Description

Landec (NASDAQ:LNDC):

Landec is an underfollowed company that has underperformed for an incredibly long-time but which we believe is now positioned to generate superior returns.

For FY19, Lifecore revenue was $75.9mm (+16%) and EBITDA was $24.1mm (+15%). For FY20, LNDC expects Lifecore revenue to grow 10%-12% and generate EBITDA of $25mm-$27mm [or $21mm-$23mm after corporate expense allocation. EBITDA presented in the chart above is before corporate expense allocation].

Over the last 3 years Lifecore has invested $55mm in new capacity and capabilities and will invest another $13mm this year. Those investments support $40mm-$60mm of incremental revenue and management expects Lifecore revenue to grow mid-teens annually for the next 5 years.

Our checks on Lifecore have been very positive at both the business specific level and the industry level. CDMO’s are playing a more integral and value added role in the pharmaceutical industry and the use of injectable drugs (Lifecore’s specialty) is growing.  

We think the following are good comps for Lifecore:LNDC is comprised of a handful of core assets, which we view as ranging from mediocre to very good. We believe that at current levels we are paying a highly discounted price for these assets.

LNDC replaced its CEO in May 2019. The new CEO is a highly experienced executive who is taking the right steps towards value creation.

As this write-up will outline, we believe that at current levels fundamental downside is limited and upside is substantial.

Business / Asset Overview:

LNDC is comprised of 3 core assets and 2 small assets:

EatSmart (reported under Curation Foods segment):

EatSmart is a leading packager and marketer (but not grower) of multi-serve & single-serve salads kits and vegetable bags & trays. This is not good business. Vegetable bags and trays are especially tough, insofar as they are wholly commoditized. Salad kits have seen some nice growth and there are some SKUs with decent margins.

For FY19 (concluded May 26, 2019), EatSmart generated $450mm of revenue, with $190mm coming from salads and $260mm coming from vegetables. EatSmart can generate 10% gross margins and MSD EBITDA margins. Management is trying to make the business as good as possible by focusing the business on the biggest, fastest growing, and most profitable SKUs.  Accordingly, EatSmart will likely see improved margins while sales modestly decline as very low (or negative) margin SKUs are pruned from the portfolio.

We think the following are good comps for EatSmart:

Additionally, Chiquita was acquired in August 2014 for .45x revenue and 10x last 6 year mean/median EBITDA and 20x EBIT. EBITDA margins were around 4%. Also, Fresh Del Monte acquired Mann Packing in early 2018 for .67x revenue (http://investorrelations.freshdelmonte.com/news-releases/press-release-details/2018/Fresh-Del-Monte-Produce-Inc-Announces-Definitive-Agreement-to-Acquire-Mann-Packing-Co-Inc/default.aspx).

We think EatSmart is as good (bad) of a business as Fresh Del Monte, Sunopta, or Chiquita. Accordingly, we think .3x-.5x revenue is appropriate.

Yucatan Foods (reported under Curation Foods segment):

Yucatan Foods owns the Yucatan and Cabo Fresh guacamole brands.

LNDC acquired Yucatan Foods in December 2018 (http://ir.landec.com/news-releases/news-release-details/landec-corporation-acquires-yucatan-foods). LNDC paid $80mm for Yucatan and the business generates $60mm of revenue and $6mm-$8mm of EBITDA. The business has attractive growth prospects and a newly built production facility in Guanajuato, Mexico that can support substantially greater revenue.

We believe our valuation approach for Yucatan is conservative.

Windset Farms (held as a balance sheet equity investment):

Windset Farms is a leading hydroponic greenhouse operator. LNDC owns an equity stake in the business (common equity + preferred). The balance sheet value of the investment is effectively the discounted value (12% discount rate) measured to March 2022, at which time LNDC will execute its put option and sell its stake back to Windset. We value Windset at its current balance sheet value.

Lifecore Biomedical (reported under Lifecore segment):

Lifecore is LNDC’s very good business.

Lifecore Biomedical is a specialty CDMO (Contract Development and Manufacturing Organization). Basically, it helps drug companies develop their drugs, take them through FDA approval, and then manufacture them once approved.

Lifecore’s business has evolved over the years. Its legacy business – which remains a core part of its business – is the production of Hyaluronic Acid (HA). HA is a naturally occurring substance in the human body that has a broad range of medical applications. The table below presents the general shape of Lifecore’s evolution:

As a result of growing HA use and Lifecore’s broadening capabilities, Lifecore has demonstrated very healthy growth over the last decade:

For FY19, Lifecore revenue was $75.9mm (+16%) and EBITDA was $24.1mm (+15%). For FY20, LNDC expects Lifecore revenue to grow 10%-12% and generate EBITDA of $25mm-$27mm [or $21mm-$23mm after corporate expense allocation. EBITDA presented in the chart above is before corporate expense allocation].

Over the last 3 years Lifecore has invested $55mm in new capacity and capabilities and will invest another $13mm this year. Those investments support $40mm-$60mm of incremental revenue and management expects Lifecore revenue to grow mid-teens annually for the next 5 years.

Our checks on Lifecore have been very positive at both the business specific level and the industry level. CDMO’s are playing a more integral and value added role in the pharmaceutical industry and the use of injectable drugs (Lifecore’s specialty) is growing.  

We think the following are good comps for Lifecore:

We believe Lifecore has a long growth runway ahead of it. We also believe that as a standalone asset, Lifecore would garner a premium valuation. We believe our valuation is conservative.

Minor assets:

-        O Olive Oil & Vinegar: a producer of specialty olive oils and vinegars. LNDC acquired O in March 2017 for $2.5mm. The business generates $5mm of revenue and is growing rapidly.

-        Breatheway:  an innovative packaging technology that better preserves fresh fruits and vegetables. Breatheway is used for EatSmart and Windset products but LNDC has not been successful in selling Breatheway to 3^rd parties.

Management Change:

LNDC replaced its CEO in May 2019. Under previous management, the Company went in a number of directions with Curation Foods. Nothing worked out well and operations in the core EatSmart business deteriorated. The previous CEO considered herself a marketing/branding person (refers to herself on her LinkedIn page as a “Visionary Leader”). Curation needs an operator. Our research on LNDC, which started prior to the management change, identified serious but fixable operational issues in the business.

The new CEO is an operator. His early messaging is spot on, as are the hires he’s making. Our checks on him have been solid.

I recommend reading this document (http://ir.landec.com/news-releases/news-release-details/landec-ceo-establishes-priorities-increasing-profits) and the F4Q19 CC.

Lifecore is run independently by long-time management so there were never any issues there.

Summary and Valuation:

In our view, LNDC is a collection of interesting assets that we can buy at a highly discounted price. We believe the right management is in place to exploit the full potential of the assets.  We believe that all the assets are eminently saleable at good valuations.

It’s also worth noting that Wynnefield Capital is the second largest holder of LNDC, it is Wynnefield’s second largest potion, and the manager of Wynnefield has been a LNDC board member since October 2018. So shareholder interests are represented.

Presented below is our summary valuation for LNDC – we think there is upside to pretty much every valuation point:

Catalyst

- Stabalization / improvement of EatSmart

- Continued LifeCore growth

- Sale or split of the business