Description

Brief Company Overview & Thesis: Simply Good Foods Company (NYSE: SMPL) is the current owner of the Atkins brand, the one loathed/cult diet that encouraged a high protein and low carbohydrate diet through snack bars, RTD shakes, and other snacking products for weight maintenance. We think SMPL is still in early days of repositioning this nationally recognized brand to one that addresses lifestyle than purely a weight management approach, thereby significantly expanding its addressable market. Recent momentum in scanner & panel data confirms the strategy is on target, and informs an above consensus outlook—including our street high top line forecasts through FY’19. Beyond this, the company has a very deep bench of former executives of large multi-national CPG companies (more on that below) – a rarity for a sub-$1bn market cap company - who are in a strong position to do a transformational deal. At first glance, the stock appears expensive at 16.5x ‘19E EBITDA, but with tremendous organic growth and bottom line growth (10%+), a clean balance sheet (1.2x net debt), and high free cash flow conversion (100%), yields a scarce high growth asset with tremendous capital allocation opportunity. Finally, there is optionality – and we use that term loosely as we think should be considered a forgone conclusion – that SMPL will engage in M&A. From this perspective, we believe that SMPL will most likely engage in an RMT to acquire other scalable assets in the packaged food space, which at current prices, would be quite accretive. Price target of $24+.    

Brief history. The genesis of SMPL was through the merger with Conyers Park Acquisition Corporation, a SPAC, which began trading in mid-2017. The deal was valued at $750M or 11.9x EBITDA. The company utilizes an asset light, co-manufacturing strategy, with a minimal amount of capex obligation – yielding in high free cash flow conversion. In addition, this is a perennial market share winner (now) with a strong inclination for M&A. In 2017, SMPL acquired Canadian company Wellness Foods, which sells Simply Protein branded protein bars, chips, and other crunchy snacks. By channel, SMPL predominantly sells to Wal-mart (42% of sales), grocery (37%) with an under-penetrated club and convenience channels as an opportunity for on-the-go nutrition.

Fact Pattern / Events / Catalyst Path

2/6/18: Announced additional offering of $112.75M @ $12.75

Insider buys:

·         Todd Cunfer (CFO) – Bought 10K shares @ $13.19 (4/23/18)

·         Clayton Daley (Director) – Bought 7.5K shares @ 12.40

·         Arvind Kash (Director) – Bought 15K shares @ 12.40

·         James Healy (Director) – Bought 4K shares @ 12.40

·         Hanno Holm (VP & COO) – Bought 4K shares @ $12.77

·         Bomi Ghez (Director) – Bough 20.3K shares @ $12.4

Significant upside to top-line growth vs. consensus & expectations

On 1/3/18, the company announced that Rob Lowe had become the new Atkins brand ambassador – a shift to a more lifestyle-driven spokesperson rather than a campaign targeted mainly to program dieters. Management’s previous guidance for FY’18 marketing spend growth had been “in line with sales growth”, and was raised to 7% y/y after the company’s intra-quarter decision to increase its marketing investment following better-than-expected initial consumer receptiveness. We can see this already paying off in scanner data. Interestingly, even as total distribution points held constant growth (a measure for breadth of distribution), velocities have improved markedly (effectively sales per distribution point). That’s a healthy sign.

What’s also encouraging is that as the nutritional and health bar growth cadence has moderated since its explosive growth in the past decade, SMPL has experienced wildly successful channel growth, vastly outpacing the category since last year.

Now, it’s obvious to anyone who has ever been in the snacking aisle of a grocery store that there’s hundreds of options, most of which are owned by large CPG. That being said, deep pockets do not and have not dictated success. In fact, General Mills (LaraBar, Fiber One, Nature Valley), Kellogg (Kellog meal bars, Kashi, Bear Baked, RXBar), POST (Powerbar) and Pepsi (Gatorbar) have actually been market share donors (exception is K’s RXBar recently) to the likes of KIND and Clif Bars. Taking a look per below, we can see the likes of Kellogg losing nearly 800bps of market share (recently stymied by their RXBar acquisition) and GIS losing nearly 300bps.   

In addition, SMPL has a few incremental avenues for growth including:

·         Channel Expansion: given the success of their flagship Atkins product, we envision that SMPL will be able to gain incremental shelf space during the upcoming shelf reset (September / October) – most likely in the grocery channel (35% of sales). In addition, SMPL is very underpenetrated in the drug channel – something we believe will be more of a focus given that this product fits nicely in the overpriced nutritional section of a CVS. Finally, and although a smaller opportunity, the company could pursue distribution gains among convenience store chains (which is a channel that is still growing) for single-serve/on the go nutrition. Again, this would be purely incremental and not reflected in numbers.

·         New Products and Existing Product expansions: Atkins is introducing a wafer form of its brand this fall in addition to re-launching their Simply Protein product in calendar 4Q. These initiatives have the potential to sustain momentum well into 2019. With consensus already modeling the apex of growth during the Q3’18 quarter of 11%, there is material upside on a go-forward basis which can be built on the existing momentum base.

M&A opportunity is very compelling and is a stated strategy

The opportunity to roll up a fragmented snacking space further provides for compelling upside optionality. From a platform perspective, Atkins is a branded asset that lends itself for bolt-on consolidation or transformative acquisition. On smaller deals, management believes it can scale emerging brands swiftly by leveraging its retailer relationships and brand building, leaning on years of being in said channels in addition to a management team fluent in such negotiations. In addition, SMPL is in strong position to utilize a nimble structure via its contracted manufacturing capabilities to ensure speed to market.

