RBC - The Middleby Corporation Offers Some Upside Despite Some Bottom Line Weakness

Summary

• The Middleby Corporation has a history of rapid growth, both on its topline and on its bottom line.
• Topline growth continued through 2022, but the firm's bottom line has taken a hit.
• The stock isn't exactly the cheapest, but the firm's rapid growth justifies some upside from here.

There are very few things that every person on this planet has in common. One of them though is the necessity of food in order to survive. But not all food is ready to eat. Throughout human history, individuals and companies have produced a wide array of equipment that aid in food preparation. The explosion in the restaurant industry and the push for the mass production of food have led to even more complicated and valuable pieces of equipment over time. And one firm that has dedicated itself to the production and sale of this equipment is The Middleby Corporation ( MIDD ). Over the past few years, driven by both acquisitions and organic growth, this particular firm has done incredibly well to grow on both its top and bottom lines. Shares are not exactly the cheapest on the market. But when you add in the track record the company has achieved over the years, it may be worth a slight premium over what I would normally prefer. Because of this, I've decided to rate the business a soft 'buy' at this time, a rating that reflects my belief that shares should likely outperform the broader market moving forward.

A niche player with robust growth

According to the management team at Middleby, the company focuses on the production and sale of food service equipment that's used in all types of commercial restaurants and institutional kitchens. It also focuses on equipment centered around food preparation, cooking, baking, chilling, and packaging activities for food processors. And it produces premium kitchen equipment like ranges, ovens, refrigerators, ventilation, dishwashers, and outdoor cooking equipment, all used primarily by the residential market.

To best understand the company, we should dig into each of its operating segments. The first of these is the Commercial Foodservice Equipment Group. As its name suggests, this unit is dedicated to the sale of food service equipment to the commercial space. Examples of end users include quick-service restaurants, full-service restaurants, ghost kitchens, convenience stores, supermarkets, retail outlets, hotels, and more. All combined, the company's equipment is marketed under a portfolio of 68 different brands. Examples include Toastmaster, TurboChef, Ink Kegs, Britannia, Thor, and more. Specific products sold include, but are not limited to, conveyor ovens, convection ovens, baking ovens, hydrovection ovens, ranges, fryers, steam cooking equipment, charcoal grills, professional mixers, fry dispensers, soft serve ice cream equipment, home and professional craft brewing equipment, and more. It also provides certain IoT (Internet of Things) solutions that are integrated into its offerings. Using data from the company's 2021 fiscal year, this segment accounted for 62.5% of sales and 65.9% of profits.

Next in line, we have the Food Processing Equipment Group. Through this segment, the company offers a large portfolio of processing solutions, such as those dedicated to the production of protein products like bacon, salami, hot dogs, dinner sausages, bakery products, and more. Solutions include, but are not limited to, those centered around thermal processing, slicing, packaging, and more. Based on data from 2021, this segment accounts for roughly 14.8% of revenue and 14.7% of profits. And finally, we have the Residential Kitchen Equipment Group. Through this, the company produces and sells kitchen equipment for the residential market. Ranges, cookers, stoves, cooktops, microwaves, ovens, refrigerators, dishwashers, and more, are all included under this segment. This particular unit is responsible for roughly 22.7% of the company's revenue and for 19.4% of its profits.

It may be tempting to view this kind of company as a slow-growth prospect. However, that would be a mistake. Between 2017 and 2021, sales of the company shot up from $2.34 billion to $3.25 billion. This is in spite of the fact that sales plummeted from $2.97 billion in 2019 to $2.51 billion in 2020. From 2020 to 2021, the 29.3% surge in revenue that the company experienced was driven by a combination of factors. Multiple acquisitions that the company made accounted for 5% of the sales increase, or roughly $124.8 million. $39.5 million of the sales increase the company reported came from foreign currency translation. Organic revenue, meanwhile, was an impressive 23.7%. Leading the way was a 28.2% surge in the Commercial Foodservice Equipment Group, with revenue spiking in response to the global economy reopening. The Residential Kitchen Equipment Group reported an almost equally impressive 23.2% rise in revenue, while the Food Processing Equipment Group saw an increase of only 9.1%.

On the bottom line, results for the company have largely mirrored what we saw on the topline. Between 2017 and 2019, net income rose consistently, climbing from $298.1 million to $352.2 million. In 2020, profits fell to $207.3 million before spiking to $488.5 million in 2021. Operating cash flow followed a similar trajectory. The only difference is that it peaked in 2020 at $524.8 million. In 2021, it dropped to $423.4 million. If we adjust for changes in working capital, however, it looks much more similar to what we see when looking at net income. In this case, the metric hit an all-time high of $619 million in 2021. The exact same scenario also played out when it came to EBITDA. After falling from $638.2 million in 2019 to $483.9 million in 2020, it rose nicely to $712.6 million in 2021.

The company's strength continued throughout the 2022 fiscal year. For the nine months for which data has been reported , sales totaled $3 billion. That's up significantly from the $2.38 billion reported one year earlier. Of the 25.9% surge in revenue during this time, acquisitions the company made accounted for 15.2%, or $362.6 million. Organic growth, led by a 15.3% rise from the Commercial Foodservice Equipment, totaled 13.1% if we ignore foreign currency fluctuations. Interestingly, revenue would have been higher if we ignore the impact associated with foreign currency. During that nine-month window, this impacted sales negatively to the tune of $58 million.

Unfortunately, bottom line results for the firm were not as impressive. Net income actually fell year over year, dropping from $385.8 million to $303.4 million. Acquisition-oriented inventory step-up charges totaling $17.3 million negatively impacted the company's gross profit margin. It also suffered from rising costs of raw materials and other inputs, as well as higher labor rates and logistics costs. Other profitability metrics unfortunately followed the same path. Operating cash flow was slashed from $346 million to $173.4 million. If we adjust for changes in working capital, the picture is a bit better, with a metric falling from $457.3 million to $405.9 million. The only metric that improved year over year was EBITDA. Based on the data provided, it rose from $519.6 million to $619.9 million.

Management has not really provided any guidance for the 2022 fiscal year in its entirety. If we annualized results experienced so far for the year, we would get net income of $384.2 million, adjusted operating cash flow of $549.4 million, and EBITDA of $850.2 million. Based on these figures, the company should be trading at a price-to-earnings multiple of 21.4. The price to adjusted operating cash flow multiple would be 15, while the EV to EBITDA multiple would come in at 12.7. By comparison, if we use data from 2021, these multiples would be 16.9, 13.3, and 15.2, respectively. My analysis also included a comparison to five similar firms. Are they price to earnings basis, these companies ranged from a low of 16.6 to a high of 76.6. Two of the five companies were cheaper than Middleby. Using the price to operating cash flow approach, the range was from 15 to 32.7. In this scenario, our prospect was tied as being the cheapest of the group. And finally, using the EV to EBITDA approach, the range was from 9.9 to 28.7. In this case, only one of the five firms was cheaper than our target.

Takeaway

Based on its business model, you wouldn't think that Middleby is much of a growth machine. But you would be wrong. The company has exhibited attractive growth over the past several years if we ignore the COVID-19 pandemic. Some of this has been driven by acquisitions, but not all. And what's really exciting is that the company continues to make purchases in order to grow. In fact, from November of last year through January of this year, the company made three additional strategic purchases , each one adding to its sales and, likely, to its profits. Shares are not the cheapest by any means, but they aren't pricey either. When you add on top of this the track record the company has demonstrated, I do think it warrants a 'buy' rating at this time.

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