2023-07-20 08:02:18 ET
Summary
- I discuss Swedish candy company Cloetta, noting its above-average margins and profitability despite challenges such as sugar taxes and input inflation.
- Despite a decline in sales during the COVID-19 pandemic, Cloetta has seen a reversal in trends, with a 22.4% increase in the last quarter alone and a 15% YoY growth in organic sales.
- I upgrade Cloetta stock to a "BUY" rating, citing an attractive dividend yield of over 5%, solid fundamentals, low debt, and favourable future growth rates based on increased pricing and reversals.
Dear readers/followers,
Some of you may recall a small company and an article I wrote years ago on a company called Cloetta ( CLOEF ). Cloetta is a Swedish candy company, though its products are sold across Scandinavia. Cloetta is actually a pretty popular company with Swedish investors, despite its relatively limited size from an international perspective.
I haven't updated on this business for several years - but I figured now might be a good time to offer an update on it - because candy is obviously a not-uninteresting investment, at least not at the right valuation.
And the right valuation may not be far off, given that my last article on the company, Cloetta has declined double digits and over 20%.
Let's see what's caused this, and what the company may do going forward.
Cloetta - potential upside in Candy
Candy isn't the easiest investment these days, all things considered. Between sweeteners and crusades against sugar, local sugar taxes (such as the one in Norway), and other considerations, it's not at all difficult to see why companies like Cloetta have seen some declines in their valuation.
Cloetta trades under the CLA-B ticker natively in Sweden. It's a good candy company - what do I mean by that?
I mean that in terms of margins and profitability, Cloetta is at the very least above average. It manages a 32.17% Gross margin, and close to double-digit operating margins. Due to input, transportation and staff cost inflation, the company's margins have been declining over the past few years though. The company runs a high COGS of just south of 70% and OpEx of below 25%. The problem, as I see it, is not high OpEx, but high cost of goods, and there isn't much that the company can do in terms of streamlining here, because most of it is input inflation.
Cloetta is primarily a packaged candy company - over 75% of the sales mix goes to various forms of packaged or bagged candy. There is also the Pick & Mix category - which many of you outside of Sweden may not be familiar with, but it essentially means open containers in the stores where people can mix their own candy. Hardly sanitary, which is also why most of that was shut down during the pandemic.
But, the segment as of FY22, is around 25%.
The company had issues during COVID-19, which were expected, but trends have gradually been improving. Pick & Mix has been reversing, with a 22.4% reversal in the last quarter alone. The appeal of the pick & mix segment is that this candy has substantially higher margins compared to packaged candy.
For the 2Q23 period, which we saw reported less than a week ago, we saw net sales of 2B SEK, with a solid organic sales growth in branded packaged as well, of almost 15% YoY.
The company's growth in top-line sales was a result not of volume but of pricing.
And as you can see, and obviously, this is done to offset inflationary impacts.
I believe it is valuable to illustrate just how bad the Pick & Mix decline was during COVID-19 to show you at least part of the reason why the company was in the "doldrums" for a while. 25% of company sales essentially went away for over a year, or at the very least saw substantial overall impact.
In fact, the company saw lower overall sales volume during the 2022-2023 period but is making up for this and more due to increased pricing and favorable FX, with the SEK being as weak as it currently is.
The "killer" according to the company's own numbers, is the SG&A and other costs, which are increasing in addition to unfavorable FX. This comes from primarily salary increases, which I view as staying high for several years going forward to stay ahead or at least catch up to the overall inflation levels, and this will certainly impact profitability.
I haven't yet invested in Cloetta. But I'm going to tell you here why I'm upgrading my rating to a "BUY" and why I may go into the company here fairly soon. Cloetta's dividend is now attractive. At a 1 SEK annual dividend, the company's current valuation dictates a yield of over 5% for a consumer durables business. It's not large - by dollar standards, it has a $500M market cap. But fundamentals are solid, debt is low at 30.5% long-term to cap, and future growth rates based on increased pricing and reversals are overall favorable.
On a high level, the company is currently trying to decrease and streamline its # SKUs and displays. We're down from almost 3,500 back in -21, to less than 2,500 in 2024E. That's a 17.5% baseline reduction in active items. The company is trying to increase the number of "Mixed bags" and other product rationalizations and innovations that make sense. The same development is true in Pick & Mix, where the company has reduced the number of active items even further.
Consider it in the following way. When the company's input costs decline, we'll see a significant profit increase in the company. The lower number of items and higher profitability, once these trends turn around, will mean better margins and bottom line.
