Current Stock Price: $47.25
New Price Target: $17
MGP Ingredients, Inc. (NASDAQ:MGPI) is a simple story that is currently misunderstood by the market and mismarketed by the sellside. It is a declining commodity producer valued to absurdity based on misunderstood revenue streams. In the face of massive new competition and demand shifts, MGPI's current valuation at $47/share is in excess of the best branded companies. Recent insider sales are a signal that the price is an irrational bubble.
Management and insiders who are selling out large quantities of shares (recently 25,000 and 10,000 share blocks) must currently be euphoric that their eroding commodity business and insignificant brand sales get over a 30x earnings multiple by the market when adjusting for nonrecurring items. This valuation could easily be cut in half and in the mid$20s/share it would still be an overpriced stock. Claims of a huge gain in operating income are based on a one time, i.e. nonrecurring gain on sale last quarter. Q3 operating income 'increase' of 81.1% includes $3.385M of 'other operating income' translating to roughly $0.20 of EPS last quarter. Being generous and giving it 12x multiple on a normalized (but really declining) $0.35 quarterly Q3EPS run rate yields at best $1.40 annualized and would price the stock of this declining commodity producer at just under $17. Oh and included in MGPI revenues are certain 'related party purchases'...which merit some clarification.
The hard reality is MGPI's fledgling brands do not have big sales. MGPI's misinformed bulls point to revenue potential from 1. Branded products and 2. Aged whiskey sales with the incorrect assumption that aged product will generate "3x" that of new-make revenue. Both assumptions are flat out WRONG given the significant number of new players entering, established players returning (for the first time in years) and available aged inventory coming to the market.
It appears that MGPI is posting declining revenue numbers that include current sales of aged product at a discounted price. As their major competitors with more attractive 'Kentucky bourbon' once again produce and sell bulk product in their newly enlarged distilleries, MGPI faces unprecedented competition. Why doesn't the market see this? ...MGPI obscures its revenue lines by not breaking out distilled revenues into 1. Bulk commodity 2. Aged Product Sales and 3. Branded revenues.
The market and sellside analysts have placed biotech-like multiples on this commodity producer and do not understand that virtually all of the company's revenue, which is well obscured in a lump sum division revenue number, comes from the commodity business, not branded goods and not at any level "up the value chain."
1. Understanding this story requires some background knowledge of the industry. MGPI had a virtual monopoly selling bulk commodity product (Indiana whiskey) from about 2013 until early this year. This has changed.
2. Consumers demand "Kentucky" NOT "Indiana." Instead of a monopoly, MGPI may now be considered an 'inferior' competitor to Kentucky-based distillers in the minds of the consumers who prefer Kentucky whiskey. New, very large Kentucky-based competitors (Terressentia: ~2 million gallon capacity and Bardstown Bourbon Co. (affiliated with Constellation Brands): Expanding to 6 million proof gallon capacity) are up and running in the last two months with the capability of producing approachable quantities of customized mashbills that allow craft brands to differentiate themselves. This new competitive threat is absent in any of the sellsider reports cheerleading for $40-$50/ share...and it is not limited to those players. That's just a small example.
MGPI presently offers only three standard products to all ~1300 "craft distillers." We are now starting a new era of price wars for this commodity. With new Kentucky distilling capacity coming online from the major legacy producers (some of whom produce the same exact recipes and have for many years), it is obvious that competitors will begin selling bulk whiskey to the market and regain the majority market share position in the bulk trade that they held as little as four years ago before bourbon and rye whiskey's meaningful return to growth forced them to hoard their production before they could complete expansion projects at their facilities. Consumers world-wide prefer Kentucky bourbon over Indiana product as Kentucky Straight Bourbon and Rye is a brand widely recognized, respected and demanded among whiskey drinkers. The overwhelming majority of the growth in bourbon and virtually all of the market share is in Kentucky. Indiana Straight Bourbon just does not carry the same cachet.
3. The MGPI supply shock and resulting revenue bump from earlier this year is over. Past performance does not equal future performance. "But they posted a great Q1 and show great prospects" says the mistaken bullish investor...If ever there has been a company that reads its own press, it is MGPI. Q1 earnings highlight of 2016 resulted from a unique industry-wide one-time supply shock from a confluence of events that began with a wood shortage as a result of the housing crisis that led to many loggers leaving the workforce. The lack of oak in 2013-2014 led to a shortage of barrels in the months to follow (wood needs to air dry for at least one year in order to be ideal for whiskey making). Once wood became available, MGPI suffered from at least two different plant fires that set back production and caused a backlog that led to the appearance of incredible growth which was really a simple case of filling backorders. This set of circumstances is unlikely to repeat itself any time soon.
