Description

Nomad Foods Limited (NOMD)

Analyst Recommendations: 5 buys, 0 holds, 0 sells ($19 avg price target)

Recommendation: Buy

Thesis Summary: As NOMD nears the end of its 18 month turnaround, we believe that there is significant upside of 50%+ as company continues to de-lever its balance sheet and pursue accretive M&A. Nomad shares trade at nearly 9% FCF yield, which is nearly 400bps wider that other US packaged food names with higher leverage and inferior fundamentals (K, GIS, BGS, CPB, FLO, etc). The reason why we believe the opportunity exists was the result of early missteps in a flawed product rollout strategy which yielded negative organic growth in the MSD. Consequently, NOMD's stock fell -55% from its $22 52-wk high as platform M&A stocks were sold with passion (see POST write-up) and Nomad's sales  performance  widened  vs  European  frozen  in  2015  (-6.5%  vs  industry  +0.5%). Led by a new CEO who joined in June 2015, the company has steadily stabilized its business, and has sequentially improved organic growth in the last 6 quarters with the most recent 2 quarters in the positive organic growth range. At this point, we believe the company is in strong position to execute its strategic vision and deploy the nearly €200M of FCF in 2018 toward accretive M&A. Price target of $22 yielding 50% upside.

Company Overview (brief description of the business): NOMD is the #1 branded frozen player in 10 countries with 20%+ market share in frozen fish, frozen vegetables, and frozen poultry. The European frozen food market has grown at roughly a 1.5% CAGR the last ten years, benefitting from consumers’ desire for convenient, ready-to-eat meals. Going forward, we expect this level of growth to continue as much of the tectonic shifts that the US package food complex is experiencing (hard discounter growth, private label penetration, etc) have already reached a maturation point in many of the geographies NOMD has exposure to. Nomad does not have any big competitors, since the second, third and fourth players compete in different frozen categories (Dr. Oetker/pizza, Nestlé/Buitoni/pizza and McCain/potato).

Fact Pattern / Catalyst

• 6/1/2015: NOMD acquires Iqlo Foods from Permira Foods for €2.6Bn or 8.5x who themselves bought it in 2006 from Unilever for €1.8bn.

• 11/2/2015: Findus was acquired from a seller consortium: Highbridge, Lion Capital and Sankaty Advisors. Bill Ackman is on record that he believes Nomad paid ~5x Findus’ EBITDA pro forma for targeted synergies.

• 6/12/2017: NOMD announced the repurchasing of 9.8 million shares from Permira at a purchase price of $10.75 per share, or a 25% discount to market price (implied 6% accretive).

• 8/24/2017: NOMD raises low end of FY 2017 guidance from €315M-€325M to €320M-€325M on Q2’17 earnings call

• 9/7/2017: Pershing sells entire position of 33M shares, of which NOMD bought 7M shares for $14.16 and public received for $14.20.

Ø  2018: Potential acquisition announcement

Ø  2018: Potential Analyst Day

Investment Thesis:

1.    NOMD is effectively in the final innings of its 18 month turnaround and poised for stabilized growth with strong category trends.

In 2015, through the prior management of Iqlo, pursued a strategy of boosting product innovation in the ongoing effort of raising frozen food consumption and pushing a one-size-fits-all branding message across Europe with similar advertising and logo. In brief, the strategy was incredibly flawed based on faulty logic that Europeans who would consider consuming frozen food (about 27%) was far from those that already consumed a frozen product (11%). Compounding the issues was Nomad’s strategy of implementing a “boiler-plate” strategy for all strategies, which ignored local preferences (a common management anecdote are that peas are a large category in Sweden, Italy, and the UK, but are very unpopular in Germany or Southern European consumers eat a wider array of fish fingers vs UK consumers). With the company excluding the use of some of its flagship branding icons (“The Captain” for BirdsEye products) and a centralized sales force that was largely ignorant of how quickly local trends deteriorated, NOMD lost nearly 300bps of market share.

Since then, under a new CEO in Stefan Desheemaeker, the company has stabilized marketshare losses but effectively halted new product development with a greater focus on core brands with a more localized strategy. This is effectively in the DNA of Desheemaeker’s heritage at ABI where the beer giant clearly hones in on the cultural tastes and nuances of the audience it aims to sell to vis a vis M&A or white space opportunities. As a quick aside, Descheemaeker's has decades of experience at ABI as head of strategy, Zone President, which is clearly being leveraged. Below, we can see trends stabilize, and in some cases, organic growth finally demonstrating positive growth.

Historical Organic Sales Growth %

Organic Sales Growth by Country %

Furthermore, we believe the stock has been wrongly dismissed or effectively put in the bucket of packaged food/hard discounter exposure that has been plaguing packaged food players in the US. Outside the UK, which I will get to shortly, the advent of the hard discounter is not something new and has been around for decades! In short, many of those trends have hit a maturation point. See below POS category trends for consolidated Europe; data below highlights NOMD sales growth, and private label growth for frozen fish, frozen meals, frozen meats, and frozen veggies.

And for those a bit more concerned about the UK data – to date, the categories for frozen fish and frozen vegetables – have shown some stabilization between private label gains vs. the category – and with a recovery in NOMD.

Below is a snapshot of private label mix for 2016 by country amongst the four core categories – fish, veg, meals and poultry. On a blended basis, there is 45% PL share across NOMD’s footprint. In terms of the three year change, mix has been relatively unchanged across the geographic footprint in aggregate. By country, the UK and Ireland have seen the greatest PL share increase, Germany has been unchanged, and Portugal, Spain and France have seen PL share decline (off of a high base, as illustrated below).