Further, a healthy gross margin profile and an asset light model (annual capital expenditures of ~$1 million; working capital needs 10%-11% of net sales) yields solid cash generation — thereby allowing the company to de lever quickly and preserve optionality (1.5x net debt / EBITDA). On larger deals, the company’s size today seemingly makes SMPL a good fit for a Reverse Morris Trust transaction—which has become more of a possibility in this environment, as worsening fundamentals and eroding multiples packaged food has incentivized these behemoths to divest non-core assets. Which leads us to our next point…

SMPL benefits from a Large Cap Management Team in a Small Cap Company

The Board of Directors is led by Chairman Jim Kilts and Vice Chairman David West, who bring a combined ~70 years of industry experience across a diverse basket of iconic consumer brands—including Gillette, Nabisco, Kraft, Oscar Meyer, Kibbles ‘n Bits, and Hershey, among others.

The bench of executives is very deep – and is much bigger than managing $450M of sales. See below:

Jim Kilts. Chairman of Simply Good Foods. Founded Centerview Capital in 2006. Vice Chairman of P&G, Former Chairman, CEO and President of The Gillette Company. Former CEO and President of Nabisco. Former Head of Kraft Foods and General Foods  (Worldwide Food Group and Philip Morris).

Dave West. Executive Vice Chairman of Simply Good Foods. Former CEO and President of Big Heart Pet Brands. Former CEO and President of The Hershey Company. Previous senior positions at Nabisco and Kraft Foods.

Joe Scalzo, CEO and President of Atkins. Formerly President & COO at DeanFoods; executive positions at Gillette and various roles at The Coca Cola Company.

Brian Ratzan. Director of Simply Good Foods. Previously was Head of U.S. Private Equity at Pamplona Capital Management and Head of the Consumer Group at Vestar Capital

Outside these main players, the Board and management team is decorated with individuals with very senior level positions at P&G (Daley), Goldman Sachs (Ghez), Nabisco (Healy), Nielsen/Cambridge (Kash), and Nestle/Roche (Laube – who was CEO of large divisions in both).

I’ll save everyone the merger math – but with a clean balance sheet, there’s plenty of optionality for bolt-on acquisitions. Management has said it is comfortable levering up to 4.0x-4.5x EBITDA, so more than $300M of dry powder off an un-synergized cash flow number. Assuming some synergy/cross selling opportunity in addition to an equity raise, clearly the company can do something even more impactful and “worthy” of the deep bench SMPL already has. It has already been well telegraphed that SMPL was in discussions to purchase a complementary asset with annual revenue in the range of $150 million to $200 million. From this, we infer that SMPL is trying to avoid growing a nascent brand but is trying to nurture a brand already with some critical mass or proof of concept, something we believe is the correct strategy given the competitive backdrop in snacking/health nutrition.

What we find even more compelling and wildly accretive is the potential for a much larger transaction via the Reverse Morris Trust structure. In utilizing said structure, there are assets that could become available in the company’s categories that would allow Simply Good Foods to acquire brands that compete in its current categories while leveraging an advantaged deal structure (tax efficiency for the seller). Given its size, the company is well positioned to take advantage of what we believe could be fertile ground in packaged food, where divestments have been one of the core themes for packaged food players.

A key asset that we think makes sense is POST’s Active Nutrition segment, which markets and distributes RTD beverages, bars, powders and other nutritional supplements under the Premier Protein, Dymatize, PowerBar, Supreme Protein and Joint Juice brands. Similar to SMPL, Active Nutrition products are primarily manufactured under co-manufacturing agreements at various third party facilities located in the United States and Europe. Now, it’s unclear if POST is entirely motivated to sell this asset, but given that POST CEO Rob Vitale is a perennial capital allocator via M&A, buyback, etc – we could see him follow suit to divest this asset as they are quite “in-the-money” after the massive growth of their Premier Protein brand. Note that Rob & team at POST most likely took a look at the Atkins asset when it was private, but were likely sidelined during the Avian Influenza debacle at their Michael Foods brand. Also, note that POST recently announced the divestiture of their private brands asset – so they are no tethered to any particular asset that is non-core.

For illustrative purposes, see below RMT analysis for Active Nutrition. From the high level math, utilizing a 14x EBITDA multiple, 40% debt financed, and 60% equity, the accretion math is very attractive.

Valuation

Given recent trends, there is a beat-and-raise upside potential – yet, putting short term trends aside, we still believe current valuation still trails CPG-growth peers. Currently, the company fundamentals are trailing above their 4-6% sales growth, HSD EBITDA growth -- and although we would be remiss to assume that management will change this algo -- we believe that upside revisions to sell-side plus a re-rate in multiple from continued higher growth cadence will yield material upside.

Note that SMPL has a clean balance sheet with high FCF conversion (over 100%) given its asset light model, so rolling forward off 2019 EBITDA numbers implies very little leverage. Applying a 18x multiple on 2019 EBITDA, which is a shade lower than where it trades today, is ~$23 or about 25% higher from today’s prices. Although this is not scientific, building top line growth algorithm through distribution and velocity metrics, in addition to making assumptions over gross margin AND selling/marketing (note that marketing spend is elevated during the Rob Lowe campaign), we derive P&L and implied base/bull/bear below. This fundamental momentum in addition to a large cap management team honed in on creating scale through acquisitions, provides for substantial upside.

Catalyst

Potential RMT with large target in packaged food / snacking category

Bolt-on acquisition in snacking category

Fundamental momentum continuing above consensus / buy-side estimates