Amplify Snack Brands - Better Snacks, Worse Balance Sheet, Real Issues Ahead

| About: Amplify Snack (BETR)
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Amplify Snack Brands serves ¨better¨ snacks, but investors are left with a sour taste.

While the company continues to show rapid growth, continued dealmaking has resulted in a huge debt load.

This leverage position is a bit of a worry amidst a compression in margins and operational challenges.

While shares have come under a great deal of pressure already, these are not fire-sale prices yet given the risks out there.

Amplify Snack Brands (BETR) is a collection of BFY snacks, which stands for ¨better-for-you¨, hence the symbol ¨BETR¨. While the food might be better for you, although it remains a snack, Amplify has not been very good for investors as of late.

An acquisition spree, which started this year, seems to have gone bad. This has saddled the company with a lot of debt, a bit too much to my taste as the company is experiencing margin pressures as well.

A BFY M&A Story

Amplify is a collection of BFY snack brands including SkinnyPop popcorn, Oatmega protein bars and Paqui Tortilla Chips, among others.

Initially, that is back in 2012, Amplify was a pure play on SkinnyPop which at the time generated $16 million in annual sales. The company acquired Paqui in 2015, which combined with spectacular growth of SkinnyPop resulted in revenues of $184 million that year.

These strong brands, which report healthy organic growth and have overseas growth opportunities, require a great deal of operational attention in the coming years in order to maximize the potential of these brands.

While the rapidly growing company should perhaps focus on integrating these brands, execution and international expansion, Amplify has decided to pursue more dealmaking. Management admitted on the conference call that it lacks the infrastructure in order to support the size of the operations. Poor execution and stiff competition hit the company hard in the most recent quarter. While revenue growth remained healthy, gross margins were down some 8 percentage points compared to last year.

Back in April, the company bought Oatmega in what is a relatively smaller deal. This transaction was followed by the GBP 300 million deal to acquire Tyrrell´s international portfolio of BFY snacks, adding $111 million in sales in the process.

That deal was valued at 3.5 times sales and 16 times EBITDA, being aggressive multiples given the fact that no real synergies were anticipated. Another headwind is the fact that the British Pound has come under a lot of pressure since the deal has been announced.

A Lot Of Debt, Growth Is Solid

In August, when Amplify just announced the Tyrrell deal, I estimated that net debt stood at $560 million following that transaction. The third quarter earnings report revealed that net debt currently stands at $575 million.

Despite the dealmaking, third quarter adjusted EBITDA came in at just $20.1 million, versus a $61.4 million number for the first nine months of the year. It should be said that the Tyrrell transaction only contributed a month to the third quarter results, boosting revenues by some $8.6 million.

With adjusted EBITDA seen at $84-$86 million for the year, fourth quarter adjusted EBITDA is seen at $22.6-$24.6 million. If annualized, adjusted EBITDA runs at $90-$100 million a year, for a 6 times leverage ratio.

Third quarter sales were up by 48.1% towards $68.0 million, driven by strength at SkinnyPop and Paqui. The purchase of Tyrrell, which contributed nearly a month in sales, added $8.6 million in sales and the contribution of Oatmega has not been quantified. Given that Oatmega added $7 million in annual sales at the time the deal has been announced, and is growing very rapidly, I estimate that it added $2.5 million to quarterly revenues. Adjusted for Oatmega and Tyrrell, organic growth came in around 26%.

While topline sales growth is impressive, margins have taken a beating, following the lower margin profile of Tyrrell and margin pressure across the rest of the business. Adjusted earnings for the quarter came in at $9.0 million as GAAP earnings amount to just $1.6 million. While the company did not provide a nice reconciliation table, it is evident that stock-based compensation and amortization charges with a sum of $3 million are excluded in GAAP earnings, being really a cost to the business. On the other hand the company has incurred M&A related charges as well, as the realistic run rate of earnings probably comes in around $5 million for the quarter.

For the final quarter of the year, revenues are seen at $86-90 million, but that includes a full contribution of Tyrrell, with revenues seen around $25-$28 million a quarter. That suggests that the core is posting sales of $61.5 million for the quarter at the midpoint of the range. If I subtract $3 million in sales for Oatmega, I expect that SkinnyPop and Paqui will generate revenues of $58.5 million in the quarter. That suggests that organic growth comes in at roughly 26%, being similar to the growth rates reported in Q3.

The Market Is Not Happy

Expectations run high for Amplify amidst a sky high valuation and highly leveraged balance sheet. Shares traded at $17 in September on the back of optimism on the Tyrrell purchase, giving the company a $1.28 billion equity valuation at the time. Ever since, shares have plunged to levels below $10, as the equity valuation has come down by half a billion. Including debt, the enterprise valuation now comes in at $1.32 billion.

A few reasons behind the shortfall result from the high expectations, usage of leverage and lack of traditional earnings. At a $1.32 billion valuation, the business is valued at nearly 4 times sales and 13-14 times adjusted EBITDA. These are elevated multiples, but given that incumbent and hardly growing food businesses nowadays fetch 10-12 times EBITDA multiples, it seems reasonable with organic growth still running at +25%. The market has been open to growth stories, just look at the valuation of WhiteWave Foods (NYSE:WWAV), even before it was acquired by Danone at 3 times sales and 25 times EBITDA.

In that light, the valuations look pretty reasonable at this point in time, especially given the growth, although leverage is very high and GAAP earnings are very limited. The worry is the fact that margins are very high, with EBITDA margins approaching 27% at this point in time. While high margins are a good thing, they pose a threat if they fall to ¨normal¨ levels, especially given the leverage employed by the business already. As such, leverage has the potential to wipe out equity investors or cause significant dilution, despite growth and strong brands. This is especially a concern as Amplify´s debt is variable, as the recent run in interest rates will create additional pressure.

That being said, if topline growth continues at 20%, revenues could come in at $425 million through 2017. Assuming margins of 20%, operating profits come in at $85 million. Current interest expenses run at $22 million per annum, but could increase towards $30 million. That would result in pre-tax earnings of $55 million, or $35 million after-tax, for earnings of $0.50 per share. That is equivalent to a reasonable 20 times earnings multiple.

If growth can indeed continue at 15% per year through 2020, sales might hit $650 million that year, with operating profits seen anywhere between $100 and $125 million in a likely scenario. If we assume no further dealmaking, interest costs could fall to $20 million, for after-tax profits of $50-$70 million, equivalent to $0.65-$0.95 per share.

With a 20-25 times multiple, that could yield a $13-25 valuation by 2020. While that leaves compelling upside from current levels of $10 per share, these potential returns are not spectacular given the risks. This include the leveraged balance sheet and the fact that its brands are slightly susceptible to being a hype. Other bad near term news is the fact that selling shareholders offer another 45 million shares at these levels, indicating they are motivated sellers at these depressed levels. As these levels are not fire-sale prices yet, I am awaiting potential lower entry levels, prohibited that leverage multiples come down.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.