Lamb Weston: 2021 Will Be A Tough Year, But All Eyes Should Be On 2022 And Beyond

Summary

• Lamb Weston is a major producer of (frozen) potato products and is feeling the COVID-related shutdowns.
• There was quite a bit of margin pressure in Q3, mainly due to COVID-related inefficiencies in logistics and production processes.
• The company will still generate plenty of free cash flow and will kick off the construction of a new plant in Asia.
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Introduction

Lamb Weston (NYSE:LW) is one of the world's largest producer of processed potato products (including fries, hash browns, etc.). As the company's B2B division remains under pressure worldwide, FY 2021 (which will end in May) won't be a great year. But despite the setback, Lamb Weston will still generate very respectable cash flows, which will be reinvested in additional growth initiatives as the company has confirmed it will build a new processing plant in Asia.

Data by YCharts

The first three quarters of the financial year have now been completed, and the results are in line with the expectations - despite a weak Q3

The Q3 performance was perhaps slightly better than what was expected as the revenue decreased by just 4% to $896M. However, the 9M 2021 revenue is still down by 10%. Sounds bad, but it's a clear improvement compared to the 14% revenue drop in the first semester. Lamb Weston seemed to confirm the volumes have bounced back nicely, in its Q4 guidance, the company mentions shipments in North America, Europe and the International segments in the first four weeks of the final quarter are at 90%, 85% and 75%, respectively, of the Q4 FY2019 results (two years ago).

What really mattered in Q3 wasn't really the revenue, but the pressure on the margins as the operating income fell by 38% to just over $100M. Substantially lower than the in excess of $275M in operating income generated in the first half of the year. According to Lamb Weston, the pressure on the margins is caused by the inefficiencies in its production and logistics processes due to the lower volumes and the COVID pandemic.

Source: press release

The net income in the third quarter was just $66.1M, which represents approximately $0.45/share. That's most definitely weaker than in the first half of the current financial year as the company generated an EPS of approximately $1.27 in those two quarters. While the revenue drop remains quite reasonable, the company's supply chain expense is suffering a bit but this is a situation that should and could be rectified once the world economy reaches its cruising speed again.

We already knew 2021 wouldn't be a great year, so we should keep our expectations low. That being said, Lamb Weston is still generating a very sizable amount of free cash flow. The company reported an operating cash flow of $375M in the first nine months of FY2021, and after adjusting this result for changes in the working capital, the adjusted free cash flow was even higher, at $394M. That's lower than the $543M in operating cash flow generated in 9M FY2020, but again, we should keep our expectations reasonable for the current financial year.

Source: SEC filings

As you can see, the total capex was just $92M which results in a free cash flow result of $302M on an adjusted basis. That's great, but considering the full-year capex guidance has now been established at $160M (down from $180M), we should expect a very high capex in the final quarter of the year. And unless we see a material pick-up in the margins, the reported free cash flow result in Q4 will likely be just around $50-75M, bringing the full-year free cash flow to $350-375M.

And that's fine. The current share count stands at approximately 147.6M resulting in an anticipated full-year free cash flow result of approximately $2.50/share. Yes, that's low for a stock trading at in excess of $80, but the FY 2021 performance shouldn't really be interpreted as "the new normal."

Lamb Weston continues to invest in growth

Just a few weeks ago, Lamb Weston announced a substantial expansion of its French fry processing capacity in China. The company will invest an additional $250M in Inner Mongolia where a new processing facility will be built. The new facility will have a capacity of 250 million pounds of frozen French fries per year, and should be completed in H1 FY2024 (which is the second half of calendar year 2023, in 2.5 years). And given the strong cash flows generated by Lamb Weston, the company can easily fund this new project using its incoming free cash flow.

Investment thesis

Despite seeing the share price fall by about 50% during the COVID-related panic selling, Lamb Weston's share price is gaining momentum again and is currently trading at just 15% below its pre-COVID peak. The company isn't cheap, but Lamb Weston has never been really cheap due to its strong position on the processed potato market, and as you can see, even in tough years like the current financial year, the company is clearly able to keep the impact on its financial results limited.

I don't think there's any rush to initiate a position in Lamb Weston, but it's for sure a company I'm keeping an eye on.

Analyst’s 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.