Description

Introduction

BellRing Brands (BRBR or BellRing) was last written up on VIC over four years ago. Since that time, the stock has performed very well, rising from $20 to $59. However, despite the strong returns, I believe there is still potential in the stock. The valuation is reasonable, and with sufficient capacity coming online, the future is bright. This write-up will provide a brief overview of the company and outline the reasons why the stock represents a good opportunity today.

Company Overview

BellRing was formed by three acquisitions completed by Post Holdings (POST) around a decade ago: Premier Protein, Dymatize, and Powerbar, for which Post collectively paid around $700 million. The Powerbar deal was a dud and the brand has been discontinued in North America, Dymatize has been a disappointment, although recent performance has been improving, and Premier Protein has been wildly successful. Collectively at the time of the acquisitions, these three companies generated combined revenue and EBITDA of around $500 million and $69 million, respectively. This compares to fiscal year (ends September 30) 2024 anticipated sales of $2 billion and EBITDA of $410 million. All this growth and then some has come from Premier Protein.

BellRing is the largest player in ready-to-drink (RTD) protein shakes in the US with a market share of approximately 21%. RTD shake revenues have grown at a compound annual rate of 17% over the past five years, despite manufacturing capacity shortfalls. RTD shakes comprise nearly 80% of overall revenue with the remainder primarily coming from Dymatize and Premier Protein branded protein powders. BellRing claims its share in the powder market is just under 10% and growing rapidly, especially for the Premier Protein brand.

RTD shakes and powders are sold primarily through club stores, FDM retailers, the specialty channel and online. Dymatize is the second largest whey protein powder brand in the e-commerce channel, with its primary product being the ISO100 brand. The RTD product has performed exceptionally well in the club format with Costco and Sam’s Club comprising approximately 64% of BellRing’s overall sales. Including Amazon, the three largest customers account for over 75% of sales. The company is primarily a domestic business as 90% of sales are made in the US. As all production is outsourced to co-manufacturers, capital expenditures are negligible.

BellRing is primarily a marketing organization, and management has built the brand over time to have mass appeal with a wide range of consumers. The RTD shake product is used for a variety of purposes including as a meal replacement, for weight loss, general nutrition, sports nutrition, etc. Use by gender is equally split between male and female. This broad appeal contrasts with other brands which have segmented the market into categories focused on body building, senior nutrition, weight loss, etc.

Financial Overview

Post caught lightning in a bottle with the Premier Nutrition acquisition in 2013. At the time of the deal, Post anticipated Premier would generate annual revenues of approximately $135 million as compared to anticipated RTD shake revenue in FY 2024 totaling over $1.5 billion. Over the past seven years, revenue and EBITDA have grown at annual rates of 15% and 24%, respectively. The gross margin reached a peak of over 36% in FY 2019 before declining to the low 30% range given ingredient, packaging, and shipping inflation in recent years. The company has experienced operating leverage with the EBITDA margin increasing from 13% in 2016 to over 20% in 2023.

Cash generation has been strong. The primary use of cash has been investing in working capital as the company has grown. Net operating working capital has averaged around 20% of sales. However, with almost no capital expenditures, free cash flow typically exceedes net income. Free cash flow has compounded at 25% annually since 2016. As no acquisitions have been made since 2015, all the growth since that time has been organic. As a result, both the historical ROIC and incremental ROIC have been very high. For example, over the past seven years, BellRing has invested a total of $181 million in working capital and capital expenditures, while during that time frame, EBITDA has increased by $245 million. BellRing’s rapid growth has required minimal additional capital.

After BellRing’s IPO in October of 2019 (in which Post sold a portion of its ownership), Post spun out 80% of its remaining stake in BellRing to Post shareholders in March 2022. As part of this transaction, Post put $800 million in debt on BellRing which brought leverage to around 4x. Due to EBITDA growth, by the end of FY 24, the leverage ratio will be around 2x. The senior notes, which carry an 8% interest rate and mature in 2030, can’t be pre-paid until 2027 at the earliest. In the two years since the spin, BellRing has paid off its line of credit and allocated capital to share repurchases, including a reduction of 3.2% of its outstanding shares during FY 2023. Impressively, these repurchases were made, on average, at a price 50% lower than the current price.

