Jamieson Wellness: A Healthy But Pricey Choice

Summary

• Dominant supplier of dietary supplements in Canada.
• Limited progress to-date to expand the business outside Canada.
• Benefited from the consumer stock-up on vitamins during COVID-19 pandemic.
• Full valuation and high-growth expectations could lead to disappointment.

[Please note that all currency references are in the Canadian dollar except if indicated otherwise.]

Jamieson Wellness $31.68 (Toronto symbol JWEL) is a manufacturer and distributor of nutritional supplements and sports drinks headquartered in Toronto, Canada. The company commenced trading on the Toronto stock exchange in its current form on July 7, 2017.

Jamieson is at the crossroads. It will either remain a small business dominating the Canadian dietary supplements market or it can transition into a much larger business with a significant presence in China and the U.S. Investors seem to be optimistic that this will happen; we believe there are considerable risks and would prefer to wait for more evidence that the strategy is working.

The history

The origins of the company date back to 1922 when it was established by Dr. Claire Jamieson in Detroit. The business remained in the Jamieson family until the 1960s when it was sold to Henry Margolis, one of the founding members of Diners Club. In 2014, his son, Eric, who inherited the company in 1989, sold control of Jamieson laboratories to the private equity firm CCMP Capital Partners for $83.5 million. Three years later, CCMP listed the company with an initial market capitalization of over $500 million.

With CCMP came professional management. In 2014, Mark Hornick was appointed President and Chief Executive Officer and Chris Snowden as Chief Financial Officer. They continue to hold those positions.

Hornick previously worked in senior roles at Fiera Foods, Maple Leaf Foods, and Reckitt Benckiser Scandinavia. Snowden worked in financial control roles at Sofina Foods, SunOpta, and Deloitte & Touche before joining Jamieson. These senior executives sold the bulk of their shareholdings at the time of the listing.

After the listing, CCMP held 45% of the issued shares but has subsequently passed their shares on to investors in their private equity funds. Current major shareholders are mostly institutional investors, including Mackenzie Financial Corporation, Mawer Investment Management, and Sentry Investments with a combined holding of about 24% of the issued shares. Management and the board members only hold a small portion of the shares.

The business

The company produces and sells food supplements, sports drinks, and health products. Major product lines include single vitamins, minerals, specialty supplements, such as omega oils, and probiotics, sleep aids, herbal products (echinacea, ginseng), sports nutrition, cough and cold remedies, joint care, weight management, and multivitamins.

The company has three manufacturing facilities and several warehousing and distribution centers, all located in Canada.

In Canada, the company has a dominant market share, estimated between 20% and 25% of the vitamin, minerals, and supplements ("VMS") market. Distribution takes place through 10,000 retail locations, including health food or grocery stores, drug stores, and mass retailers; the company also has an online retail presence. Walmart (WMT) and Costco (COST) both carry the Jamieson branded products in Canada.

Outside of Canada, the company has distribution partners in 45 countries, including China, the U.S., Saudi Arabia, Hong Kong, Italy, and Spain.

The main brand is "Jamieson" which is also responsible for the majority of product sales. This brand is rated number one in health supplements in Canada, and scores particularly well on consumer trust and brand awareness. Other brands in the Jamieson stable include LVHS, Progressive, Precision, and Iron Vegan.

Apart from its own branded products, the company also uses spare capacity to manufacture products for other consumer health companies.

It owns 243 trademarks that are registered in the main markets in which Jamieson operates, including Canada and the U.S. Registration of a trademark enables the registered owner of the mark to bar the unauthorized use of the registered trademark in connection with a similar product.

In 2019, revenues amounted to $345 million, EBITDA was $68 million, and net profit was $32 million. Revenue has grown consistently and at a compounded annual rate of 12.3% since 2014. Profit margins have also improved. The EBITDA margin increased from 14.2% in 2015 to 19.6% in 2019. Most of the revenue is generated from sales in Canada, while the branded products (mainly Jamieson) contribute almost 70% of the revenues and 90% of the EBITDA profits.

Stiff competition

The company competes with other branded food supplement manufacturers as well as private labels sold by large retailers, including Costco's Kirkland label.

Some of the largest global producers of food supplements include Amway, Bio-Banica, BioNova LifeSciences, Glanbia, Nature's Bounty, and Herbalife. Pharmaceutical companies also have an interest in the space - Abbott (ABT) owns some of the leading nutritional product brands. Pfizer (PFE) sells a range of dietary supplements. Johnson & Johnson (JNJ) makes products to lower cholesterol and dietary supplements for people who are lactose intolerant.

Apart from the strong Canadian standing, supported by the 100-year-old Jamieson brand, the competitive positioning of the company in the U.S. and elsewhere is considerably weaker. The company simply does not have the scale or capital resources to make deep inroads in the highly competitive U.S. market.