The company has also been increasing its online exposure. I am personally doubtful of the survivability of such companies and services in what I see to be a non-ZIRP market. I question the profitability and necessity of services like Foodora and Uber Eats - but perhaps I am in the minority of not minding walking a few minutes (or more) to get my food or candy, or what I am buying. Clearly, there still is a market for this, and the company is using it.
The company is building on its CandyKing brand, and aside from this, new plans and moves forward are being realized with regard to the greenfield project, which will go a long way in improving the company's cost basis even further. This also goes to explain why FX is such a heavy impact - because much of the production is outside of Sweden, with even more of the production planned to be outside of the country going forward.
Going forward, I would keep an eye in particular on input prices. Stabilization has occurred to some degree - now we want to see if these can go lower. There is also energy pricing, and as this goes down, more profit should be possible. The company itself has guided to some positive effects on a forward basis, but at the same time, it's important to remember that a trio of impacts for Cloetta is relevant - namely energy, input pricing as well as FX. Because the company buys most of its raw materials in EUR/USD, FX is a significant impact, and the recent trends have been negative.
For now, the expectation is for further lowering or stabilization to occur at the onset of 2024E.
One question I had was regarding further price hikes, which I do not believe the company can afford - but Cloetta was very clear in that further price hikes are not to be expected due to the current prices, but if they're necessary, they'll of course hike prices further.
Overall, those are the things I would look at during quarterlies - and my valuation thesis for the company is as follows.
Cloetta Valuation - Favorable, with a good upside
I'm shifting my stance on Cloetta as of this article, and am now considering the company to be a "BUY". This is because I view the company as fairly valued or attractive at or below 15x P/E, and the company's current valuation implies an average weighted P/E of 11.92x., despite a forecasted growth rate in the double digits for 2023-2024 when prices for energy and raw materials normalize. This also includes company streamlining.
I believe the market is underestimating the potential at the upside for Cloetta as these trends start materializing, and that 15x P/E is the low case/bearish case for what we could expect from the company.
As you can see above, this implies a 24%+ annualized RoR at a forward P/E of 15x and a yield of above 5% that at this level and EPS, is very well-covered. The drawback is that this yield/dividend of 1 SEK has not been changed for a very long time - nor do I view it as likely as changing going forward. Because of the low chance of dividend growth, I've always wanted a combined upside of both capital appreciation and growth in a company like this. And we finally have this here.
S&P Global analysts forecast Cloetta to a PT of 24 SEK per share. But because this is based on a single analyst following the company, I wouldn't give this estimate all that much credence or conviction. It's too little data to work with.
Instead, consider that while the forecast accuracy might be somewhat low, the upside at this valuation is to me rather "natural". Inflation is going down. Prices in the energy sector are reversing. Input costs aren't rising, but stabilizing. All of these are current facts. Because these facts are currently lining up, I don't see the potential results as not materializing.
What I say above is the reason why I recently started my first position in Cloetta after following and tracking the company for years and years. It goes to show you that just because a company is something I follow or rate, does not mean that I'm actively investing or even interested in investing at that particular price.
If necessary, I am willing to wait years for a company to reach a level I will consider investable. And that is the way I believe that everyone should act when investing in stocks. Do not let yourself be stressed - and 3 years certainly is not allowing me to be stressed.
I now view Cloetta as a "BUY", and I've initiated my first position at 0.15% of my commercial portfolio. I expect a 60-90% 3-year RoR, including a yield of 5%, and will start revisiting this on a continual basis.
Here is my thesis for the company.
Thesis
- Cloetta is one of the largest candy companies in Scandinavia. It has an entrenched market position, with many of customer favorites and Pick and mix trends being favorable to Cloetta. Since most of the comps aren't publically traded, I would view Cloetta as very favorable in this context.
- The valuation for Cloetta was not favorable during the last time I reviewed it. That has changed in July of 2023, and this causes me to change my PT and expectations for Cloetta.
- I now expect Cloetta to manage a 70% upside to a PT of 29-30 SEK in 2025E, based on a 15x P/E and an EPS growth of 14%. The company yields an impressive 5%.
- I give Cloetta a PT of at least 25 SEK.
- That means the company is now a "BUY" for me.
Remember, I'm all about:
1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them (italicized).
This company is overall qualitative. This company is fundamentally safe/conservative & well-run. This company pays a well-covered dividend. This company is currently cheap. This company has a realistic upside based on earnings growth or multiple expansion/reversion.
This means that the company fulfills every single one of my criteria, making it relatively clear why I view it as a "BUY" here.
Thank you for reading.
For further details see:
Cloetta: Would You Like Some Candy? (Rating Upgrade)