Bimbo's Short-Term Challenges Are Intensifying, But There's Value For The Patient Investor

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Stephen Simpson
17.65K Followers

Summary

  • Bimbo is facing a worsening Mexican economy and tougher labeling laws, as well as market share losses in the U.S.
  • Product innovation can help counteract the share losses in the U.S., and more price-conscious packaging is an option in Mexico, while Latin America is a long-term improvement project.
  • Bimbo is looking at a tough 12 months, but there is long-term value emerging in this name.

If Grupo Bimbo’s (OTCPK:BMBOY) (BIMBOA.MX) Osito, its white teddy bear mascot, were real, it would be pretty black and blue after the last couple of quarters. While Bimbo’s margin-improvement efforts in the U.S. do seem to be paying off, the company has seen a long run of market share losses compress revenue growth. Worse still, Mexico’s economy has slowed significantly and new labeling laws could weaken volume further, while the Latin American operations south of Mexico remain underperforming.

I was pretty cool on Bimbo back in late June, preferring Gruma (OTCPK:GMKKY), and Gruma shares have outperformed by about 20% as Bimbo’s near-term outlook has eroded. Given the ongoing share loss in the U.S. and near-term challenges in Mexico, I can’t say Bimbo has already seen the worst of this cycle, and the near-term challenges are meaningful. On the other hand, if the company can manage just 3% to 3.5% revenue growth and 75bp to 100bp of FCF margin improvement over the long term, the shares look priced for a long-term annualized return in the high single digits.

In Mexico, The Hits Keep On Coming

Since my last update on the company, Bimbo has seen a rare down quarter in Mexico, as second quarter sales contracted a bit before growing 2% in the second quarter. Gross margins have also weakened, leading to a trailing 12-month EBITDA growth rate of just 3.5%.

Mexico’s economic weakness seems responsible for at least some of the downturn. With the economy slowing and consumers feeling a pinch, they are spending less on higher-priced goods and while Bimbo’s breads, cakes, and snacks may not really qualify as luxury items, they are more expensive than true staples, and consumption is declining. Management is aware of this issue, though, and one of the initiatives they highlighted in their November investor day is to expand packaging options and product development to create more brand options at lower price points.

A bigger issue could be on the horizon in the form of new labeling laws. Mexico has above-average rates of obesity and diabetes, and Mexico’s government believes that new labels warning consumers of the sugar, salt, and fat contents of foods and beverages could lead them to make better nutritional choices. Given Bimbo’s weighting to cakes, pastries, salty snacks, and the like, they could be among the most impacted of the packaged foods companies I follow in Mexico (though this would certainly not help Coca-Cola FEMSA (KOF) either).

The pictures below, the right one sourced from an HSBC sell-side report, shows what similar labels instituted in Chile actually look like. As far as potential impacts go, while there is a lot of controversy as to whether labels impact consumer behavior, sales/consumption of products with multiple warning labels have declined about 4% per year on average in Chile since that country’s labeling law went into effect in 2015.

source: UNICEF

source: HSBC

Share Losses In The U.S. Threaten The Progress Made On Margins

It has taken some time for the benefits to show, but the efforts that Bimbo has made to improve margins in the U.S. (closing/optimizing plants, consolidating SKUs, reconfiguring delivery routes, et al) are starting to show in the results. Trailing 12-month EBITDA has grown 15% versus 3% growth in revenue, and Bimbo looks poised to report double-digit EBITDA margins on a relatively consistent basis now.

Unfortunately, sales growth has been weak and market share has been eroding, with Nielsen data showing steady market share losses for Bimbo since the middle of 2019. Given the trends at Flowers (FLO) and the market in general, I wonder if Bimbo has pushed a little too hard for price, but then volume doesn’t seem to have fallen off so badly as you’d expect if that were the case.

I don’t see much more that Bimbo can do to really improve on the operating execution side of the business in the U.S. over the next year or two. Management believes there are still opportunities to optimize the supply chain and route-to-market, but further benefits are likely to be small. Longer term, I like the company’s strategy of adopting more automation in its bakeries, particularly as skilled labor is becoming harder (and more expensive) to find.

As far as driving better top-line results, management needs to focus on product innovation. Although bread is an attractive category for retailers, retailers are pushing hard on suppliers to maintain their own margins, and introducing new premium-priced products (in bread and other categories) is likely the best option Bimbo has to counteract that push.

Latin America Needs A Lot Of Work

Bimbo’s Latin American operations (meaning operations in countries south of Mexico) are still a mess, with just 152 million pesos of EBITDA over the last 12 months (against over 28 billion in revenue). Operating scale remains a challenge across the business, with limited brand/SKU selection in many countries and inefficient distribution. Management is not giving up, though, and given the scale of the opportunity in Brazil, Argentina, Chile, and other countries like Peru and Colombia, I can appreciate why.

Broadening product offerings across the operating footprint is one high-priority driver, and it looks like management will make greater use of international distribution to expand its offerings in the region. Management is also looking to expand/improve its distribution to the small retailers that make up the majority of retail distribution points in most of these markets, but this is likely to be a multiyear effort at best, and doing so in a cost-effective fashion will be challenging (it’s a challenge in Mexico too, but Bimbo’s larger network of bakeries across the country significant reduces the burden).

Given the mess that is Argentina right now, I wouldn’t expect much good news here in the short term, but Brazil’s improving economic situation is more encouraging, and Bimbo has hired McKinsey to help it figure out a turnaround strategy over the next 24 months.

The Outlook

Given the weak trends in Mexico and the market share losses in the U.S., I’ve lowered my near-term expectations (for 2019-2021); Latin America isn’t really any worse than I expected it to be, so it doesn’t drive any meaningful incremental modeling changes. While my changes to revenue are fairly minor, due in part to already being below the sell-side average estimates, the leverage of Bimbo’s operating model is such that the changes have a much more significant impact to near-term FCF (in the neighborhood of 25%). The changes to the estimates further down the line aren’t so significant.

With that, I’m still looking for Bimbo to generate revenue growth in the 3% to 4% range long term, but more likely on the 3%-3.5% side of the range, and high teens FCF growth. Although that sounds like a robust growth rate, readers should note that the starting point (2018 FCF) was unusually low and my long-term average FCF margin assumptions call for a 75bp to 100bp improvement – not trivial or “in the bag” by any means, but perhaps not as aggressive as the headline growth rate would suggest.

I’ve chosen to reduce my forward EBITDA multiple by a full point (to 8x) to reflect the greater near-term risks and lower near-term margin and ROIC prospects.

The Bottom Line

Discounted cash flow suggests that Bimbo is priced for a high single-digit long-term total return to shareholders, while EV/EBTIDA suggests 10% to 15% undervaluation. While that’s not bad for a defensive food company stock, investors may not see that as sufficient compensation for the near-term challenges and/or the elevated operating risk of a company with extensive emerging market operations. Be that as it may, I believe Bimbo could outperform if the stock market weakens and if the company can show some stability in margins in Mexico and the U.S.. This isn’t my favorite idea for the next 12 months, and I do still see downside risk over the next 12 months, the valuation is getting more interesting for long-term investors who can look past the near-term challenges.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

This article was written by

Stephen Simpson profile picture
17.65K Followers
Stephen Simpson is a freelance financial writer and investor. Spent close to 15 years on the Street (sell-side, buy-side, equities, bonds); now a semi-retired raccoon rancher. That last part isn't entirely true. Probably.
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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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