I recently introduced the Concentrated Portfolio Of Great Companies. The purpose of the portfolio is to identify companies that are good buy-and-hold candidates for a multi-year or, possibly, a multi-decade timeframe. I want to keep an eye on great companies and do the homework in advance so that I can buy them when they trade at attractive levels. In this article I will focus on Chefs' Warehouse (CHEF). Chefs' Warehouse is the smallest company on the list and I do not usually consider companies of its size for a buy-and hold portfolio. However, I am very bullish on Chefs' Warehouse and believe that it has an attractive business model for the long term. My previous article, Bullish On Chefs' Warehouse: 60% Upside Potential In 1-2 Years And Great Long-Term Story, focused on the near term and in this article I will focus on the long term. I will subject Chefs' Warehouse to my Concentrated Portfolio Questionnaire, which I will also use for the other companies on the list.
What Is The Company's Story?
The company was founded 1985 by CEO Chris Pappas, who still owns a large percentage of the company. Chefs' Warehouse is a distributor of specialty food products. Regular people buy food from supermarkets, restaurants buy their ingredients from companies like Chefs' Warehouse.
Chefs' Warehouse operates in a $200 billion industry, which is dominated by Sysco (SYY). Chefs' Warehouse focuses on the upper-middle and high-end of restaurants and dining establishments. Chefs' Warehouses focuses on top chefs and tries to be their source for the best ingredients.
The company went public in 2011 and has a $485 million market cap.
What Are The Industry Dynamics?
The US foodservice industry is estimated at $191 billion annually. It is comprised of 16,500 distribution companies. The top three competitors control 31% of the market. The industry remains very fragmented and ripe for continued consolidation.
Restaurants represent 58% of the customers for the industry (the rest are hotels, schools, healthcare facilities, etc.). Supermarkets are not included in these figures.
Of the $110 billion restaurant segment, 56% are chains and 44% are independents. (Source: Chefs' Warehouse Q2 2013 investor presentation)
Chefs' Warehouse mostly focuses on the high-end independent restaurants as well as country clubs and some catering businesses.
Restaurant spend has grown in the 1-3% range since 2010.
Does The Company Have A Durable Business Model?
Yes. Basically, the company is the "supermarket" for top restaurants. It has a product selection of over 23,000 items. Food manufacturers do not want to sell to individual restaurants and individual restaurants do not want to source ingredients from individual food manufacturers.
It seems that both food manufacturers and restaurants will need a middleman like Chefs' Warehouse in the future, so the business model is durable.
Will The Company Be Around In 10 Years?
Likely. The company has existed since 1985. The industry giant, Sysco, has been a public company since 1970 and has been operating for longer. As long as there are restaurants, there will be a need for food distributors.
What Changed From 10 Years Ago?
The company was not public 10 years ago, so it is hard to get that perspective.
Since the late 1990s the company expanded from a small cheese distributor in the New York area to offer more products in more locations. It has expanded to cover top cities across the country and is now operating in Canada.
In terms of the business, it is probably much the same as it was 10 years ago.
It is hard to tell from the outside, but it seems that the company is using technology more that it did 10 years ago. The company now talks about IT systems, route optimization etc. The new technology systems give the big companies advantages over smaller companies that do not have leading technology.
Since the company is in the business of delivering food, fuel is an important cost item, which has increased over the last 10 years.
The biggest change is the growth of the high-end restaurant and food culture over the last 10 years. The concepts of "celebrity chefs" and "foodies" are gaining more traction. Although the lackluster economy has been a headwinds, the growth of the high-end food industry has been a tailwind.
Another interesting dynamic is the expansion of restaurant groups. High end chefs used to focus on a single restaurant, but they are increasingly going national and global.
How Does Technology Impact The Company?
In general I want to avoid industries that face competitive destruction from new technology.
It is possible that at some point in the future new technology will make it easier for restaurants to buy directly from food manufacturers and cut out the middleman. However, this seems like a very distant possibility. There are probably advantages to both food manufacturers and restaurants to have the middleman in place.
As I mentioned above, technology also gives the larger companies in the industry an increasing advantage over the mom-and-pops.
How Does Inflation Impact The Company
It is important that buy-and-hold companies benefit from inflation over the long term (this is one reason why few technology companies make the cut).
Chefs' Warehouse should benefit from inflation over the long term.
In fact, the CEO recently said that modest inflation is good for the company, modest deflation is manageable, but hyper inflation/deflation is a negative (Source: webcast of presentation at Cannacord conference, august 14, 2013).
Is It Cyclical?
There is a cyclical element to the business. During recessionary periods people spend less on eating out. Also, there are less corporate events and business dinners.
Chefs' Warehouse estimates that it has 7% attrition annually, mostly from restaurants closing. This is probably higher during recessions.
Is The Company A Global Leader?
No. The company is a leader in the US high-end specialty food segment, but it is not an international company (except for recently acquired operations in Canada).
Does The Company Have Exposure To Emerging Markets?
What Are The Cash Flow & Dividend Dynamics?
The company is currently in a growth phase. It is using cash flow and debt to buy more companies and consolidate the industry. The company generates a nice amount of cash flow, but the cash is not (yet) reaching shareholders through dividends or buybacks.
Eventually, the growth phase will transition to a mature phase. At that time, the company's cash flow dynamics will likely resemble Sysco. Chefs' Warehouse has higher margins that Sysco now, so its cash flow dynamics may outperform Sysco at maturity.
Sysco has consistently increased its dividend, even during the recent recession, and dividends are an important part of the investment thesis for Sysco.
Chefs' Warehouse does not pay a dividend, but I expect that it will at some point in the future.
How Does Leverage Impact The Company?
Chefs' Warehouse is taking on more debt to buy more companies. However, the business does not necessarily require leverage. I expect that as the company matures it will stop relying on its balance sheet.
Why Is It Suitable For A Buy And Hold Portfolio?
Yes. I view Chefs' Warehouse as a younger, and higher-end, version of Sysco. Sysco has been a big success for buy-and-hold investors over time and I expect a similar performance from Chefs' Warehouse.
What Are The Risks?
There are always risks. I touched on some in my previous article. However, there are other risks from a buy-and-hold perspective.
- CEO transition - At some point, the current CEO, Chris Pappas, will step down. The company never had another CEO, so it is unclear how successful that transition will be. The CEO also owns a large stake in the company.
- Leverage - Currently, the company has a prudent approach to leverage. However, there is always the risk that it takes on too much debt before the next downturn and suffers through the down part of the cycle.
- Acquisitions - There is no guarantee that the company will be successful in making enough acquisitions and consolidating the industry.
- Competition - The company faces a lot of competition. The biggest risk is if more companies seek to consolidate the high-end segment. Furthermore, Sysco has been increasing its acquisition program as its sales have slowed down. Sysco may become more aggressive in acquisitions, which negatively impact the company's ability to make acquisitions at attractive terms.
Chefs' Warehouse is a small, fast growing company (mostly through acquisitions) but it has a place in my "Concentrated Portfolio Of Great Companies."
I view Chefs' Warehouse as an emerging Sysco. However, it is focused on a more attractive industry segment (high-end), has better margins and better near-term growth prospects. Over the long-term it will mature and may become a good dividend growth company like Sysco.
For more about Chefs' Warehouse please see my original article, linked above, as well as a follow-up: Updated Analysis Of The Bullish Case For Chefs' Warehouse.
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