Much to the surprise of many investors, myself included, National Beverage Corp. (NASDAQ:FIZZ) posted outstanding FY17 Q2 results during the middle of trading on Wednesday. The firm's earnings growth easily outstripped my projections, and as a result, I am increasing the low end of my value range to $59 and the high end of my value range to $67. Let's take a look at the quarter's highlights and the key drivers that increased my valuation.
Revenue growth robust, earnings growth even better
As usual, most of FIZZ's standard management quotes were mildly outlandish and demonstrated visceral hatred of the short sellers that have recently weighed on the share price. Just for fun, here's a nonsensical quote from CEO and chairman Nick Caporella, an apparent supporter of President-elect Trump. I'm not particularly fond of these, but they are part of the FIZZ shareholder experience:
"America put a capital 'H' on Hope again recently and with that - a capital 'H' on Health again too... this puts us in the cockpit of innovation and the yoke in our hands."
Q2'17 earnings release
Regardless, revenue was up 13.5% y/y to $203.2 million, about in line with what I had projected. Although not broken out separately, I think it's safe to say its LaCroix sparking water brand is the growth driver. Per a recent Nielsen report:
"LaCroix continued its dominance in the sparkling flavored water category with 71.1 dollar sales growth in the 4-week period and a 73.3 percent growth in the 52-week period. Average unit price increased 10.4 percent in the timeframe. Overall, the sparkling flavored water category saw a 16.5 percent sales jump."
The real star of FIZZ's second quarter was the gross margin, which came in at 38.7%, up 482 basis points from the year-ago period and about 150 basis points above what I had previously estimated. The company is clearly experiencing tremendous overhead absorption from its volume growth, and if the momentum continues, we may see gross margins touch 40%. I was slightly apprehensive that the margin expansion was an isolated experience and that we would see margins would revert to the ~37% level. I was completely wrong, and after thinking through the inherent overhead absorption, I have increased my terminal gross margin assumption to 37.5% (still conservative) from 37%.
SG&A was also kept in check, declining 40 basis points y/y to 20.4% of sales. In combination, FIZZ posted an 18.4% operating margin, demonstrating the tremendous earning potential of the business. Overall, EPS grew 61% y/y to $0.53.
YTD, free cash flow is up about $13 million y/y to $45 million. Although capex is starting to tick up slightly, operating cash flow is growing at a robust pace and the company is effectively managing its inventory and accounts receivable. As a result, earnings quality remains strong.
Gross margin justifies a higher value
After reviewing the quarterly results and updating my forecast, I have increased my fair value range to $59-67 from $58-62. Why the wider range? The combination is two-fold: (1) Base-case gross margins to 37.5% (previously 37%) and (2) bull-case tax rate sensitivity of 27%. With a shareholder-friendly management team and the core LaCroix franchise going at a robust pace, I continue to believe FIZZ shares are a buy.
Disclosure: I am/we are long FIZZ.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.