Increasing regulations

There is currently no uniform regulation applicable to dietary supplements worldwide, but there has been an increasing movement in certain foreign markets to increase the regulation of these products.

In Canada and other jurisdictions, the company is subject to the laws and regulations applicable to any business engaged in the production and distribution of consumer health products.

Their natural health products are regulated by Health Canada under the National Health Products Regulations of the Food and Drugs Act, which contains requirements for the manufacture, packaging, labelling, storage, importation, distribution, and sale of natural health products. According to these regulations, natural health products must have a product license before they can be sold. Further, all Canadian manufacturers of natural health products must have site licenses issued by Health Canada.

In China, Jamieson faces a lengthy and costly registration process, with three main entities involved in policing the industry. The State Food and Drug Administration is in charge of dietary supplements and registration. The Ministry of Health oversees the approval of new novel food ingredients. Finally, the Administration of Quality Supervision Inspection and Quarantine controls all the imports and exports.

In the U.S., dietary supplements are regulated by the Food and Drug Administration as foods, not as drugs. The label may claim certain health benefits, but unlike medicines, supplements can't claim to cure, treat, or prevent disease. Because supplements are regulated as foods, not as drugs, the FDA doesn't evaluate the quality of supplements or assess their effects on the body.

Attractive growth opportunities

A McKinsey study dating back to 2013, correctly identified the market for dietary supplements as having a long runway, supported by aging populations and heightened interest in preventative health. Estimates of market size and growth vary - here are some indications.

The nutritional supplements market is growing at a moderate pace. According to Euromonitor, the North American VMS industry grows at about 3.1% per year and will have an estimated retail value of US$33 billion in 2020. The global VMS segment grows somewhat faster at 3.4% per year. The North American sports nutrition segment was estimated by Euromonitor to be worth US$7 billion in 2015, growing to about $11 billion by 2021; that's an increase of 8% per year.

Working with a different definition, the U.S. based Council for Responsible Nutrition estimates that the dietary supplement market in the U.S. was worth about US$122 billion in 2016. The Council also reports that in 2019, 77% of U.S. adults took dietary supplements, with 81% of adults between 35 and 54 taking supplements and 79% of those adults over 55. The top reasons why people take supplements are for health and wellness benefits, to improve energy levels, to enhance immune systems, and to fill nutrient gaps.

Grand View Research estimates that the global dietary supplements market was valued at US$123 billion in 2019, growing at 8.2% per year. The U.S. is the largest market estimated at US$51 billion followed by Asia Pacific ($39 billion). China is considered the second-largest VMS market in the world, with sales of around $17 billion (ex-HK) and growing at 10% per year. The Canadian market is worth about US$2 billion per year.

Jamieson has a long history of dominating the Canadian market for food supplements. However, the company's global market share is small, indicating that the opportunity to grow is outside of Canada.

At the time of the listing in 2017, the company spelled out their international growth plans. This included the ramping up of growth into the two largest markets, the U.S. and China.

As the second-largest global market for dietary supplements, China is a major opportunity for the company. Jamieson now has 21 products available for the domestic Chinese market distributed through its local distribution partner. The Jamieson products are also available through Costco which opened their first store in China in August 2019.

However, at the time of the listing in 2017, the company was already actively selling products into the Chinese market with sales tripling between 2014 and 2016, and with further plans for substantial growth. There were probably some setbacks along the way - we presume it was related to regulatory approvals for their products.

Somewhat surprisingly, the company mentioned in its 2018 annual reports that it "...incurred one-time expenses pertaining to professional fees in establishing our presence in China including regulatory and logistical processes, distribution and supply agreements, along with costs incurred on a China market study." It would seem that China's plans underwent a complete rethink after the listing.

In the U.S., another large market, the company launched the Jamieson brand on Amazon.com (AMZN) in 2020. Progress with this initiative has not been made public.

Between 2016 and 2019, the non-Canadian business increased from $22.0 million to $34.4 million. That's a 56% increase albeit from a small base. For 2020, the company is projecting a further 25-35% growth rate in international revenues. However, the international portion remains a disappointingly small part of the revenues, increasing from 7% in 2016 to 12% in 2020.

The company also makes selective acquisitions to enhance its growth potential. Since 2014, it has made 3 acquisitions; these were LVHS (2014, women's natural health), Body Plus (2017, natural health products), and Sonoma (2017, private label supplements).

Solid balance sheet, healthy cash flow

The company had shareholders' equity of $269 million by the end of March 2020, total debt of $184 million, and cash of $5 million. Net debt-to-adjusted EBITDA totalled 2.6 times, the debt-to-capital ratio was 0.41, and EBITDA covered interest payments 8.1 times. The company mentioned in its recent results that it had $107 million in cash and revolving credit facilities available.

