Goodfood: The 'Pandemic Stock' Narrative Is Not Supported By Facts
Summary
- Goodfood has a measurable competitive advantage.
- The company continues to expand its margins with growth margins already exceeding those of most major competitiors.
- Goodfood is trading at a discount to peers.
Investment Thesis
We will look at the cold hard numbers to quantitatively prove that Goodfood is a serious grocery player with an operational competitive advantage in the Canadian market that shouldn't be ignored.
Business Overview
Goodfood Market Corp. (OTCPK:GDDFF) has seen its share price take a big tumble from its all-time highs. The company benefitted greatly from the pandemic and its stock shot up very quickly. It's fair to say that the price got ahead of itself, but to say that the company is only a pandemic stock that won't see continued success going forward is nonsense.
Launched in 2014, Goodfood started as simply a meal kit company. In only 5 years, the company went from zero to over 100 million CAD in sales before the pandemic.
Since then, Goodfood began introducing grocery items that rapidly expanded from around 30 SKUs in 2019 to almost 1000 SKUs currently, with a long-term goal of 4000 SKUs. Here's what Goodfood's CEO Jonathan Ferrari said in the most recent earnings call:
Today, we're hitting close to our 1,000 SKU count, well ahead of what we were projecting for calendar 2021. And we're very close to that inflection point where we'll have a critical mass of SKUs that will enable our customers to do most of their weekly shop with us. And that will probably happen somewhere between the 1,500 and 2,500 SKU mark. So we don't actually need to get to the full 4,000 before having kind of that inflection point and the vast majority of what our customers need for their weekly shop. So we're really pleased with that progress there.
We agree with the above paragraph. As users of Goodfood, we can say that the selection is great, but we need a few more products for us to be able to not shop in physical stores at all. Goodfood recognizes this and is constantly adding new products. The company expects that grocery will make up 20% of revenue on a run-rate basis sometime in fiscal 2022, which is up from 10% currently. The meal kits are what established Goodfood as a leading player in the online food business, but we think it will be the groceries that will drive the real growth going forward.
What Makes Goodfood Great
We like the grocery industry because it is essential, making it resilient to economic shocks. It is reasonable to assume that the industry will continue to grow as long as the inflation of food prices exists. However, it is also very competitive with lower margins compared to others such as tech. Therefore, operations must be efficient. This is where Goodfood's competitive advantage lies.
If we take a look at the cash conversion cycle, we can see that Goodfood does a great job of converting inventory into cash.
The formula is as follows
CCC = DIO + DSO − DPO
where:
DIO=Days of inventory outstanding
DSO=Days sales outstanding
DPO=Days payables outstanding
Source: Author using data from Finbox
The cash conversion cycle measures how long a firm will be deprived of cash if it increases its investment in inventory in order to expand customer sales. The lower the cash conversion cycle, the better. As we can see, Goodfood's CCC is negative which means that cash is not tied up at all into inventory.
This allows Goodfood to invest a larger portion of revenue into growth initiatives such as its courier network. The company now controls 65% of total deliveries through Goodcourier as per the picture below.
This is very crucial to the success of online groceries. For starters, it has allowed Goodfood the ability to offer same-day delivery which is hugely convenient. Many still incorrectly believe that people mostly ordered online products because of fear of the pandemic. However, as it turns out, the main reason for ordering online can be attributed to convenience. According to Dalhousie University's Faculty of Agriculture, 33.8% of all Canadians ordered food online because it was more convenient versus 13.8% of those who were concerned for their health.
In addition, when people were asked if they intend to continue buying food online after the pandemic, 49.4% said yes to buying at least once a week. This makes perfect sense because convenience was already a driving force for e-commerce in general prior to the pandemic so it's unclear why some investors believe that people will suddenly want to inconvenience themselves simply because the worst of the pandemic is behind us. Of course, there is going to be a boom in restaurants this summer, but that doesn't mean that people won't buy groceries and it definitely doesn't mean that people who value convenience will have a sudden urge to buy them in-store. A lot of people simply do not enjoy going to grocery stores or even shopping in physical stores in general.
