YoCream Benefiting from Strong Yogurt Demand

Includes: COST, YOCM.PK
by: The GeoTeam

We established a position in YoCream (YOCM.PK) well over a year ago at around $9.00. We never highlighted the company as its stock trades on the pink sheets. However, YoCream has put together seven straight quarters of superb EPS growth, with its lowest growth rate quarter coming in at plus 90%.

The stock currently trades at a P/E of 12 x trailing EPS and a P/E of 10 x our 2009 EPS estimate of $3.10. The stock, which recently hit a 52 week high, also weathered the recent market turmoil rather well.

The YoCream story is as simple as it gets. The 23 year-old public company (32 years in business) has taken a popular food category and established a reputation and marketing strategy that has taken its growth to new heights, surpassing our expectations.

While the company has seen growth in the past, recent initiatives have helped to accelerate growth and position YoCream to meet opportunities that lie ahead.

Understanding YoCream

What Does YoCream Do? YoCream produces, markets and sells frozen yogurt, ice cream and frozen custard mixes as well as fruit and dairy smoothies and frozen beverages. The frozen yogurt category comprises the majority of the company's revenues. The company sells its products primarily to food service companies.

We have broken down the YoCream revenue stream into three categories:

  1. Food Service Non-Club Markets.
    • Specialty yogurt shops: single stores and chains
    • Quick serve and full service restaurants
    • Convenience stores
    • Business & Industry
    • Colleges & Universities
    • Government
    • Healthcare
  2. Food Service Club (membership) Markets. Costco (NASDAQ:COST) has been a significant and consistent customer since 1987. YoCream yogurt products are sold in all 400 Costco United States locations as well as in Korea, Taiwan, Australia and Mexico. YoCream serves its markets in a variety of ways:
    • Company branded products - Customers sell the company's products that bear the YoCream signature.
    • Company licensee products- YoCream manufactures products that bear the licensor's name along with YoCreams's trademark. To this end YoCream has licensing rights to use the Jolly Rancher™, Twizzler™, Jarritos™, Rock Star™, Bubble Yum™ and Ice Breakers™ names for frozen beverage. The Company also holds the exclusive rights to use the Hershey's® Kisses™, Heath™, York™, Mounds™ and Resse's™ brands for soft server frozen yogurt.
    • Custom manufacturing- YoCream provides expertise to the custom manufacturing and private label market. In addition to manufacturing, clients may also contract the use of the Company’s Research and Development and Logistics departments. Jack in the Box has been a private label customer since 2007 and has been a significant component of YoCream's recent growth.
  3. Company Retail Owned Stores. YoCream has one retail location that serves as its Company Showroom and training center for operators that want to open frozen yogurt stores. The Company does not intend to expand retail operations because of its policy of not competing with customers.

Impetus for Recent Growth

What has propelled YoCream's current growth cycle? While YoCream had been a profitable firm with respectable growth in the recent past it reached a point, where in order to maintain and accelerate its growth rate, it had to address a specific road block: Capacity constraints.

By January 2006 the company achieved much of what it could out of its current manufacturing capacity and decided that in order to continue to grow it would spend money to increase production.

This was also the time that the company voluntarily delisted itself from the NASDAQ, feeling that money was better spent on upgrading its capacity than on complying with costly Sarbanes Oxley rules.

By 2007, as stated in its 2007 annual report, the planned expansion was complete:

Expansion of our production facilities was finalized providing for a number of simultaneous production lines, various packaging capabilities and extended storage capacity.

The decision has paid off as the company's new capacity enabled it to introduce new products, attract new customers, increase efficiency and jump start its growth.

As YoCream has gained a solid reputation and as its customers have found success with its brand, more food service giants are seeing the opportunity to offer a soft serve product that taste like ice cream yet is still healthy.

One other major force opportunistically coincided with YoCream's expansion. The benefits of probiotics in yogurt has received significant public attention, giving the company an additional angle with which to market its products. In short, probiotics have shown that they may, in preliminary studies, help to manage lactose intolerance, potentially reduce the risk of colon cancer, lower cholesterol and high blood pressure, improve mineral absorption and are thought to help the immune system stave off certain kinds of infections. This will also make the brand more recession resistant and has given a mature product new growth venues.

Investors should be aware that trading on the pink sheets often comes with a negative perception and lower stock valuation. We are optimistic that the company may experience P/E expansion as investors find this story, especially if the company upgrades to a higher exchange which may legally have to occur if the number of shareholders reaches 300.

The company currently has approximately 250 shareholders. Many shareholders hold their position in street name and for SEC purposes all of the shareholders at a single firm are counted as one.

Growth Opportunities

  1. Growth by continuing to serve the proliferation of specialty yogurt shops.
  2. Growing with Costco (NASDAQ:COST) domestically and internationally.
  3. Building on the success of its custom manufacturing business which currently comprises only 15% of total revenues.
  4. We feel there may be opportunity to build new relationships with food service companies that target the health-conscious consumer with quick service restaurants that are upgrading their menus with healthy but tasty products.
  5. More opportunities exist to build on their licensee product concept.
  6. While the Company's logistic system is such that it effectively distributes nationwide, much of its recent expansion has been in the west. Distribution has intensified in the east, especially in the New York area. Other emerging markets include Texas, the Southwest and Florida. The Company also enjoys profitable overseas business, especially in Europe and the Pacific Rim.
  7. With $6 million in cash and an ample credit line YoCream can seek acquisition opportunities.
  8. More food service giants are seeing the value in the YoCream model.

We have started to accumulate YoCream shares once again. On May 27, 2009 the company reported its second quarter fiscal 2009 financial results. Sales increased 35% to $12.6 million, while EPS grew 90% to $0.76 . This gives us reasons to be optimistic about the remainder of its 2009 fiscal year as the company enters its seasonally strongest second half.

Over the last three years, the first half of YoCream's fiscal year has accounted for about 37% of its total revenue production. We have applied this relationship to estimate that the company can potentially achieve EPS of around $3.10 on revenues of approximately $57 million for its fiscal 2009 year ending in October.

The growth trend for YoCream seems to be gaining traction and bodes well for a possible P/E expansion, despite trading on the pink sheets and being highly illiquid. We are focused on finding solid companies even if they happen to trade on the pink sheets, especially if they were once on a higher exchange and still seek to maximize shareholder value.

YoCream is still communicative with Wall Street, publishing press releases and financial reports accordingly. In YoCream's annual letters to shareholders, investors can realize that the company is focused on maximizing shareholder value.

We also believe that YoCream could be a pretty interesting acquisition target.

Please see our potential valuation scenarios for YOCM.

Disclosure: Long YOCM