TTCF - Tattooed Chef: One More Hurdle To Entry Point Wait For The Greenlight

Summary

• TTCF has performed awfully for the last year, with its shares plummeting by about 85%.
• The company has entered into agreements with Walmart and Desert Premium Group to turn things around.
• Despite the promising agreements to turn things around, the company has to address its cash burnout to become profitable.

Investment Thesis

Tattooed Chef, Inc. ( TTCF ) has performed awfully for the last year. Its stock price has plunged by almost 85%, and its cash flow and profitability are also terrible. To add insult to injury, the number of shares outstanding has increased by 2% over the past year, diluting the holdings of existing shareholders.

The company's revenue has increased by 18.76% year over year and by 63.84% on a 3-year compound annual growth rate basis, but its profit margins are extremely low, and its cash flows have been consistently negative. This poor showing, in my opinion, is due to the company's rising cash burn in the midst of a challenging economic climate.

The company entered into a distribution partnership with Walmart and Desert Premium group in August last year to turn things around and become profitable. In the company's estimation, the acquisition would pay off this year. Since January, its stock has outperformed the market by about 8% with a 16% gain. Despite the fact that this could be attributable to expanded distribution, I believe the company has a long way to go in resolving its underlying challenges to sustain such robust growth.

Expanding Distribution Nationwide

Tattooed Chef, Inc. and Walmart, Inc. signed a new agreement in August that would make more Tattooed Chef-branded products available at Walmart stores across the United States. At the same time it announced the signing of the new lease agreement, the company also announced signing an asset purchase agreement with Desert Premium Group, which would strengthen its vertically integrated operating model.

In accordance with the terms of the deal with Walmart, Tattooed Chef will raise the number of SKUs available under the brand's frozen banner from five to thirteen, with distribution increasing from an average of three hundred Walmart stores to an average of two thousand.

Tattooed Chef also signed a definitive agreement and simultaneous closing to acquire certain assets from Desert Premium Group for approximately $10 million and a lease agreement for an 80,000-square-foot manufacturing facility in Albuquerque, New Mexico, where the acquired assets operate. The assets owned by the Desert Premium Group include packaging and production machinery, while the leased building significantly increases the company's manufacturing space through extensive ambient and cold storage.

Due to the plant's location in close proximity to Tattooed Chef's Foods of New Mexico, the company will be able to centralize its distribution operations and reap the benefits of increased scale. The purchase and lease agreements went into effect on August 19, 2022. Through the end of 2022, the new facility's activities were expected to have no impact on cash flow, and by the beginning of 2023, they were expected to have an accretive effect on earnings.

The Implication Of This Move

In summary, the company is scaling up production and increasing distribution simultaneously, which is a good move. To go by the figures above, the company seeks to expand its SKUs by a factor of 2.6X from five to thirteen and increase its Walmart stores by 6.6X from 300 to 2000. This implies that its supply to the market has increased, which would translate to increased sales.

In light of this finding, the logical next issue is whether doubling or multiplying revenues by six would be enough to turn the company's fortunes around and make it profitable. In the next section, I'll provide my thoughts about this issue.

Is Increasing Sales the Remedy to Drooping Profits?

While a rise in sales is a possible indicator of future profitability, it is not sufficient to conclude the company's prospects based on this metric. Since profits are directly proportional to the ratio of sales to costs, tracking the dynamics of these two variables is essential.

To give my verdict on this fundamental concern, I draw readers' attention to the company's Q3 2022 results and evaluate how these variables interplayed.

• Cost Of Goods Sold

The cost of goods sold for the three months ending September 30, 2022, was $58.0 million, up from $53.0 million in the corresponding period in 2021. This represented an increase of $5.0 million, or 9.4 percent. The cost of goods sold as a share of sales went up from 91.4% to 107.2% in the three months ending September 30, 2022, compared to the three months ending September 30, 2021. The main reason the cost of goods sold went up is that inflationary pressures haven't stopped, so labor and freight now make up 34.1% of net revenue, up from 24.9% in the same period last year.

• Operating expenses

Operating costs went up by $18.8 million, or 146.8%, from $12.8 million for the same time period in 2021 to $31.6 million for the three months ending September 30, 2022. The main reasons for the increase are a $7 million increase in stock-based compensation, a $4.6 million increase in marketing and advertising costs, a $2.5 million increase in outside services costs, a $2 million increase in payroll-related prices, and a $0.7 million increase in facility costs.

• Gross (Loss) Profit

For the three months ending September 30, 2022, gross (loss) profit was $(3.9) million, a decline of $8.9 million (178.6%) from the $5.0 million reported for the three months ending September 30, 2021. During the three months ending September 30, 2022, the gross margin was (7.2)%, down from 8.6% in the corresponding period in 2021. Two million dollars more spent on salaries and benefits, and another half a million on rent and utilities.

My Verdict

Although expanding sales is likely the company's goal in light of the agreements I've discussed, I am skeptical about its viability given its mounting cash outflow, particularly regarding its cost of goods sold, which directly affects revenue. Profits will stay low, and the firm will continue to have negative cash flows unless better cost control is implemented.

In conclusion, I argue that increased sales alone won't save this firm. With growing output and distribution, management must also introduce strategies to reduce costs. It's important to recognize the optimism in the acquisitions while waiting to see how management handles the growing cash burnout. Because of this, I am holding off on deciding on the company's rating until I see how management addresses the cost concerns. In light of the firm's intriguing acquisitions, I believe this will be a good investment once the company manages to limit its cash outflow.

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