Description
Brief Company Overview
Vital Farms was founded in 2007 by Matt O'Hayer. He effectively invented the Pasture Raised egg market because he personally believed eggs from hens fed grass tasted better. He was good friends with John Mackey (the founder of Whole Foods), which is how O'Hayer got shelf space to start the business. Through savvy marketing and a genuinely good product, VITL was able to grow to their current network to ~22,000 stores (although Whole Foods was still ~23% of revenue in 2022).
VITL has kept a low SKU count over the years and currently only have 25 SKUs. While the vast majority of these are eggs (organic pasture raised, pasture raised, blue eggs, etc.) they tried horizontal expansion a few years ago and now generate a small amount of sales (~6% of revenue) in butter.
While Vital Farms has traditionally been almost exclusively focused on selling to end consumers through grocery stores, they have recently been focusing more on foodservice as well (currently a very small part of the business at 3% of revenue).
Egg Market
Eggs are a staple of the American diet with very stable consumption over time:
However, there are many different types of eggs marketed in the US. A Conventional Egg is laid by a hen living in a cage with virtually no room to move around and a cheap, nutritiously poor diet. Cage Free means the hens aren't in cages and instead roam "freely" in what's usually an overpacked coop / hen house (they don't go outside). Free Range means they have outdoor access for at least some part of the day but their food is usually provided in the overpacked coop / hen house. Pasture Raised means that the hens are allowed to roam freely on open pastures (but similar to the other categories there's no standardization on how much pasture they're given and what supplemental feed the bird is given). Given Pasture Raised hens are generally much healthier, the nutrition content of Pasture Raised eggs is materially higher than Conventional Eggs. After testing all the egg types in cooking, I can attest they all look and taste materially different.
Vital farms is the largest US brand of pasture raised eggs that sells a premium "ethically produced" pasture raised egg product. Similar to most CPG companies, they don't own farms themselves but instead source from a network of 300 family farms that they manage to ensure they comply with their marketed quality + ethics standards. They process these eggs at their Egg Central Station in Missouri and distribute to their network of ~22,000 retail stores (includes Kroger, Whole Foods, Sprouts, Albertsons, Walmart, Target, Publix, etc.).
In terms of 2022 retail sales the total egg market size is $9.4bn. Specialty Eggs (Cage Free, Free Range, and Pasture Raised) were $1.7bn of this number and Pasture Raised eggs were $428mm (VITL 2022 sales was $362mm). The egg market overall grew 10.5% CAGR over the past 4 years, specialty eggs grew 15% CAGR, and Pasture Raised had a 32% CAGR.
With the higher income population increasingly focused on eating healthier and increased education over time about the difference between all these different egg types, I think Pasture Raised eggs should continue taking share in the Egg market.
Major Debate
Bears point to VITL's lack of current profitability and claim that competition will prevent them from realizing their target of sustained double-digit EBITDA margins. In their minds VITL is a distributor of a commoditized product (eggs with a fancy name) and has no reason to earn margins above other peers such as CALM, TSN, and PPC (high-single digit EBITDA margins).
I believe that VITL has real brand value and should be able to expand margins + retain market share as Pasture Raised eggs category grows. It's interesting to note the history of competition in the industry as supporting evidence. As the category grew, a few years ago retailers that VITL sells to (including Whole Foods) introduced private label Pasture Raised egg products priced significantly cheaper than VITL. This caused some drop in market share over the 2015-2020 period with revenue growth coming more through distribution growth vs growth in sales at existing stores. Despite this competition though, VITL has continued to dominate the market with revenue market share of 85% in 2022 despite being priced at a huge premium to cheaper products. In my opinion, this is a great sign of brand value as VITL has cultivated a reputation for high quality eggs that you can trust. VITL's affluent consumers would rather pay a premium for Vital Farms eggs (which sit right next to identically labeled, cheaper eggs) instead of vetting if the cheaper offering is actually sourcing / selling the highest quality eggs possible. Online reviews (and personal tasting) of the taste difference between the offerings suggests that consumers are rational in their preference of Vital Farms eggs over cheaper offerings like Whole Foods brand.
I think VITL should be able to earn margins similar to dairy CPG companies (somewhat commoditized products but genuine brand value / taste differences). I look at Danone who has 10% operating margins in their "Essential Dairy & Plant Based'' business (sells mostly yogurt and plant-based milks under brands like Horizon, Oikos, Silk, etc.) and think that as VITL scales and increases utilization of their processing facility (currently ~50% utilized) they should be able to realize margins closer to Danone than the commoditized producers that bears point to.
Valuation
I sensitized VITL's fair value to their market share of the egg market and operating margins and come to an expected IRR of 10%-20% with fairly low risk (VITL has ~20% of their EV in cash).
Summary financials below
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
Continued margin expansion / sustained double digit margins over intermediate-term