Cash flow from operations (after adjustments for working capital) amounted to $29.2 million over the past 12 months, while capital expenditure was $9.2 million leaving a sound free cash flow balance of $20.1 million. Free cash flow has been positive in each of the past 5 years. In 2017, Jamieson stated that it had sufficient production capacity to accommodate growth plans until 2022 and could further expand production capacity with modest capital investments.

The company pays a regular quarterly dividend; this amounted to $0.40 over the past 12 months for a total dividend payment of $15.6 million. Ideally, free cash flow should cover the dividend, which was indeed the case over the past 12 months.

Risks on the horizon

Jamieson is still a relatively small company competing with much larger U.S. and Chinese pharmaceutical and food companies. It may have an entrenched position in Canada, but its ambitions are to grow in the U.S and Asia where it will compete head-on with these behemoths. Private labels from big retailers such as Costco and Safeway may also squeeze their market share.

There is a considerable body of research indicating that most people can get all the vitamins they need from a healthy diet. Quoted in the New York Times, Dr. Pieter Cohen of Cambridge Health Alliance said that "supplements are essential to treat vitamin and mineral deficiencies" and that certain combinations of nutrients can help some medical conditions, like age-related macular degeneration. However, for the majority of adults, supplements likely provide little, if any, benefit."

A significant amount of U.S. produce is already fortified with vitamins, so it's rare to find someone without a pre-existing health condition who has a serious vitamin deficiency. With milk fortified with vitamin D and flour fortified with vitamin B, most diets include sufficient amounts of vitamins. But with clever marketing and branding plans, consumers continue to buy these products, even after rigorous studies find that their health benefits are negligible or based on incorrect assumptions. There is a risk that consumers over time may become less inclined to spend money on these products.

A strong start to 2020

In its first quarter, ended March 31, 2020, revenues increased by 17% as consumers increased their intake of food supplements to boost their immune systems in the face of the spread of the COVID-19 virus. Adjusted EBITDA increased by 15% while adjusted earnings per share increased by 19%.

Results from the Jamieson-branded products were particularly strong with a 25% jump in quarterly revenues while adjusted EBITDA increased by 31%.

The outlook for 2020 was confirmed at the time of the first-quarter results announcement. Revenue for the full year to December is expected to grow by 6-9% with domestic Canada growing at 3-5% and internationally at 25-35%. This is mainly based on expected growth in China and excludes potential growth in the U.S. market.

The company's products are considered "essential" in Canada and both its manufacturing and distribution activities have continued operations throughout the COVID-19-lockdown periods. However, the company did note increased costs at its manufacturing and distribution facilities due to increased sanitation, maximized physical distancing, and shift gaps to avoid congestion during shift changeovers.

Long-term growth

Over the past 20 years, the company managed organic revenue growth of about 7.4% per year.

At the time of the listing in 2017, management predicted that it could grow revenues to around $400 million and adjusted EBITDA to about $100 million in 2021 for an annual compound growth rate of 6.6% and 11.9% over the five-year period. EBITDA margins were expected to improve from 19.6% in 2016 to around 24.4% by 2021 as better utilization of manufacturing capacity would lower fixed overhead costs per unit of production.

Based on consensus forecasts for 2021, the company may get close or meet these objectives (see graph). This would constitute a reasonable performance. However, the company may also be able to shift its growth plans for China and the U.S. into a higher gear with positive implications for longer-term growth.

Source: Company records and Refinitiv

Takeover target

We note several acquisitions of natural health product manufacturers by larger companies over the past few years. Given the strength of the Jamieson brand in Canada and the obvious potential with the right partner in the U.S. and China, the company may also become the target of a larger food or pharmaceutical company.

Alliance Boots launched a specialized investment fund, B&B Investment Partners, which focuses on small- and medium-sized consumer brand businesses within health, wellness, beauty, and personal care. One of its first deals, announced in November 2014, was the US$30 million acquisition of PhD Nutrition, a producer of protein powder and nutrition bars. Natures Bounty was acquired by Kohlberg, Kravis, Robert, the private equity firm, and Pfizer, acquired Alacer, the producer of Emergen-C products, the largest selling Vitamin-C line in the U.S.

Expensive valuation

Investors have pushed the price of the stock considerably higher over the past few weeks as it became clear that consumers were buying larger quantities of VMS products during the COVID-19 pandemic. Since mid-March, the stock price increased by 38% and has recently reached an all-time high of $34.

Given the stock's current price and consensus estimates for the next 12 months, the company is valued on a price-to-earnings ratio of 28.5 times and an EV/EBITDA ratio 16.6 times. These are rich valuation multiples with an implied expectation of an unrealistic high growth rate. The company is also valued at a considerable premium to its main peers (see table).

Bottom line...

The company has fared reasonably well since its listing in 2017. However, its main business remains in the relatively small and slow-growing Canadian market. Investors seem to be pricing in a rapid expansion in China, but this comes with considerable risks.

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

Business relationship disclosure: By Deon Vernooy, CFA, for TSI Network