Description

National Beverage Corp (FIZZ - $66, $3.1bn market cap)

Currently trading at 19x trailing EBITDA and with a chart that would give many VIC readers vertigo, FIZZ is not a “value stock.”  Nonetheless, I thought it would be good to revisit in this forum (last written up on VIC by wan161 in February 2013) given (1) controversy (short report by Glaucus), (2) poor Street coverage, and (3) my view that the LT risk/reward is still favorable.

1. Brief Company Description

National Beverage Corp is the 5th largest soft drink company in the United States. It was founded in 1985 when serial entrepreneur Nick Caporella bought Shasta to help fend off an unwanted acquisition of a publicly-traded telecom installation company he ran. Nick switched horses (a la Ron Shaich) when National Beverage became an independent company in 1991, and from there, he primarily built his stable of beverage brands through acquisitions. Nick still owns 74% of shares outstanding, and his son Joseph is the President.

Today, the brand portfolio includes Ritz, Crystal Bay, Faygo (midwest soft drink), Everfresh (juices), and Rip It (energy drink). The crown jewel of the business is La Croix. While the company does not disclose the size of the La Croix brand specifically, I estimate La Croix makes up ~40% of revenue and >60% of profits.

La Croix is a flavored sparkling water that contains no artificial sweeteners and no calories. The label reads, “Carbonated Water, Natural Flavors.” While “natural flavors” is a vague term, consumers are clearly more comfortable consuming a touch of “natural flavor” than high fructose corn syrup, phosphoric acid, citric acid, and other ingredients in CSDs that rot teeth and effectively clean toilet bowls.

2. Investment Thesis & Recommendation

Buy FIZZ with a time horizon of 2-3 years. The owner of La Croix, the #1 flavored sparkling water brand in the US, will compound EPS at a 20%+ CAGR over the next 3-5 years. EPS will be driven by strong category growth (>10%/ yr.), distribution gains (currently ~0 presence in C-stores), SKU proliferation (bottles, single serve), and margin expansion (due to mixshift & leverage of fixed costs). Scarcity/strategic value should help its premium multiple hold.

Massive industry changes (shift away from soda & diet soda) creates a fertile backdrop for value creation (see MNST and SAM for case studies). Soda is big business (50-100x larger than sparkling water), and we are in the early innings of consumers ditching CSDs (carbonated soft drinks) towards “healthier” options. The internet and growing importance of social media is accelerating this shift in consumer behavior.

3. Price Target Scenarios

In my base case, I expect FIZZ to be a $134 stock (16x FY20E EBITDA of $353mn) in 24 months (+90%). When thinking through the range of outcomes for FIZZ and assessing its risk/reward, it is important to remember the size of its market opportunity. The average American drinks 45 gallons of soda per year, representing $65bn of sales at retail yet the sparkling water market is less than $1bn. I was channeling my inner Peter Lynch when I initially bought this stock - I have several friends that ditched Diet Coke for La Croix.

Note, while the base/bull scenarios above may appear overly optimistic, I feel as though the underlying assumptions are reasonable (although I look forward to dissenting views particularly on assumption #3).

Key base/bull assumptions

1. The sparkling water category will continue to grow at a 15%+ rate. 3rd party forecasts (Mintel) project the category to grow at a 17% CAGR through 2020. I think this may prove conservative given (1) this implies a deceleration from recent trends (category grew 26% y/y in 2015), (2) scanner data has shown accelerating trends at La Croix, and (3) we are still in the early part of the “S-curve.”

2. La Croix can hold/grow its market share. I was able to cobble together market share for the category in 2015 through publicly available news articles (see below). In October 2016, according to Nielson data, La Croix grew 67% y/y, well outpacing sparkling water offerings from Nestle (+18.7%) and Polar (+14.9%).  

3. EBITDA margins will expand from 19.7% (TTM) to ~25-30% by FY20. The key assumption here is that FIZZ’s healthier “power brands” are 1000-1500bps higher margin than its low quality private label CSD business. This assertion is consistent with commentary in SEC filings (where product mix has been cited as driver of recent expansion) and in CY16 results, where gross margins expanded 363bps as La Croix grew as a % of the mix.

4. FIZZ will trade at a 15-20x EBITDA multiple in 2-3 years. Currently, staples that have ~0 organic volume growth are trading at 10-15x EBITDA, so I don’t think it is a stretch for a company growing volumes at 15%+ organically to trade at 15-20x. In the past, growthy staples assets with a “healthy halo” have traded at a large premium to the market, and many have been purchased by bigger players who have shown a willingness to pay up for on-trend growth brands (see GIS/BNNY for 30x EBITDA and Danane/WWAV for 22x).

*Note, I am not assuming FIZZ’s tax rate goes down to 20% or more cities implement a soda tax, but obviously, those are other sources of potential upside.

