- Revenue improved at National Beverage in Q3'20, though performance remained below the company's high water mark.
- Cost controls seem to be working, creating some operating margin expansion.
- The company still generates strong free cash flow, and shares are relatively inexpensive versus more established and high growth companies.
- If revenue growth returns to the mid-single digits, I may be tempted to start a position.
Shares of LaCroix parent company National Beverage Corporation (NASDAQ:FIZZ) have held up relatively well amongst a broader market selloff. Over the past month, shares are up a little over 2% versus a 17% decline in the S&P 500. Since early February, we’ve heard some positive news from the company, including a victory in the court case challenging LaCroix’s “natural ingredient label,” as well as positive quarterly results. Management claimed sales of LaCroix grew in Q3’20, after a 3% decline in calendar year 2019 sales, per estimates.
However, I am not entirely certain that National Beverage is back to being a Buy. Let’s take a look at the company’s recent performance, competitive dynamics, and why I find National Beverage on my watch list once again.
Financial Performance: A Relief
National Beverage’s third quarter earnings were actually a relief. Revenue grew nearly 1% y/y to $222 million. While this remains below the Q3’18 high water mark of $227 million, it is the first quarter of positive revenue growth since Q1’19. Gross margin actually ticked up 30 basis points y/y to 36.8%, and SG&A declined 50 basis points y/y to 21.9% as the company reduced actual spending by about 1.3%. Consequently, operating margin grew 90 basis points y/y to 14.9% of sales, leading to EPS of $0.57, up 7.5% y/y.
From a P&L perspective, I consider this a step in the right direction, though it is important to remember that gross margin and operating income remain well below Q3’18 figures of 40.1% and 20.1%, respectively. I believe this implies a decline in average selling price for LaCroix, causing the company to discount to avoid losing too much share.
Unfortunately, this is the reality of the situation for LaCroix. Pepsi (PEP) and now Coke (KO) have entered the market with far superior cost profiles, while smaller competitors like Spindrift raise significant capital to compete. The market is getting as crowded as I have ever seen it, and I know see local grocery stores with new aisles dedicated entirely to this new category with new products with CBDs, caffeine, and other additions popping up. The marketplace is tough, and though LaCroix is not getting taken to zero, I think they are losing share, and I do not think they have the cost profile to win on being a low-cost provider versus Pepsi’s high growth Bubbly product. I would ideally like to see high single digits growth from LaCroix, which, in my view, would imply flattish share. However, that seems unlikely to happen, though positive growth remains a possibility.
Balance Sheet and Cash Flow Make It Compelling
Although I do not love the current competitive dynamics of the ever more crowded sparkling water category, I do like National Beverage’s balance sheet and cash flow. Inventory is down about 15% y/y to $61 million, and cash sits at $262 million, nearly replenishing all of 2019’s $135 million in special dividend payments. There could be an opportunity for another special dividend in 2020.
Logically, National Beverage has replenished its cash because its ability to generate free cash flow has been great. In FY19, the company generated total free cash flow a touch over $100 million. YTD in FY20, National Beverage generated nearly $110 million in free cash flow, and I would not be surprised to see this number approach $130 million by the end of FY20. National Beverage cut capex significantly, and cash conversion looks to have improved slightly.
If we assume somewhere between $120-130 million in free cash flow, then the company currently trades at roughly 15-16x FY20 FCF, which is not an outrageous multiple, especially if the company can achieve mid-to-high revenue growth. I think a return to mid-single digit growth will lead to some gross margin expansion and SG&A leverage, so presumably, this free cash flow multiple could be an even more reasonable 13-14x.
15-16x is a reasonable discount from best-in-class operators like Coke, but it is also a large discount to another smaller beverage companies like Monster (MNST), which, admittedly, also has a significantly better gross and operating margin profile, as well as a strong track record of low double digit growth. With its Coke distribution deal and margin profile, Monster is a much more valuable business. However, at 35x free cash flow versus 15-16x for National Beverage, I think there is some value here.
That said, I am waiting to see how revenue trends in Q4’20. I am interested to see if LaCroix growth is more than an aberration, and if we see acceleration to the mid-single digits on the topline while maintaining a decent gross margin, I will look long and hard about dipping my toe back into some shares.
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