Description

Hilton Food Group plc (“HFG LN”) is a UK-based company that provides white-label meat and seafood products to grocers.  Despite growing sales by 14% on average over the past 10 years while maintaining stable margins, the stock currently trades at just 5.7x EBITDA, a 46% discount to its historical multiple of 10.5x, as HFG LN’s non-core business faced temporary challenges in 2022.  The company has already implemented initiatives to recover profits, and there’s 116.3% upside to an investment in HFG LN if the shares return to their historical multiple.  Additionally, we see further upside as we expect HFG LN will extend its growth runway with the announcement of new customer expansions.

Similar to grocers, meatpackers generally are low margin, commoditized businesses; however, what makes HFG LN unique is its single-customer site business model offering customers a superior value proposition.  Unlike a typical protein processer that sells to multiple grocers, HFG LN partners exclusively with a single, large grocery chain in each geography (e.g., Tesco in the UK, Ahold in Holland, and Woolworths in Australia/New Zealand).  These exclusive relationships allow customers to know that any information shared will not undermine their competitive position.  This avoids the normal grocer-meatpacker relationship, which is akin to purchasing a used car – each party believes the other is not acting in good faith.  These open book relationships allow HFG LN to better serve customers with market insights and logistical efficiencies allowing for lower unit costs.

Additionally, HFG LN’s cost-plus payment model allows customers to be confident in the quality of product supplied by HFG LN.  While conditions are not as poor as in Upton Sinclair’s 1906 book The Jungle, news outlets often uncover stories of non-meat product, or meat from other animals, such as horse, unsanitary plant conditions, and intentional product misdating.  Thankfully, HFG LN’s cost-plus billing and single grocer partners produce a fully transparent relationship which avoids shady ways of creating profit margin and keeps HFG LN out of news exposes.

In practice, on a call with management, the company explained that this transparency allows grocers to understand the full ramification of their decisions.  For example, when customers want to promote a particular cut/size of lamb as a Christmas special, they can work with HFG LN to fully understand the additional labor, logistic, changeover, and ingredient costs to ensure their Christmas special is a profitable cut/size to promote.  In short, full transparency enables better decision making by grocers, allowing them to earn a higher margin on meat and seafood while still being cheaper for consumers.

The success of HFG LN’s differentiated model is seen in its financial results as the company achieved ten-year sales and EBITDA CAGR of 14% and 12%, respectively.  HFG LN grew with existing customers by increasing market share, expanding food offerings, and entering new geographies.  Partnered with Tesco in the UK since 1994, HFG LN expanded this relationship to Ireland and central Europe, and increased its red meat market share with Tesco in the UK to near 100%.  The success of partnering with HFG LN is also noticed by others, unlocking new customer relationships for HFG LN.  Since entering Australia in 2013 through a JV with Woolworth, HFG LN has grown this partnership to £1.6 billion sales and £52.2 million EBITDA in 2022.  The company is working on new partnerships and we believe it is likely to announce expansion into a new geography in 2023.

HFG LN’s single-customer site business has a stable margin profile because all costs are passed along to customers through a cost-plus business model, which accounts for 82% of HFG LN’s revenue.  However, 18% of revenue is derived from multi-customer sites, which lack the ability to immediately pass cost increases to customers.  These multi-customer sites predominately process seafood, and seafood prices spiked in 2022 due to Russia’s invasion of Ukraine as most seafood fished in Russian waters was no longer able to be sold in the west.  Unable to pass the higher costs to customers, in late 2022 HFG LN issued two profit warnings, which took the stock from £10.70/sh the day before the invasion of Ukraine to £5.57/sh at year-end 2022.

We believe the market overreacted to the profit warnings, as HFG LN’s market capitalization dropped more than £500 million in 2022 on £26 million of temporary profit reduction.  Despite severe challenges, HFG LN finished 2022 with flat EBITDA YoY.  We expect price increases already put in place by the company and cost initiatives will allow profits at the multi-customer sites to recover in 2023, and as inflationary pressures ease, the stock should re-rate as uncertainties diminish.

Catalyst

Multi-customer sites business profit recovers

New customer expansion announcement