used in various avenues.
After accounting for capex and likely scenarios in each year of their production and sales, Craft Brew’s valuation doesn’t look very appealing. Craft Brew was an incumbent in the recent craft brewery trend but is now struggling as this trendy niche has now become an oversaturated mainstream market. Can Craft Brew survive the influx of competition into this niche space?
Craft Brew Alliance (CBA) was formed in 2008 through a merger of Redhook Brewery (from Washington) and Widmer Brothers Brewing (from Oregon). They also added to their portfolio in the same year, Hawaii’s oldest and largest brewery, Kona Brewing Company. CBA has 5 brands:
The original CEO from the merger, Terry Michaelson, transitioned out of the role in 2013 but has stayed on as a senior advisor. The CEO that took his place, Andy Thomas, has been with CBA since 2011.
CBA distributes to retailers through wholesalers in the Annheuser-Busch network, and more than 90% of their sales comes from this channel.
CBA is riding the wave of the craft brew trend, but competition in this space is fierce, due to low barriers to entry and a relatively high margin drawing attraction. Many local breweries can start with a business loan from the bank. In the last decade, the craft brew market has seen a double digit growth year over year. Craft brew now makes up ~21.7% of the total US beer market (as of Sep 2016). US craft beer production grew 20% CAGR from 2010-2015:
Source: WSJ Article
Breweries Association reported that in Dec 2015, the number of breweries in the US surpassed the previous record in 1873 with 4,144 breweries, many of which came online in the recent part of the decade. But, craft brew supply has now reached the demand and will likely start to see a plateau.
The larger brands (Boston Beer, Sierra Nevada, New Belgium) have become stagnant because of an overflow of volume in the marketplace, and the growth of the market is now led by local breweries driving the growth of the market as opposed to the large brands. The 2 driving forces left in this competitive market to out-win competition are quality/innovative beers (such as introduction of nitro-infused beer) and lowering prices. (Source: Bevindustry.com Article)
The overall volume shipment of barrels has decreased in the last 2 years since 2014 because of declining popularity of Widmer and Redhook brands.
Even though overall volumes have decreased, net revenue has increased because of a higher average selling price from shifting from draft to packaged goods sold. The Company unfortunately probably won’t benefit much more beyond the current draft to packaged ratio, and in fact, recent quarterly filing saw a slight shift back to draft:
Therefore, a similar level of draft to packaged goods ratio and therefore a similar level of average selling price per barrel are assumed in deriving revenue.
The only noteworthy things to mention in the above valuation are:
Key Risks & Opportunities Summary
Widmer and Redhook brands have been around for a long time, but they never gained popularity outside of the Pacific North West (and a bit of lower West Coast). With a crazy influx of craft breweries in the last decade with local brands winning the hearts of beer fans in their communities, older brands just can’t keep up with the competition.
Kona at least brings something unique, because it comes from “overseas,” so it could maintain some traction. And, CBA was smart to introduce Omission and Square Mile – something unique to the table. Continuing to introduce innovative products will be key to survival.
It is slightly of concern that Annheuser-Busch is CBA’s exclusive distributor and that over 90% of their sales come from this partnership. But, it is not too alarming, because that’s just the nature of the business, and it is unlikely that A-B will suddenly raise their fees to ridiculous levels.
CBA’s capex levels have been pretty high and their expansion of the breweries for ~$20million a piece seems egregious. Their opportunity to fill the new increased capacity will come from increasing their international sales efforts and if they acquire or introduce a new unique brand.
Could we see CBA dismember their alliance of brands and either (1) operate as a lean company of one or two brands or (2) divest their underperforming breweries and position their more popular brands to be acquired by large brew companies like Boston Beer?
Source: Google Finance (Link)
Key Risks & Challenges
Key Opportunities for Upside