Farm Brothers: Throwing Money Out The Window

| About: Farmer Brothers (FARM)

Summary

The company is trading at 17.8x EV/EBITDA.

Despite the high valuation the company lacks in top and bottom line growth.

Current P/E metrics are distorted by NOLs that will run out in 4-5 years.

Farmer Brother's (NASDAQ:FARM) reported its second quarter results yesterday after the market close and missed both EPS and revenue expectations. FARM is a national coffee roaster, wholesaler and distributor of coffee, tea and culinary products.

FARM is not a good business to own in the long run, especially given the rich valuation. The valuation is based on the fact that management is implementing its strategy well and they are on track to growth EBITDA margins from 8.1% to 13% over the next couple of years.

Link to press release containing margins, tax assets and net debt.

However, the value added by these actions is already priced in and ignores any downside risk in terms of general business risk and the likelihood of an economic downturn. Furthermore, FARM has a load of tax assets on its balance sheet and will not be paying taxes for the next 4-5 years. Even with a tax rate of 0% its P/E is still 21. I expect FCF to be $42 ml in 2021 with a yield of 7.4%. This would be acceptable, but personally I would not own this kind of company in the long run because of the lack of growth prospects, high CAPEX and the impossibility to add value through margin expansion.

Net debt of the company is 4x net debt/EBITDA. I include pension liabilities in net debt to give a realistic picture of the company's balance sheet.

The problems will come after 2021. From then on FARM will have to pay taxes again and FCF will drop to $25 ml from $42 ml the year before.

Taking this event into account FARMs stock price is drastically overpriced because investors seem not to care what will happen 5 years in the future. However, only around 30% of the current price paid will be gain until then and 70% of the current valuation has to be earned afterwards. With $25 ml in FCF the stock will yield roughly 4.4% in 2022.

rest of 2017 2018 2019 2020 2021 2022
NI 22.4 28.2 34.3 40.9 48.0
DA 20.1 20.5 20.9 21.5 22.1
CAPEX (23.9) (24.3) (24.8) (25.4) (26.1)
NOWC (0.9) (0.9) (1.2) (1.5) (1.7)
FCF 6.9 23.4 29.3 35.5 42.2 25.0
Free Cash Flow Yield 4.1% 5.2% 6.3% 7.4% 4.4%

In conclusion, FARM is worth $20 at the most. My scenario is showing the scenario management is hoping for.

Personally, I would not short the stock right away because there is no catalyst for the stock to drop. However, I recommend current investors to sell their shares and interested investors to stay away.

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.

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