Description

Background

Gruma is the leading global producer of tortilla and corn flour.  It was founded in 1949 by Roberto González Barrera, who passed away in 2012. His son, Juan González Moreno, has led the business since.  The founder established the world’s first industrial production facility of corn flour.  Using corn flour as an input allows for simpler and less labour-intensive production of tortillas compared to what is referred to as the ‘traditional method’, or nixtamalization.  The traditional method involves soaking, grinding, cooking and kneading corn into a dough.  This remains widespread in Latin America but is giving way over time to the use of purchased corn flour.  In addition to corn flour, Gruma produces tortillas as a branded product distributed by grocers, and unbranded when supplying the foodservice sector.

Gruma operates globally but makes most of its money in the US and Mexico, which respectively accounted for 64% and 23% of 2021 EBITDA. In Mexico, Gruma mostly sells corn flour under the Maseca brand, where it has a 74% market share, 3.7x that of the number two in a duopoly.  In the US, sales are split 80:20 between tortillas and corn flour.  Gruma is also the largest corn flour producer in the US and has the #1 and #2 tortilla brands, Mission and Guerrero.  Based on Nielsen panel data captured from retailers, Gruma has a c.55% market share of tortillas, c.5x that of #2 player, Olé.  Gruma’s management believe this may overstate their share and estimate this to be closer to 35%.  Their share has been robust or growing over time. The numbers speak for themselves: this largely unknown food producer enjoys Coca-Cola levels of category dominance.

Moat

Gruma’s moat largely stems from its scale advantage, which confers benefits in production and distribution, combined with brand strength.

Having operated in the space for 7 decades, Gruma has accumulated knowledge and experience in efficient tortilla and corn flour production.  This extends to having proprietary engineering technology.  In the US, they have 20 tortilla plants and 6 corn flour mills.  In Mexico, they have 18 corn flour mills.  Some of these are very significant operations that can cost up to $250m to develop.  We believe that, given its scale and investment in proprietary technology, developed in-house, Gruma is the global low-cost producer. The capital and time investment required to replicate their position would be substantial.

Endowed with a national production footprint in the US and Mexico, Gruma enjoys distribution advantages.  They are the only player that can offer large retail customers full national distribution of a product which is sold fresh, with consistent product quality.  Also, they have the ability to replenish stocks regularly. This means they are a valuable partner to retailers, who reward Gruma with an attractive share of shelf/website space. Their strength of position is further underlined by the fact that it is a significant supplier of corn flour to smaller US tortilla producers, who are also competitors.

Gruma’s brand positioning is also a strength. In Mexico, Maseca essentially defines the corn flour category, and the 100,000 tortillerias (small producers of tortillas) will be loyal B2B customers, sometimes with limited alternatives.  In the tortilla category they have the largest B2C brands with commensurate shelf space.  In the US, their scale allows them to innovate with frequent new product launches.  They have had success in recent years in narrowing and consolidating their SKU range to a more profitable and efficient core whilst increasing the share of more premium ‘value-added’ products such as ‘Carb Balance’ or ‘Gluten Free’ tortillas.

We should not over-state their brand strength. Objectively, Gruma’s brands are not particularly aspirational and operate in categories which are not especially brand-led. Ultimately, there is a limit to their pricing power; customers would switch to an available alternative if there were a gulf in price.

Growth

Growth is quite stable and predictable as one might expect in this sector. We find volumes have increased at an average of 2.0-2.5% per annum in recent years.  Growth in Mexico will be driven by population growth, economic development, and a gentle tailwind from increasing use of corn flour versus the traditional method.  Growth in the US exceeds some contiguous categories such as bread.  This is driven by the faster growth of the Latino population in the US, and the growing popularity of Latino food in the broader population.  Tortillas may benefit from perceived health benefits over bread.

Why mispriced?

Whilst the founder was undoubtedly a visionary and highly successful entrepreneur, as well as living a colourful life, he did not manage Gruma for profits, and we understand that most of his fortune came from his interests in Banorte, a large Mexican financial group. Gruma’s financial performance inflected upwards after his son, the current CEO, took over in 2012. He simplified the group, divesting some non-core operations, rationalised the SKU range, reducing costs, and made Gruma more margin-focused.  The EBITDA margin increased from c.10% to 16% within 4 years.  Pre-tax return on tangible capital employed increased from less than 10% to over mid-20s%.

We think the market became carried away with this inflection in performance and extrapolated continued fast profit growth where this was unrealistic. As profit growth slowed (but continued more in line with stable volume growth) and margins plateaued, the business de-rated from an EV/fwd EBIT of over 16x in early 2016 to c10x now.  

There have been concerns about the margin impact of the sharp spike in corn prices which comprise c.1/3 of cost of goods sold. Having engaged with the company, we believe they are being disciplined in recovering this through increased prices and whilst margins are a bit suppressed, they are at least the making the same amount of profit in dollars or pesos per ton, which is what actually matters, at least in the short term.

Risks

Finally, we should address the issue of geography. We generally invest in developed countries, so Gruma’s incorporation in Mexico prompted an additional layer of risk assessment. Our research and engagement with the company convinced us that Gruma is well managed by trustworthy people and that there are levels of reporting, control and governance similar to our other portfolio investments in developed countries.  We like the fact that the founding family are 48% shareholders alongside us.  Gruma’s capital allocation is commendable, with excess cash over that required for capital expenditure returned to shareholders via dividends, and increasingly via share buybacks, given recent share price weakness. Gruma recently changed its reporting (since Q1 2022) from the Mexican peso to the US dollar. This makes a lot of sense, given the company generates two thirds of its profits in the US.  When we first started looking at Gruma they had minimally engaged with proxy voting advisers. This has changed and for the last two years ISS has recommended voting in favour of all Board proposals at the AGM.

Catalyst

This is not predicated on catalyst. However, normalised or less volatile corn prices + the lagged effect of price rises feeding into higher margins would likely be viewed positively by the market