Description
I think Simply Good Foods Company (SMPL) is an attractive long investment at its current valuation. SMPL is a good business (underlying growth, asset light, FCF generative) that has been pressured over the last several months due to covid-19 and should benefit from a return to more normal consumer mobility/behavior over the next 12 months. In addition, I think SMPL should benefit from favorable category shelf reset dynamics - i.e. its Atkins and Quest brands increasing share with retailers while smaller, emerging brands have likely lost space as retailers are focusing on their highest turning products. Smash432 posted SMPL on VIC in September 2018 and provided some good background on the business, industry and management.
Background
This has been a challenging year for SMPL. The company and its recent Quest acquisition (completed November 2019) have been pressured due to covid-19 which has led to reduced consumer mobility and on-the-go activity. SMPL’s pro forma business is 60% bars, 22% shakes, 10% snacks and 8% confectionary so it’s not surprising to see the business pressured as consumers are on the go less (gym, work, etc.). Legacy Atkins was -8% y/y in 2H20 vs +12% in 1H20. In addition, Quest’s specialty channel was a massive drag this year (~20% of Quest and down ~50% y/y). I think these headwinds are reflected in SMPL’s performance YTD: -16% relative to consumer staples +7% and packaged food +2%. Trends will likely remain subdued and volatile for the next few months/over winter but I think the market will begin to discount a return to normal over the next year. Trends have improved from the Mar/Apr lows but have plateaued in recent months (graph below).
Business
SMPL is arguably executing as well as can be given the environment. The Quest acquisition is largely complete despite covid disruptions and management has reaffirmed its expectation to realize $10 mm in net cost synergies this year and $10 mm in FY22. I also expect recent shelf resets to be a positive for the company. It sounds like retailers are refocusing their shelves on the larger brands with higher turning SKUs. This should benefit Atkins and Quest over the next six months at the expense of smaller, emerging brands that have proliferated in the past couple of years. In part due to covid/on the go pressures, SMPL has shifted much of its recent innovation to snacks/confection (chips, cookies, etc.). These products are doing well and resonating with consumers demonstrating the company’s ability to innovate and leverage its brand equity. There is also an opportunity to drive further Quest growth through product development and distribution. Management estimates that Atkins has 40 items on average in food, drug and mass (FDM) while Queust has 20 items (~15 a year ago).
Valuation
SMPL is an attractive business supported by long term health and wellness trends. The company’s long term algorithm calls for +4-6% revenue growth, EBITDA growth slightly ahead of revenue growth and strong free cash flow (capex is under 1% of revenue due to its outsourced manufacturing model). SMPL’s gross margins are ~40% and EBITDA margins are ~19%. There is clearly uncertainty in the near term given covid but I think SMPL’s long term business drivers remain intact. In addition, the company’s near term guidance (1H21) and consensus estimates appear conservative/reasonable. The guide assumes a continuation of 4Q20 trends (i.e. not embedding an on the go recovery). Ex. Quest, that implies legacy Atkins continues trending -MSD through 1H21. On capital allocation, SMPL’s net leverage is now 3.3x and mgmt expects to end FY21 well below 3x net. This provides flexibility though I’m not expecting anything near term. Management is comfortable levering up to 4-4.5x for the right acquisition. I think SMPL could be worth high $20s in the next 12 months driven by upside to estimates, modest multiple expansion and its FCF generation/deleveraging. The stock has performed well over the last week due to vaccine news but I think SMPL should continue to benefit from a building focus on reopening related investments.
Risks
Further material lockdowns due to covid - this could pressure fundamentals and the multiple.
Poor innovation that distracts or dilutes the Atkins and Quest brands.
M&A - Quest is a good fit but levering up for the wrong deal is a risk.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
Earnings, Nielsen data, shelf reset performance.