Why Buy the Stock Today:

1.)   Potential Acquisition Target

When Post announced the BellRing IPO in November of 2018, the CEO, Rob Vitale, provided the following rationale for the transaction:

“Since 2014, the segment (Active Nutrition) has grown adjusted EBITDA by 68% compound annual growth rate. We believe we are in the early stages of category and brand development. We intend to offer the business directly to the public market by an IPO, representing approximately 20% of the ownership of the new company. We expect to capitalize it in a manner that enables it to serve as an acquisition vehicle. Our Active Nutrition President, Darcy Horn Davenport, will lead the newly formed business as CEO, and I will serve as Executive Chairman…..We're quite excited about the prospects for this transaction and for creating additional value through organic growth and M&A.

Regarding future M&A for both Post and BellRing, Mr. Vitale stated:

“I think when you look at the character of cash flow across our portfolio, and I'm going to specifically try to avoid talking about multiples, but that when we have an M&A strategy that is in a segment that has a multiple characteristic that is different from the balance of the business, it can be challenging to pursue M&A in that category. And that, I think, by isolating the business into a distinct separately traded entity, it allows us to pursue M&A of similarly structured businesses in a manner that would be challenging to pursue in a blended multiple.”

Post clearly believed that the value of BellRing wasn’t being fully recognized inside of Post, especially given the differing growth profiles, which has proven correct. However, in addition to highlighting the stand-alone value of BellRing, Post also sought to give BelllRing its own properly valued equity currency with which to carry out M&A in the active nutrition space. Post made this very clear leading up to the IPO. Yet, BellRing has not pursued any transaction that I’m aware of, while at the same time it has delevered and repurchased $200 million of shares in the past two and a half years. One could argue that, given the company’s rapid growth and capacity issues, it hasn’t been the right time to pursue M&A. Or perhaps the right deal simply hasn’t come along. M&A hasn’t even been mentioned on a conference call since Q1 FY 2023 when the CFO said:

I think it is also plausible that the company recognizes how valuable the Premier Protein brand is and any acquisitions it could make at this point would be dilutive to the business given Premier’s success. This is pure speculation on my part, but perhaps part of the reason BellRing has not pursued M&A is because it wants to make itself as attractive as possible to a potential acquirer. Premier Protein is arguably the best asset in the fast-growing RTD protein shake industry and would be a desirable asset for other companies in active nutrition who could realize synergies or larger packaged food companies looking to buy growth and/or seeking exposure to protein. Given the differences between Post and BellRing, it didn’t make sense to keep BellRing inside of Post. However, that doesn’t mean that BellRing wouldn’t be a good fit as part of another company.

2.)   Reengagement of Advertising and Promotion/Production Capacity Expansion

One of the most impressive aspects of BellRing’s RTD growth in recent years is that it was achieved despite price hikes and limited marketing support. Growth first began to outpace production capacity in the back half of FY 2018 as production capacity was maxed out. From the FY 2019 Q1 call:

Advertising and promotion fell by 40% in FY 2019 as BellRing pulled back on demand generation spending for the RTD Tetra Pak shake product. As capacity came online, sales picked back up and RTD revenue grew by 22% in FY 2020 and 25% in FY 2021 despite A&P remaining below the levels of 2016 as a percentage of revenue. However, with the company unable to add capacity quickly enough to match growth in demand, capacity once again became stretched in FY 2022. From the FY 2022 Q4 call:

For FY 2022, overall RTD shake revenue increased by 7% while volume fell by 8%. Despite taking significant price during the year to offset inflation, while reducing the assortment of flavors, brand metrics remained strong. In fact, the company reported that non-promoted volumes increased during the year despite the reduction in flavors, price increases, and the fact that overall A&P declined by 42% from the prior year! From the Q4 FY 2022 call:

