Whole Earth Brands
Q3 2020
By Manuel Maurício
November 19, 2020
If you’re new to Whole Earth Brands, you can read my first write-up HERE.
Whole Earth Brands posted its third quarter results earlier in the week. Not only that, but the company has also closed its first acquisition during the past week.
Mr. Market was clearly expecting better results and that’s why we’ve seen a big sell off.
Let’s look at the numbers:
While the sweeteners business was up by 2% from a year ago…
… the Licorice business was up 9.2%.
This was actually pretty good. My biggest fear was that this business could turn out to be a melting ice cube. So far so good.
The management has reduced the guidance for the full year to $270-$280, stating headwinds related to the COVID-19, especially due to the fact that the food-service business is still down. I’m seeing this happen in several other companies.
Then there was a big $8.7M non-cash cost related to a revaluation of inventory, which led to a $3.3 million loss for the quarter.
This is quite normal in companies that went public recently, especially through a SPAC. There are a lot of one-off costs for going public and for integration. If one does the proper adjustments, the net income would’ve been $6 million for the quarter. That would mean a net income for the whole year of $24 million. The current market cap is $300 Million, which is about 13x earnings.
Going forward, I believe that the company can make around $30 to $35 million per year on a steady state, before acquisitions. That puts it at 10x Free-Cash-Flow of 2021. Cheap. Many of these packaged food companies trade at north of 20x FCF.
Swerve Acquisition
Then there was the Swerve acquisition. Swerve is the leader in sweeteners used for baking in the US. As I’ve mentioned on my previous write-up, 50% of all the sugar in the world is used for baking. The company knows this and it’s aggressively going after that market.
The numbers on this acquisition didn’t get me all that excited. The total amount paid was $80 million dollars (32 in cash and 48 in debt). In 2020, Swerve will do $36 million in sales and approximately $5 million in EBITDA. This means that the multiple paid was 16x. Expensive as hell. The company says that, after synergies, it can squeeze out another $2,5 million in EBITDA so the multiple will look more like 9x. Also not that cheap, but better.
This is one way to look at it. Another way is that the company has invested $32 Million of its own cash to buy a cash flow of, at least, $2 million after tax, or a P/FCF of 16x. If it’s able to squeeze those extra $2.5 million, the multiple would fall to 8x.
Note that Swerve fits right in to Whole Earth’s capital light model. It doesn’t own its production facilities. It uses co-packers – other companies that actually do all the work for a toll fee. Swerve grew its revenue by 74% last year and it’s expected to grow by 15% this year. It’s unclear why the growth rate has diminished so much.
The way I see it is that Swerve is a very good fit for Whole Earth Brands. It’s the leader in baking sweeteners in the USA and it has still to penetrate the rest of the world.
The fact that we have limited information on the company, such as retail penetration, makes it look like the acquisition was a bit pricey, but at least it makes strategic sense and I would argue that inside the Whole Earth platform, it will grow even faster. What we don’t want to be seeing is acquisitions outside of the core business niche.
Thoughts and Conclusion
Apart from the revenue figures, I wasn’t particularly happy with this quarter’s results. But I wasn’t unhappy either. It was kind of meh. I understand that, given the recency of the company, there are non-recurring costs that make the financials look worst than they could be. I guess that’s what everyone’s seeing, hence the sell-off.
I’m not that happy that the company talks about growth without mentioning shareholder’s return either. For instance, the board authorized a $20 Million share buyback, but so far there were no shares repurchases.
Although the results were full of noise, especially because of the non-recurring charges, I still believe that this can turn out to be a success story in the short term and that potential isn’t baked in the current share price.
If the company is able to grow its revenue by 10% each year going forward – mostly through acquisitions – and it pays around 9x EBITDA for those acquisitions – we could be seeing it generate $1.3 in Free Cash Flow per share in 2025. At a 15x multiple, the share price would be around $19 which would represent an 18% annual rate of return.
I believe that this scenario is perfectly achievable, since the NET DEBT/EBITDA ratio would still be lower than 3x, and 15x FCF would be perfectly reasonable for such a company.
But this is the medium-term view. I’m not sure that I want to hold it for that long. At least not without some strong signs of good capital allocation. This is actually a shorter term play.
The company mentioned on its Earnings Call that, soon, there will be more analysts covering the stock. The way it works is that Irwin (Chairman) will be making Mergers & Acquisitions. And for that to happen he will have to use the Street (as in Wall Street) investment banks. They, of course, are rubbing their hands because they will earn their fees.
Now, Irwin can flex his muscle and say to any of those banks, OK, we’ll give you a deal, but first you need to cover our stock, and say good things about us. This isn’t fundamental analysis and has got nothing to do with the merits of the business, I know, but that’s how the financial world works.
One year from now, the financials will be much cleaner, which will lead the quants to buy it; the company will likely be added to the Russel 2000 by spring (I’m yet to confirm this information) which will lead the Indexes/ETF’s to buy it, and the stock will have more overall coverage.
To make a long story short, the reasons I bought it still stand. I believe that this can be a good short-term play and I will keep it in the Portfolio until it’s fairly valued. What would that look like? A 15x or 20x FCF multiple would make me reduce my position.
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