4. MGPI Branded products are all talk and no sales. Bullish thesis holds that the company can 1) sell branded products at premium prices for big margins and 2) sell aged product at big profit to merit the sky high multiple. Reality is that they have very little branded sales, almost certainly no legitimate earnings as a result of the branded products and there is no "magic button" they can press for success in the branded goods business. It is extremely time and capital intensive to grow a brand and the vast majority FAIL after millions were poured into them (Virgin Vodka [William Grant and Richard Branson Virgin Group], Qream [Pharrell Williams and Diageo], Turi Vodka [Bacardi]). What are the sales volumes of its brands? As management alluded to on their recent conference call, it may be safe to assume that they posted declining Q3 quarterly revenue inclusive of some aged inventory sales. Perhaps the company's "inventory" is actually growing as a result of an inability to sell new make rather than a strategy to hold for "up to 3x profits." Only a fool would believe that this level of profits would be sustainable over any meaningful period of time. Competitors and speculators are rushing into this market already. Further, if MGPI is selling new make at growth levels several times higher than the category average growth, who will be out there demanding its aged goods in a few years? Its own customers will be oversaturated with new make.
5. Actually, MGPI fledgling 'brands' face a big uphill battle. The branded beverage alcohol game attracts hundreds of entrepreneurs every years with deep pockets and many with considerable industry experience and networks; however, very few of these products ever realize commercial success. Even major players frequently bail on their "innovations" after spending tens of millions of dollars for naught. MGPI management has a huge distillery at its fingertips that requires large volume brands as customers. The three products that the company has offered appear to be relative flops, either one-time sales of very small quantities (Metze's Select) or they are just stickers on bottles searching for their place in the market. The fact that MGPI has acquired an unheard-of brand with presumably no sales shows that management is either wasting its money or doesn't understand its needs. Even with a bolt-on acquisition the company's competitive cost advantage of producing the product in-house is only a marginal benefit. Presently, MGPI can be viewed as a holding company. It is now holding two start-ups: Till Vodka and George Remus Bourbon. The multiple being put on this company is light-years ahead of even established competitors like Beam and Brown Forman and exceeds those multiples on such great successes as Absolut and Grey Goose (and those were brands, not commodity businesses...the opposite of MGPI). It is difficult to find a direct comparable for MGPI but perhaps a reasonable one might be Archer Daniels Midland which net of nonrecurring items trades at ~12.3x TTM P/E. In a very rosy scenario that multiple would put MGPI at $17.22/share.
6. Stock price hype from the fanfare of Press releases... The stock may have gone up on the news that they bought the George Remus brand, but no revenue numbers are available for this brand. If you are starting from close to nil it is easy to show large percentage increases, but it will not make any dent in the bottom line. The stock could have gone up with the announcement that the company just hired Andrew Mansinne, a retired executive from Brown Forman, to help them with their Brands. His experience is in the wine business and it is unclear whether he has ever built a successful whiskey brand from scratch or created any new spirits brand for that matter. It's also unclear if Mansinne will be taking a job in Kansas or merely working in a part-time consulting relationship.
7. The future: declining revenue. MGPI whiskey revenue should begin to snowball downwards as they have just started to decline in the last 2 quarters. Last QOQ net Whiskey sales were down slightly. On the Q3 conference call management refused to break out sales mix of aged products. They took some one time gains from legal settlement and sold a non-core asset. It is likely MGPI will continue try to plug the increasing sales declines by selling aged inventory of bulk product at steep discounts of the 3x pricing that management has advertised. The same cheerleading $50/share sellsiders should make a strong push to increase the transparency of revenue streams to unmask the aged inventory sales that are already ongoing. The declining revenues will drop over the next few quarters as bulk revenues drop and price premiums will vanish in light of new capacity coming on from major trusted players in both Kentucky and Tennessee.
8. Management Projections are baseless. Management projects they can far outgrow the industry rate of growth. They claim 10-15% growth over 3 years. So far recent revenue declines appear to be reality.
9. Big Insider Selling. Insiders know that the company and the business is being misunderstood and they are selling large portions of their holdings. Recent insider sales are spiking to unprecedented levels.
10. What is an appropriate valuation? MGPI benefits immensely by obscuring its revenue mix by achieving in excess of a great brand company multiples for what appears to be a commodity bulk producer with declining revenues and massive new competition. It certainly does not merit a 30x earnings valuation. In 2014, the Jim Beam family of brands, a major marquis in the whiskey business, was acquired for a little over 20x LTM EBITDA. When the bubble pops, MGPI stock price will come down with a hard landing and longs will opt for a big Kentucky bourbon in the form of a whiskey sour. It would be expected to see this stock trade down to $17 or less as the revenue declines are unmasked, the bubble pops and the insiders dump more stock.
Disclosure: I am/we are short MGPI.
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.