Gruma Offers An Interesting Mix Of Offense And Defense
- Gruma is a staple food provider in Mexico and offers revenue growth and operating leverage potential in the U.S. and Europe through premiumization, increased scale, and changing eating habits.
- Commodity inflation is a manageable risk, with the U.S. business fully hedged and pricing leverage in Mexico.
- Foodservice demand should rebound as pandemic-driven restrictions are lifted over time, and increased shelf space and premium assortment in the U.S. offers margin leverage opportunities.
- Mid-single-digit revenue and FCF growth and mid-teens ROICs support a near-term fair value 15% to 25% above today's price and decent prospective return thereafter.
Though there have been a few exceptions, defensive food stocks haven’t performed so well over the last six months or so, as investors have switched back to industries and stocks offering more leverage to post-pandemic recovery and growth. Mexico’s Gruma (OTCPK:GPAGF) (OTCPK:GMKKY) is no exception, as pretty solid financial performance has gone largely unrewarded in recent months.
I was lukewarm on Gruma back in September, mostly just because I thought the market had caught up with the story. I’m a little more bullish now, and I like the company’s combination of somewhat defensive basic food exposure to Latin America, growth opportunities in the U.S. and Europe, and margin leverage. I believe the shares trade at a greater than 15% discount to fair value now, and would still offer a decent mid-to-high single-digit return thereafter.
Commodity Inflation Remains A Risk, But A Manageable Risk
One of the reasons I call Gruma “somewhat defensive” as a basic food company in Latin America is because the company is still exposed to grain prices in Mexico. Hedging that risk is often impractical, but the company has generally been able to offset grain prices with price hikes (and is expecting to do so again this year). In the past, these shares have often traded as an inverse proxy for corn prices because of this exposure.
The U.S. business, however, is fully hedged for 2021 and at prices better than what the company paid in 2020. This actually matters quite a bit more. The U.S. business is twice the size of the Mexico operations in terms of revenue and almost three times larger in terms of EBITDA. Moreover, with value-added products making up a far larger share of the U.S. business, there are more options on pricing.
The U.S. Growth Story Remains Attractive
Gruma still has several ways to win in the U.S. market. Demographic shifts continue to favor the company’s basic range of products, and many of the company’s consumers in the U.S. are more willing to pay for the convenience of ready-made tortillas (as opposed to Mexico, where the large majority of sales are in harina (corn flour)).
Beyond that, the company has done a good job of product innovation and premiumization. Gruma now offers a range of products with features like low/no-carb, low-fat-, baked (versus fried), or organic ingredients – all of which support higher prices and margins.
According to Nielsen data, Gruma’s mix of premium to mainstream products has shifted by about two points since 2018 to 39% / 61%. That sounds like slow progress, but the process has been accelerating and JPMorgan analyst Lucas Ferreira estimates that every 5% shift correlates to a 50bp EBITDA margin improvement.
Gruma has also been making pricing decisions with a long-term focus – holding off on price increases to gain more shelf space with retailers. That has not only allowed the company to highlight new premium products more effectively, it has also helped limit the leverage and consumer visibility of competing brands.
Many food companies benefited from a shift to in-home eating during the pandemic, but the impact on Gruma’s business has been a little different. The company’s U.S. and European operations are still more weighted to the foodservice channel than the retail/at home channel, and so the lockdowns and changes in consumer behaviors did have a more negative impact here than for many other food companies.
In the U.S., there was a definite shift toward more at-home consumption and the business didn’t suffer too much (U.S. volumes were up 4% in the fourth quarter, flat in the third quarter, and up in the second quarter of 2020). Europe saw a bigger impact, with volume still down 12% in the fourth quarter (the only region were volume declined).
As dining habits shift back toward pre-pandemic norms later in 2021 and 2022, I expect to see a pick-up in volumes from the foodservice channels in the U.S. and Europe, though probably more significantly in Europe.
Gruma is not likely to see a big recovery yet in 2021, but I do expect long-term revenue growth around 4% with above-trend growth in 2022 and 2023. Ongoing premiumization in the U.S. and improved scale in Europe over time should provide some ongoing positive momentum for margins, helping drive EBITDA margins from around 16% in 2019 and 16.9% in 2020 to over 17% in 2022 and 2023.
Over the longer term, I expect about 100bp to 125bp of improvement in average FCF margins, helping drive around 6% annualized FCF growth (on a pandemic-adjusted basis).
The Bottom Line
Between discounted cash flow and EV/EBITDA (using a 9.5x multiple driven by margins and returns), I believe Gruma shares to be around 15% to 25% undervalued today, and even at fair value, I would expect to see a mid-to-high single-digit long-term annualized return. That’s not bad for a food company, particularly one that pays a decent dividend, and I think Gruma shares are worth a look, though I will note that the U.S. ADRs are not especially liquid.
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