Once again, as additional capacity increased growth picked back up in FY 2023 with both RTD volumes and prices rising by low double digits. Production capacity will increase by an additional 20% in FY 24. Two dedicated co-manufacturing facilities opened in Q4 FY 2023 and are in the process of fully ramping up. These facilities can add additional manufacturing lines in the future as needed. Further capacity additions in FY 25 and beyond are ongoing. It’s remarkable that despite limited A&P and significant price hikes, BellRing has consistently been unable to fully satisfy demand for the RTD product. The product has grown organically because its on-trend and consumers love it. This speaks to the strength of the brand as well as the future potential as the company fully supports the product with A&P. Growth could potentially accelerate moving forward.

3.)   Secular Growth Tailwinds/GLP-1s

BellRing has grown in recent years not only because consumers love the brand, but also because the overall convenient nutrition category is growing. It’s no secret that approximately 70% of adults in the US are overweight, and this continues to trend in the wrong direction. Like obesity, diabetes is a growing problem in the US with over 33% of Americans having prediabetes. Obesity and related complications cost the US over $200 billion per year. Post understood these trends which is why after its spinout from Ralcorp in 2011, it leveraged the cash flows from the legacy cereal business to expand into active nutrition as well as egg products with Michael Foods.

As more consumers understand the weight management benefits of reducing carbohydrates in the diet and increasing protein intake, protein supplementation has been a growing trend. Protein supplementation is anticipated to continue growing at a high single digit rate for the next several years, a trend which could be significantly bolstered by the growing use of GLP-1 medications. These drugs have proven to be very effective for weight loss, and the drugs’ prevalence will increase as additional capacity comes online. Both Novo and Lilly are investing billions just in the US to boost their domestic supply chains and production capacities. Once the drugs become more widely available, a significant number of Americans stand to benefit.

One of the primary side effects of GLP-1s is loss of lean muscle mass. The drugs serve to decrease one’s appetite and food cravings, resulting in a reduction in caloric intake which leads to weight loss. However, up to 40% of the weight lost on GLP-1s is lean muscle mass, which is very detrimental to overall metabolic health, not to mention the ability to keep the weight off longer-term. This is because a loss of muscle mass reduces the body’s resting metabolic rate, or the number of calories the body burns while at rest. This is why yo-yo dieting not only fails but leaves people worse off. A person cuts calories and loses weight, including lean muscle mass. The loss of lean muscle mass reduces the body’s overall ability to burn calories. The person goes back to eating the way he or she did before the diet and they end up with more fat than before because consuming the same number of calories with a lower metabolic rate leads to additional weight gain. It’s a vicious cycle.

One of the most important things a dieter or user of GLP-1s can do is to increase protein intake along with exercise in order to preserve lean muscle mass. It is impossible to know the extent to which GLP-1s and other weight loss medications will be utilized in the future, but it’s safe to say many more people will be on them five years from now. And given BellRing’s top position in the RTD shake space, it is very well positioned to benefit from this trend going forward. The implications for BellRing of widespread use of GLP-1s could be huge and is not priced into the shares today. BellRing was recently mentioned in a WSJ article as a potential beneficiary of the new weight loss drugs[1]:

For dieters, patients on GLP-1s, or anyone seeking to live a healthier lifestyle, awareness of the importance of lean muscle mass and protein intake is increasing. And BellRing is in a leading position to satisfy that future demand.

Valuation

At a current price of $59, BellRing is trading at TTM normalized free cash flow yield of 3.8%. This compares to about 6% at the time of the spin in early 2022 as well as about 6% at the time of the IPO in 2019. In other words, returns have come from both multiple expansion and growth. Moving forward, I think the stock can work with no multiple expansion, although that could still happen, especially if growth continues to surprise to the upside.