4. Investment Positives & Risks

Positives:

(+) #1 brand in a category that is likely to grow at a 15%+ rate for a long time. The category is growing 20%+ as people swap out their diet coke habit (increasingly viewed as unhealthy) for sparkling water. Anecdotally, La Croix has a cult like following and I see it in the fridge at many of my friends apartments.

(+) Competitors are too big to be nimble, and are reluctant to evangelize the category and cannibalize their legacy CSD profit pool. Soft drink consumption is in long-term secular decline, and PEP/KO are using price and packaging tricks to try to offset 3-4% annual volume declines.

(+) Size (big enough to matter but small enough to grow and be nimble) and vertical integration gives La Croix a sustainable competitive advantage. With its 12 manufacturing facilities, La Croix is able to respond faster to changing market conditions than competitors that rely on independent 3rd party bottlers.

(+) Clean balance sheet and strong track record of returning capital to shareholders. The company has over $100mn in net cash, and has paid out $10.16/share in special dividends over the past 12 years. Given it has generated FCF almost every year since its formation (except for when it burned $100k in FCF in 1999), its capital structure is certainly sub-optimal and adding debt to the capital structure would certainly be accretive.

Risks:

(-) Competition may hinder pricing and margin expansion. Can a company that sells sparkling water sustainably earn returns above its cost of capital? Doesn’t it all taste the same??

→ Mitigant - The same argument can be said for many branded food companies. While some say there is no moat or product differentiation,many people I have spoken with believe that La Croix has better flavors, and seem to prefer the brand over others.

→ Mitigant - I had a conversation with an employee of Pepsi (who had done work researching the firm’s sparkling water strategy) who indicated that Pepsi is fully aware that La Croix is running away with the biggest growth category in beverages, and they are late to the game.

→ Mitigant - The “competition” short thesis never played out for MNST.

(-) “Expensive” valuation at 19x TTM EBITDA. Obviously, this is even more concerning if you believe that La Croix is a fad, or that margins are overstated, and that earnings from 2011-2014 are a more true representation of the future business.

→ Mitigant - Today, MNST trades at 20x EBITDA and KO trades at 18x EBITDA. I expect FIZZ will grow much faster than both of of these companies.

→ Mitigant - Even if you think FIZZ’s margins are inflated (the Glaucus view), the sales are undoubtedly real (scanner data, Google trends, & my eyeballs don’t lie). While I haven't dug deeply into accounting allegations, FIZZ’s margins pass the sniff test in my opinion, and valuation is reasonable on multiples that normalize for profitability. FIZZ currently trades at <4x revenue, which is cheaper than the Vitamin Water transaction (its $4.2bn purchase in ‘07 represented 6x sales) and DPS’s recent $1.7bn acquisition of Bai (7.4x 2016E revenue).

(-) Non-La Croix business (<40% of FIZZ’s revenues) is low quality.

→ Mitigant - it doesn’t really matter anymore. I estimate these lower quality, private-label-esque brands have fallen from ~50% of sales in FY14 to ~20% today.

(-) Management team is controversial and bench may lack depth. CEO Nick Caporella has an amazing background that is worth reading about. He is almost 80 years old, owns 74% of FIZZ, and pilots a Falcon 2000-EX jet that is partially owned by the company. With seemingly limited management depth, it appears that a bet of La Croix is still a bet on Nick, for better or worse. While I have never met him and there are some yellow flags, my view is that he is a money-maker. His attorney tried to sue him for $4mn for work he did on a potential sale. All of these issues are covered in the Glaucus short report in a sensationalized way. While Nick may have engaged in some “cookie jar” accounting to smooth earnings (like many companies), I don’t think he is committed outright accounting fraud (as the report suggests).

→ Mitigant: Nick’s background is impressive. Nick’s father was a coal miner, and Nick began working odd jobs when he was 11. At age 22, he purchased an excavating machine for $9000, using his life savings ($250) as down payment. With this machine, he moved to Puerto Rico 2 years later, and at the age of 30, he sold his business and retired as a millionaire. Within 7 months, he formed another company which became Florida’s largest site preparation company, which he sold to Burnup & Sims in 1972 where he remained as President. In 1976, he became the President and CEO of Burnup & Sims.  

→ Mitigant: Why now, after a 30yr period without fraud? And if he was using related party transactions to artificially understate reported SG&A, wouldn’t he sell some of his stock?

5. Mental Models

Despite constant concerns around valuation/competition, MNST shareholders realized 29143% returns (56% CAGR) between ‘04-’15. SAM shareholders realized 1261% returns (30% CAGR) between ‘05-’14.

6. Mini Model

Catalyst

• Continued category growth (sparkling water), continued share gains of La Croix, & mix-shift driven margin expansion 
• Potential sale of company (becoming less likely)