2.    M&A opportunity is still ripe for consolidation

We could get in the details of the management team and Board in Martin Franklin and Stefan Deeshmaker, but will save those details as both are well known “deal” guys with extensive experience in European consolidation plays. According to management they believe incremental EV/EBITDA targets can be acquired at 6-9x since they are not buying the premium brands vs. where the company is today. Below is a list of players that directly compete Nomad in key categories. Pre-synergy, Nomad bought Findus for ~8.2x with post-synergy multiple <5x EBITDA.

Below is an illustrative list of competitors who have some overlap with NOMD. Although many are off the table, we believe the market is still ripe for NOMD to fill in the portfolio holes in its offering.

Based on NOMD’s €250M cash on hand (post the recent buyback), its ability to tap the capital markets, and the “clean” free cash flow generation into 2018, NOMD has ample dry powder for accretive future acquisitions. Given our work, we think there are logical acquisition targets that could “plug” the holes where NOMD. We note that a €300M acquisition, assuming a 9x EBITDA multiple and that the company funds the deal with €100M in cash and €200M debt, would be €0.15 or almost 20% accretive to EPS, before synergies. We view any tuck-in very positively as there is still latent capacity in which increased through-put would be highly highly synergistic as NOMD leverages its pan-European platform (meaningful procurement, supply chain, and sale forces synergies). Per packaged food M&A comps, we believe NOMD could generate synergies equal to 5%-10% of its target’s revenue base, in line with its Findus acquisition (expects to generate €43M-€48M of synergies by 2018 which equates to 7%-8% of Findus’ revenue), adding further upside to our analysis. At this point, the company has indicated that it will not raise indebtedness to buy back shares. Below assumes synergies equivalent of 6% of sales (conservative).

M&A in packaged food typically yields strong synergies – with nearly 7-8% of target sales as likely cost savings. Please see below M&A comp set:

3. NOMD margins have opportunity for upside as Street estimates give little credit for increased through-put

Legacy Iqlo EBITDA margins in 2014 were about 20% (ranging from 20%-22% from 2012 to 2014). The Findus acquisition was materially lower margins at (€71M / €619M) or 11.5% EBITDA margin pre-synergy. Layering on the €48M of cost savings (the high end of guidance), should yield 19% EBITDA without any additional leverage from through put since the acquisition. After consolidating and closure of the factor and pea processing operation in Bjuv, Sweden, we would argue that the street is conservatively modeling a 18% EBITDA margin and is set up well for upward revisions.   

Valuation:

Nomad offers the highest FCF yield in packaged food off 2017 and 2018 estimates, trading at a 9+% yield vs group at ~4%. Nomad also trades at a steep discount to US and Europe Food stocks at ~13x EPS (group >20x) and ~9x fwd EBITDA (group 11-14x). Further, the market is valuing Nomad on a somewhat depressed 2017 EBITDA  baseline, which still lacks full organic growth and flow through from Findus synergies. As mentioned above, packaged food in the US is experiencing what could be tectonic shifts from hard discounter penetration, “renewed” pressure from WMT, over-boxed grocery capacity, and now Amazon entering the market place vis-à-vis the WFM acquisition. Given NOMD’s exposure abroad, market leading positions in nearly every category across Europe, and the maturation of the industry its (having already gone through the private label expansion), NOMD can continue to block-and-tackle into moderate organic growth with optionality for M&A and de-levering its balance sheet.  

Base Price Target: $22.00 (50% upside)

• Based on 2018 EPS of €1.15 vs. street at €1.07 and based on 2018 EBITDA of €352 vs. street at $345

• Applying 10.9x 2018 EBITDA multiple, a slight premium to BGS and SJM, and a turn of multiple off NOMD’s current valuation.

• FCF for 2018, a clean number, will be about €1.29/share and should yield 6% (a discount to BGS) = PT of $21.60

• $300M acquisition = 15% accretion to EPS

Downside Case Price Target: $12.50 (-15% downside)

• Based on 7.9x 2018 EBITDA utilized 0% organic growth

• No acquisition

Upside Case Price Target: $25.00 (72% upside)

• Two acquisitions = 20% accretion  

**1x in EV/EBITDA multiple = $2.00 in equity value.

Earnings/Catalyst Driver Sensitivity:

• Which of our assumptions are the most sensitive and what is the EPS/EBITDA impact?

• 1% change in organic growth = $7M in EBITDA

• How do our assumptions compare to Street for each of these key assumptions?

• We are lapping easy comps for the next two quarters (-3.3% organic growth in Q3’16 and -2.7% in Q4’16)

• 2017 EBITDA is €325M vs. Street of €322 and 2018 EBITDA of €352M vs. €345M

• Better gross margins of 30bps and better EBITDA margin of 50bps in 2018

Management Compensation: Management team get compensated, rather handsomely, at $20 / shares. Although compensation is rather generous, we are comfortable that compensation is aligned with shareholder interests.

Appendix

NOMD still trades at a discount to extremely levered, negative organically growing BGS and SJM although the company is in stable categories and market-leading share outside US packaged food industry. The comparison is even more egregious to stumbling packaged food names like CPB, K, GIS, FLO and trades at a nominal premium to struggling THS.   

With 2018 EBITDA estimates coming down precipitously providing for a low hurdle…

Catalyst

• Potential Analyst Day annoucement
• Sell-side initiations
• Potential accretive aquisition