With leverage trending towards 2x by the end the current fiscal year, the company has ample capital to allocate, whether that be to share repurchases or M&A. With low double digit revenue growth moving forward, I can model free cash flow per share compounding at 20% annually over the next five years assuming constant leverage and excess cash allocated to share repurchases. With a TTM FCF yield just under 4% and likely double-digit revenue growth moving forward, especially with additional capacity coming online and A&P support, the stock price could compound a mid-teens rate over the next five years assuming a 25x FCF exit multiple. Assuming the exit multiple declines to 20x, compounding is between 9% and 10%. If the multiple declined from here, I would anticipate that BellRing would engage in significant stock repurchases, like in FY 2023.

Risks

• The company faces a high degree of customer concentration as over 60% of sales are made to Costco and Sam’s Club. The RTD product has been hugely successful in the club format and ongoing success in this channel will be crucial to future growth. Given how important Costco and Sams’s Club are, BellRing likely doesn’t have as much negotiating leverage it would prefer. Moving forward, BellRing will attempt to grow in other distribution channels.
• Given that RTD shakes comprise nearly 80% of the company’s revenues, BellRing is totally dependent on the future of the shake business. Despite being the market leader in RTD shakes, the industry is competitive as many other companies are looking to take share in the growing industry. One of the primary barriers to entry in recent years has been an overall lack of production capacity given the sector’s rapid growth. However, as more production continues to come online, competition is likely to increase. BellRing also faces deep-pocketed competition from the likes of Coke with Fairlife Core Power, Nestle’s Orgain, and Pepsi’s Muscle Milk. Overall category growth has been strong and that will likely continue, so there is room to grow without taking market share. BellRing claims that 80% of its growth has come from consumers new to the category. However, eventually as the market matures and capacity continues to grow, competition will be intense.
• As mentioned earlier, I find it very surprising that BellRing has engaged in no M&A since its IPO in 2019. There could be a couple of reasons for this including the company has been too preoccupied with capacity issues to integrate an acquisition, net leverage was 4x post the spin in 2022, management is very sensitive to valuation, and the primary capital allocator, Executive Chairman Rob Vitale, also had a recent health scare during which he took a leave of absence from his role. Maybe the company simply hasn’t found any deals worth doing. Or like I posited earlier, any deals would be dilutive to the Premier Protein brand and may make the company a less attractive acquisition candidate. At any rate, if the company did engage in M&A, this would bring risks given ples in the space as well as the hit-or-miss nature of potential targets. Post, which is regarded as a good acquirer, only went 1 for 3 on its active nutrition deals. Ultimately, given his track record, I have confidence in Mr. Vitale and his ability to rationally allocate the significant capital that BellRing will generate in future years.
• While I think the valuation today is very reasonable given BellRing’s strong cash generation and growth outlook, it has traded at lower multiples in the past and the multiple could de-rate in the future. If you assume the stocks de-rates to a 6% free cash flow yield over the next few years, returns would be muted.

Conclusion

Secular tailwinds of increasing focus on diet and exercise, use of weight loss drugs, and growing awareness of the importance of protein intake, combined with the massive problems of obesity and metabolic disease, will lead to category growth for many years. With capacity ramping, increased investments in A&P, strong brand awareness, and leading market share, BellRing is uniquely positioned to benefit from these long-term trends. Cash generation and ROIC are both very strong, and the company will have significant capital to return to shareholders in future years. Executive Chairman Rob Vitale has an excellent track record and will likely allocate capital to the benefit of shareholders, or potentially even sell the company if an attractive price was offered. BellRing would be a highly valued prize for a company wanting to get into the space or wanting to improve its position in the active nutrition category. At any rate, assuming low double digit revenue growth, constant leverage around 2x, free cash flow allocated to repurchases, and a 25x free cash flow exit multiple, I can model mid-teens compounding moving forward.

Catalyst

• Additional capacity coming on line
• Increased investment in A&P
• Potential acquisition target
• Capital return to shareholders