2023-11-07 15:48:13 ET
Summary
- Freshpet, Inc. shares have experienced a boom-bust cycle during the pandemic, but have recently shown signs of recovery.
- The company's revenues have grown significantly since its IPO in 2014, but it has yet to become profitable.
- Freshpet's third-quarter earnings report showed strong sales and margin growth, but there are still challenges ahead for the company.
Shares of Freshpet, Inc. ( FRPT ) have shown some signs of life as of recent, warranting a long overdue update on the investment thesis. In February 2020, when the world was seeing the early innings of the pandemic, I concluded that humanization was paying off.
The company saw rapid growth since its public offering in 2014, as I sold the remainder of my small position early in 2020, a position which I had initiated after the public offering.
After a real boom-bust cycle during the pandemic, shares are back to the levels seen early in 20202, while Freshpet is a lot bigger now, but still not profitable, although real advancements are made on that front.
Some Perspective
Freshpet went public in 2014 as a prime beneficiary of the humanization trend of pets and their food. By offering healthier and premium alternatives, Freshpet catered a premium segment of the market, with meals costing as much as $4 per animal per day. (at the time of the offering). On top of the premium food, the company had an interesting business model as well, including company-owned fridges located in retail stores.
In 2015, Freshpet was a roughly $100 million business which actually posted EBITDA margins in the mid-teens, although that the physical fridge component made that the business was somewhat asset heavy. Nonetheless, I recognized the potential of the firm.
This was in part seen early in 2020, when the company posted sales of $246 million for the year 2019, making that sales rose a factor of 2.5 times since the IPO. The company posted EBITDA of $29 million, although accompanied by net loss of a million. With shares trading at $70, the valuation has risen to $2.5 billion, as a 4 times sales multiple at the time of the IPO had expanded to 10 times, all while no real profits were seen.
This made me cautious, as I sold of out of the remainder of my position in the $70s, after having acquired a stake in the mid-single digits in the years following the offering.
Boom - Bust
Soon after my take on Freshpet in February 2020 the pandemic broke out as this fueled an enormous momentum rally with shares trading up to the $180s in 2021. This was followed by a big correction in 2022, when shares fell to the $50 mark, as shares have largely traded in a $50-$80 mark ever since, now trading at $68 as shares jumped by ten dollar overnight in response to the quarterly earnings report.
Forwarding to February of this year, Freshpet posted its results for the fiscal year 2022. The company posted full year revenues of $595 million, up 40% on the year before, after 2021 was already a strong year as well. That is just part of the story, but the issue is that adjusted EBITDA fell from $35 million in 2021 to $20 million in 2022, which meant that net losses doubled from nearly $30 million to nearly $60 million, after accounting for stock-based compensation and depreciation charges, among others.
For 2023, the company guided for a further increase in sales, albeit at a more moderate pace, with revenues seen up to $750 million, which would still represent 26% sales growth. Adjusted EBITDA is set to recover to $50 million which is encouraging, but not enough to create realistic earnings. That is just part of the story, as cash flows are furthermore pressured by large investments with capital spending estimated at $240 million, being roughly 5 times as high as the depreciation charge in 2022!
To create some much-needed cash inflows, the company closed on a $402 million convertible senior note offering in March, with the 2028 notes carrying a 3% coupon, with dilution only incurred over the $120 per share mark.
In May, Freshpet posted a 27% increase in first quarter sales to nearly $168 million as a break-even EBITDA number in the first quarter of 2022 improved to $3 million this quarter. In the meantime, Freshpet ended up in a fight with activist investor JANA Partners which pushed for a sale, a route which the board was not willing to pursue.
By August, Freshpet posted a 28% increase in second quarter sales to $183 million, while EBITDA improved to $9 million, as the stronger (adjusted) margin profile made that the company hiked the full year EBITDA guidance to $55 million, or more.
Growth Acceleration
Shares of Freshpet got a real lift following the release of the third quarter earnings report, revealing a near 33% increase in third quarter sales to nearly $201 million. Moreover, adjusted EBITDA of $23 million in change resulted in real margin accretion as net losses narrowed to $7.2 million for the quarter.
It was the strong beat, both in terms of sales and margins, which resulted in the full year sales guidance being hiked to $755 million, with EBITDA now seen at $62 million. With adjusted EBITDA reported at $35 million year to date, the fourth quarter EBITDA number is seen around $27 million which is stronger than the third quarter, even as sales numbers are expected to be largely in line with third quarter sales.
What Now?
Right now, the 48 million shares of Freshpet value equity of the business at $3.3 billion, which includes a modest net debt load of around $55 million. This is comprised out of a $338 million gross cash position and $393 million debt load, as the low interest on the convertible makes that net interest expenses are seen flattish, perhaps even positive in the coming quarter.
The similar enterprise valuation values the business at just over 4 times sales, which is down a lot from past valuations, although that the business still has not become profitable yet, even as the company has grown sales by a factor of 7 times since the public offering. That said, the arrival of JANA and organic improvement is really showing off in the third quarter margins, which is comforting, as realistic earnings rapidly come within sight here.
That is desperately needed, as the achievement of a break-even results would be great, yet it only tells part of the story. Net capital investments remain very large, with capital spending of a quarter of a billion being four times as large as the annualized depreciation charge of $60 million.
While it is comforting to see an acceleration of the business in terms of sales and margins in a tougher economic environment, the hole for Freshpet to dig itself out of is large. While I am very impressed with the third quarter performance and the trajectory for revenue growth and margin expansion, there is still a long way to go.
Given this, I understand the positive reaction of the firm, but given the levels of improvements still to be delivered upon, and myself having some doubts on that, I am curious to keep following Freshpet, Inc. here, but see no reason to get involved at these levels.
For further details see:
Freshpet: A Balancing Act Following Green Shoots