- Company beats top and bottom line estimates in Q1.
- Shares however have not managed to punch above upper resistance thus far.
- Downside risks (detailed below) may explain why the market is not letting CHEF shares trade higher.
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If we look at a technical chart of The Chefs' Warehouse, Inc. (NASDAQ:CHEF), we can see shares are potentially undergoing an ascending triangle which invariably is a bullish pattern irrespective of where they occur on the technical chart. In saying this, we have clear divergences in both the MACD indicator as well as the RSI momentum indicator which is not a bullish sign for a sustained rally. Therefore, we would advise caution at this point where the best course of action would be to wait for a clear breakout to materialize. Many investors would have thought that CHEF's reported significant sales and earnings beats in the company's recent first quarter would have powered shares above resistance but this in the end did not pan out as expected.
Q1 Sales Growth
Remember the market is a future predictive mechanism that takes account of every piece of information that could potentially affect CHEF's share price going forward. The announcement of the company's first-quarter earnings recently for fiscal 2022 (being a binary event) was a primary opportunity for a breakout in the share price but this failed to materialize. Top line sales growth of $512+ million drove the quarter forward where gross profit almost doubled over a rolling quarterly basis. Furthermore, although profitability remained constrained due to high costs and persisting labor problems, the company was still able to eke out a narrow bottom-line profit in the quarter.
Moreover, management increased guidance both for top-line sales and adjusted EBITDA to reflect the current trends CHEF is experiencing. Top line sales are now expected to come in at approximately $2.23 billion but inflation can act as a double-edged sword if indeed market conditions do not work out as planned for CHEF. The reason being is that a company like CHEF is very open to how disposable income is spent in the economy. So when talking about weddings, restaurant dining, corporate events, cruise holidays, etc., spending (demand) in these areas can certainly fall off significantly if indeed market conditions do not open up as envisaged.
Another area that may be making investors tentative is CHEF's valuation. Despite the fact that bottom line earnings are expected to grow to $0.79 per share this year, this means the stock's forward GAAP earnings multiple comes in at 46.6. This works out to be a forward earnings yield of 2.15% which is well behind the inflation rate at present. In fact, with the 10 US treasury yield now at approximately 3% (which is classified as a lower-risk investment), investors may not be attracted to the current risk/reward setup in CHEF.
Below average earnings usually lead to below average cash flow and this is exactly what is evident on CHEF's cash flow statement. Over the past four quarters, $14 million of net profit generated a mere $2 million of operating cash flow. Furthermore, when we allocate the capital that went towards investing spend ($88 million) & financing ($9 million), we see that the company's cash balance actually fell by $96 million to now stand at $79 million.
Share count & Balance Sheet
When a company is not generating enough cash flow, it always puts a time element on proceedings with respect to eventually needing external funding. That funding can come from asset sales, more debt, or an equity raise. In fact, although management has done a good job in keeping shareholder equity elevated on the balance sheet, the number of shares outstanding now surpasses 38 million (a 25%+ increase in the last two years alone). Recent acquisitions have increased goodwill to $231 million and long-term debt now comes in at $394 million. Suffice it to say, when we take into account the substantial reduction in cash over the past four quarters as well as the trends mentioned above, CHEF needs internally driven cash-flow growth now more than ever.
Therefore to sum up, with shares testing the upper resistance of the triangle once more at present, investors need to be mindful of the fact that the longer resistance holds, the harder it will be for shares to punch through. Furthermore, despite recent momentum which has led to higher highs, downside risks firmly remain if expected growth is not achieved this year. We look forward to continued coverage.
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This article was written by
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