MGPI - MGP Ingredients: Niche Positioning Could Be Nice

2023-05-09 07:01:10 ET

Summary

• MGP Ingredients has proven to be a savvy value creator in the premium alcohol segment.
• The company is focused more on M&A these days as valuations look reasonable given its track record.
• I like the strategy, and while I have some question marks on the long-term margin potential, it is time to follow the company more structurally here.

MGP Ingredients ( MGPI ) is somewhat of a strange animal. Founded during the second world war to provide supply during the wartime period, the company has gone public in the 1980s.

Over the decades which followed shares have seen occasional swings, but in 2013 shares were trading around the $5 mark, the same level as late in the 1980s, creating a huge underperformance for long term investors. That changed as alcohol, but mostly premium spirits attracted attention from investors, sending shares to the $80s in 2017, with shares increasing a factor of 20 times in just a few years.

A pullback to the $20s followed early in 2020, party due to the pandemic, but partly because shares saw general weakness ahead of the Covid-19 outbreak as well. This was followed by a renewed rally to $125 last November, with shares now trading around the $100 mark.

About The Business

MGPI aims to provide superior financial results by participating in all levels of the alcohol, spirits and food ingredients segment, while creating value for all stakeholders involved.

For the year 2022 the company generated a reasonably large $782 million revenue number, with distilling solutions making up for just over half of revenues at $428 million, posting gross margins of 30% in the process. Activities include distilled spirits which go into bourbons, whiskeys, gins and vodkas.

The branded spirits business is responsible for $238 million in revenues, 30% of total sales, as its gross margins of 40% are superior. These activities are complemented by a $116 million ingredients solutions business, the smallest segment, with gross margins of 27% being the lowest among the three units as well. These activities focus on specialty wheat proteins and starches.

The company has steadily grown revenues from around $300 million to $400 million between 2014 and 2020 as operating margins improved from around 10% to 15% of sales. The company made a huge move with a $475 million deal for Luxco in 2021, which made that revenues jumped to $627 million that year. Growth continued in 2022 with sales advancing to $782 million as operating profits of $149 million approached the 20% mark.

In part due to the Luxco deal the company has seen 30% dilution over the past decade as the company actually reported adjusted earnings of $4.94 per share in 2022.

Picking Up Coverage

Early in May the company posted first quarter results with sales up 3% for the three months period to $201 million. That was the good news as gross profits were down 3% in dollar terms, with operating earnings down 17% to nearly $42 million. This triggered a 30 cent reduction in quarterly earnings to $1.39 per share.

The 22 million shares trade around the $100 mark, granting the company a $2.2 billion equity valuation, as this excludes $196 million in net debt, the vast majority of which is convertible. Net debt is no major concern with quarterly adjusted EBITDA trending at an annual rate roughly equal to net debt.

For the year the company sees sales up in a minor fashion to $815-$835 million, with EBITDA seen around $180 million, plus or minus a few million. Adjusted basis earnings per share are actually seen up a bit to $5.05-$5.20 per share, as such kind of earnings power might easily justify a valuation around the $100 mark.

After all, a 20 times earnings multiple, amidst reasonable debt, seems reasonable given the premium and niche positioning of the firm, although that margins have increased quite a bit already.

Days after the earnings report the company reached a deal to acquire Penelope Bourbon. Founded as recent as 2018, the company is an American whiskey company which is now acquired for $105 million in cash, although earn-outs through the end of 2025 have the potential to essentially double the purchase price.

Little additional information was provided other than that $5 million in costs synergies are seen with deal closing set to happen as of June, as I do not like the lack of disclosure on the revenues or profitability of the firm.

With an upfront deal tag of $105 million, the transaction is equal to about 5% of the enterprise valuation (pre-earn out), and will double net debt (upon achievement of the earn-outs), thereby not creating a leverage overhang.

What Now?

Before getting too upbeat on the specialty niche positioning of the business, investors have to realize that the shares and company are controlled by the Cray and Lux family, holding preferred shares to hold and control the business, while holding a big chunk of the common equity as well.

While the current valuation at less than 20 times forward earnings looks reasonable, given the specialty positioning, I am mindful of the big and cyclical share price performance in the past. There are many long term drivers behind the shares, and while margins look a bit rich on a historical basis, I generally like the underlying business performance over the past decade, having created a lot of value for investors.

Hence, I am placing shares on my watch list following the Penelope deal. I look forward to learning more on that deal and its contribution in the coming quarters, taking up coverage from there as I feel no urge to get involved here on the spot.

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