Shopping at physical stores is good if you need something quickly or if there are great deals that can't be found online. Goodfood WOW's ability to deliver same-day shipping already tackles the speed of delivery. In addition, Goodcourier has allowed the company to reduce overall delivery costs by 33%. Over time as Goodfood improves automation and its delivery network, it will be able to realize more cost savings which will be passed on to the customers.
We believe that eventually, Goodfood will be able to offer a large selection groceries at very competitive prices to brick and mortar stores. In fact, Goodfood is already starting to get highly competitive with a few products. For example, in the weekly deals section, 2 avocados are selling for $1 CAD.
Source: makegoodfood.ca
If you compare this to the prices below from Real Canadian Superstore, you'll see that even the No Name brand (a cheap Canadian brand) 3lb avocado bag is just slightly more expensive. Also, note that No Name's product quality is definitely not as good as Goodfood's quality. We've had many occurrences where the produce we buy from physical stores was not good. However, we've never had an issue with Goodfood products. We chose avocados for this example but there are at least 20 other grocery products that are priced well under physical store prices. This is a great sign for Goodfood as it is already showing that it can beat/match physical stores. 
Source: realcanadiansuperstore.ca
Looking at the major grocery companies with hundreds or thousands of stores, it's definitely not cheap to open, operate, and maintain those stores. Maintenance capex alone is often hundreds of millions if not billions of dollars.
Goodfood is currently able to sell products to all provinces with only 9 facilities. For Goodfood WOW, it simply needs one facility in a populous region to serve the entire region. In contrast, other grocery companies like Metro (OTCPK:MTRAF) or Loblaw (OTCPK:LBLCF) sometimes have multiple locations within a few miles of each other. Right away, this puts pressure on their margins which is why the grocery industry is notorious for razor-thin margins.
As a result, most of the large companies don't really see significant increases in gross profits as revenue increases. On the other hand, Goodfood has seen its gross profit margin increase 6.2% from 28.8% in Q3 2020 to 35% in Q3 2021. This already puts it ahead of giants Walmart (WMT), Costco (COST), Loblaw, and Metro. HelloFresh (OTCPK:HLFFF) is currently the only one that has a higher gross profit margin at 66% but it only offers meal kits that are priced at a premium to regular groceries. Again, we would like to make clear that although HelloFresh is seeing great success financially, we believe that disrupting the essential grocery market is more lucrative in the long run.
Now, some may believe that the larger players will simply come in with their deep pockets and seriously impact Goodfood's ability to grow. Quite frankly, that is not a valid argument unless there's proof that it's happening. The larger players have already entered the online market through companies like Voila. Yet, Goodfood continues to grow and see gross profit margins expand.
There are a lot of operational challenges when it comes to efficiently delivering food with very quick turnarounds. Logistics need to be well thought out which takes time and expertise. Simply throwing money at a project doesn't always produce a superior product as our experience working for a major Canadian bank has shown us. Nonetheless, even with competition from the big players, that doesn't necessarily mean everyone will begin flocking to them just because they're bigger.
Their services will have to be substantially better and their products much cheaper to make a significant impact on Goodfood. However, as Goodfood continues to reinvest in automation, Goodcourier, and its facilities, it will continue to also improve its service, margins, and offer more competitive pricing. Therefore, we would like to reiterate that until there is actual proof in terms of financial performance that the big players are actually "crushing" Goodfood, that argument does not hold any weight.
We would also like to touch on competitors such as Instacart and Uber Eats (UBER). There is a very important distinction between Goodfood and these companies that poses very little threat to Goodfood. Instacart and Uber Eats will always make ordering food online much more expensive. Goodfood's aim is to become as efficient as possible to make ordering food online less expensive and competitive with brick and mortar. This is an extremely important difference.
