Description

A major wave is slowly washing  over America. It is the wave of health foods. It is a wave brought on by the Millennials, by the kids of today, leading the charge and leaving behind the seniors who brought them to the dance. They are looking for and purchasing food products that offer health benefits, which are considered functional foods and clean foods. They are living the life that Hippocrates esposed-“let food be your medicine and medicine your food”. This movement is forcing food companies to rethink product ingredients and reformulate old standards. Hydrogenated oils are disappearing, sugars reduced or replaced by stevia, xylitol and artificial colors eliminated.

One of the major areas this trend has appeared is in the soft drink area. Sales have stopped growing and flattened out. Coca Cola, Pepsi have taken notice and lessened sugars and changed ingredients as well as looked for new products. And it is much simpler and safer to buy it then try to build a new food line.

According to SPINS, a data service, catering to specialty, organic and functional beverages reports that this segment  has grown in past two years some 23% to over $40 billion. Volumes of carbonated soft drinks are expected to fall for the 12^th straight year. Recent news out of Washington seems to show a growing coalition to eliminate sugary snacks and sodas from varying government programs as WIC.  Of course some manufactures and supermarkets chains don’t approve (hint loss of sales).  San Francisco and Chicago’s Cook County have added taxes on sweetened beverages. And it seems to be taking a toll. Philadelphia Supermarkets and distributors say beverage sales have dropped 30 percent to 50 percent after the city instituted a 1.5-cent-per-ounce tax on sugary and diet drinks. Mexico also added a sugar tax which has reduced sales 5-10%.

With cities trying to limit or tax sugary drinks, beverage acquisitions have quickened. Last year we saw Dr Pepper Snapple buy Brai Brands for $1.7 billion with an estimated $230 million in sales. Not to be left behind, PepsiCo bought KeVita for $200 million on estimated revs of $60 million. The large beverage companies are seeking bolt on acquisitions which they can quickly scale up thru their bottling plants and extensive marketing and distribution networks.

Reeds is and old line specialty soda brand  started in 1989 that can be found in 40000 supermarkets, health food stores and other retailers. Outlets for products include CVS, Whole Foods, Kroger, Costco, Safeway, BJ’s among others. Probably best known for its award winning non-alcoholic microbrewed ginger ale using filtered sparkling water, it also sells Virgil’s root beer- a premium craft root beer that uses all-natural ingredients.. The most exciting new product is Kombucha, a fermented tea beverage promoted as  gluten-free, organic and  vegan.

 The Kombucha market is growing at 30% annually and Reeds is one of the top three producers. As a solid and well regarded probiotic, Kombucha is in the world of kimchi, yogurt and other fermented items, a market that should continue to grow quickly.

Thus we have some excellent industry trends in addition to well regarded products. Yet growth has been slow. The problem – execution.  Reed has periodically faced production problems. Demand has been there but factory issues have caused the miscues.

New leadership has been brought in with solid industry experience. In March 1915, Mark Beaton was named Chief Operating Officer after multi- year stints with Dr Pepper and Pepsico. Dan Miles was named Chief Financial officer, a 20 year veteran of Pepsico  and Miller Coors. They immediately studied manufacturing processes and brought important changes to eliminate production bottlenecks. Product was ordered but not delivered causing retailer disappointments. The demand was there but the product not available- they were out of stock. Reed  upgraded its main bottling plant in Los Angeles., expanding capacity  by over 300%. The plant is fully automated and should move costs down when fully operational.

Sales have expanded to an estimated $55 million for 2016 up from $46 million in the prior year. Early eps estimate is a small loss for 2016 compared to $0.31 loss in 2015 but with the plant expansion, we expect initially some disappointment in costs. Thereafter efficiencies should become evident and margins will expand. Additionally the company believes a restaurant soda fountain offering currently testing could provide incremental sales.

At this point of the year we feel a bit uncomfortable to project sales and earnings for the year in the light of past issues. But we feel strongly that Reeds offer a very attractive acquisition candidate for many food/beverage companies. Their strong and well recognized brands and wide spread distribution, offers an unusual launching pad to a major with widespread bottling plants and distribution. The heavy lifting-creating attractive brands and marketing to storefronts - have been done.

Recently  acquisitions have been completed at three times sales. With $60 million of sales and 14 million shares , debt of  $7 million and using a two times sales multiple, we arrive at a $9.00 per share value.   We believe we will see a takeover within the next  two years as food companies are pressured to find new products replacing  slowing sales.

Catalyst

1.Sugary sodas losing share

2.Majors looking for new product replacements

3.Governments pushing for a healthier diet