In addition, Goodfood has greater control over food selection to monitor for quality as well as the delivery process to make sure refrigerated foods are transported properly. Instacart and Uber Eats uses random drivers who might not care to pick out the best food and do not have refrigerated vehicles. We mentioned in our previous Goodfood article the issues that this may cause.
Growth Catalysts
A major growth catalyst for Goodfood is margin expansion which is being driven by operating efficiencies.
As per the pictures above, costs have come down since 2018 which has resulted in a 12% gross profit margin expansion. In addition, capex as a percentage of revenue has come down more than half despite the increased spending on new facilities and improving existing ones. The company has a long-term goal of reaching a 10-15% adjusted EBITDA margin which is well above the 7% industry average.
Although adjusted EBITDA margin decreased from the same quarter last year, we believe the EBITDA target is achievable because Goodfood continues to invest in expanding its same-day delivery capabilities and is therefore consciously choosing to delay profitability. However, these investments should continue to drive efficiencies that will result in margin expansion going forward. Nonetheless, it still squeezed out a positive EBITDA margin of 1.6%.
In addition, Goodfood continues to add new products at a blistering pace which has led to higher average order sizes. This is demonstrated by the fact that Goodfood's revenue increased sequentially from Q2 despite a drop of 2000 subscribers from 319,000 to 317,000. This drop does not worry us as it was expected considering how fast the subscriber count grew over the course of the pandemic.
We don't expect anything to go up in a straight line forever and a few small bumps in the road are to be expected as all major companies have experienced at certain points throughout their existence. What's important is the long-term trend and the way management responds to bumps that matters the most. We believe the subscriber count will continue to trend upwards once the short-term headwinds from the re-opening wear off.
Founder-led Company
One of the reasons we like Goodfood is because it is a founder-led company. As we've mentioned in many of our articles, founder-led stocks have outperformed the market in the past for many reasons. The main idea is that founders have a greater sense of purpose and are more innovative, which leads to greater performance. Jonathan Ferrari (CEO of Goodfood), and Neil Cuggy (chief operating officer), co-founded the company and they have proven to be a very innovative and driven duo.
A key thing to note is that they have a large ownership in the company as you can see below, with each of them owning over 13%. This shows that they are aligned with shareholders' best interests and it gives us extra confidence in holding the stock.
Valuation
We will use linear regression in which we will compare price to sales versus expected 3-year revenue CAGR. This approach is similar to the popular PEG ratio except we will be using sales instead of earnings and is somewhat more scientific given the use of the linear regression.
Source: Author using data from Finbox
Using the companies that we believe are the most reasonable comparisons to Goodfood listed in the picture above, the result of the regression formula is as follows:
11.8(expected sales growth) + 0.175 = Fair Value
The green dot is Goodfood, and since it is below the line of best fit, the company is considered to be undervalued. With an expected growth rate of 19.3%, the fair value should be 2.45 times sales instead of its current 1.68 times sales.
Risks
The obvious risk to Goodfood is competition. Companies such as Voila will challenge Goodfood in the online grocery market and others such as HelloFresh will challenge in the meal kit market. With very few barriers to entry, it doesn't take much for new competitors to spring up. However, it is very important to remember that a low barrier to entry does not mean a low barrier to success.
It takes a lot of resources to succeed in this industry. Marketing is very important, but logistics is vital. Without well-thought-out logistics, a company will have a hard time scaling and will operate inefficiently, resulting in higher costs. Therefore, in a low-barrier industry, efficiency does become the barrier and we believe Goodfood has all the right traits to take on the competition.
Final Thoughts
Goodfood has seen its stock drop substantially from its highs due to the belief that it would struggle post-pandemic. However, the cold hard evidence paints a picture of a company that is actually poised to see substantial growth in the years to come and the recent drop has provided investors with a great opportunity. Goodfood has the management team and the efficiency to take on competitors that come its way. Additionally, the valuation model suggests that Goodfood is trading at a discount to its peers when factoring in expected growth. As a result, we believe Goodfood is a great long-term opportunity.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of GDDFF either through stock ownership, options, or other derivatives. 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.