2023-04-26 16:22:18 ET
Summary
- Revenue should benefit from price increases and good demand at QSR and retail channels.
- Margin should benefit from improving product and customer mix, easing supply chain challenges, and cost synergies from the integration of recent acquisition.
- Valuation is lower than the historical average.
Investment Thesis
Lamb Weston Holdings, Inc. ( LW ) has outperformed the broader markets and has gained ~10% since my previous bullish coverage in March. Looking forward, LW has good revenue and margin growth opportunities. The company is expected to benefit from the carryover impact of recent price increases, strong demand for its retail products, and rising traffic in quick-service restaurant chains as consumers seek more affordable dining options amid an inflationary environment. On the margin front, Lamb Weston is expected to benefit from an improved product and customer mix, carryover impact of price increases, easing supply chain challenges, and cost synergies resulting from the Lamb Weston/Meijer acquisition. Lamb Weston's current valuation is lower than its historical averages and given its promising growth prospects, I believe that the stock can continue to outperform in the near future as well.
Revenue Analysis and Outlook
Since my previous coverage of Lamb Weston in March, the company has reported better-than-expected third-quarter earnings for fiscal 2023. The company benefited from price increases as well as robust demand for potato fries in QSR chains and retail channels, which more than offset lower demand in full-service restaurants. Consequently, the company's sales for the quarter increased by 31% year-over-year to $1.25 billion, driven by a 31 percentage point benefit from price increases and flat volume.
Moving forward, I anticipate that Lamb Weston should continue to deliver sales growth as it benefits from price increases, and increasing demand at QSRs and retail channels.
Over the past year, the company has successfully offset inflationary costs through price increases, which has contributed to its sales growth. It continued to take incremental pricing in the third quarter, and it increased its prices towards the end of the quarter. So, while the pricing increase's incremental impact didn't show up that much in Q3 (since it was taken near the end of the quarter), Q4 should benefit from it. This pricing increase coupled with the carryover price increases from previous quarters is expected to provide continued support for revenue growth going forward.
Furthermore, the company is gaining traction for its at-home and ready-to-eat fries products in the retail channel as consumers look for affordable eating options in an inflationary environment. The at-home fries category in the retail channel is the most affordable among Lamb Weston's three sales channels (full-service, QSR, retail) and this channel is well-placed to benefit from trade-downs from consumers. In Q3FY23, despite a 44% price increase in the retail channel, the company saw a 6% increase in volume, leading to a 50% YoY increase in total retail sales. This demonstrates a healthy end-market in the retail segment. The company increased its advertising activities in Q3FY23 to support the retail products, and I anticipate the benefits of healthy demand and increased advertising to further increase traction for at-home fries products, which support sales growth in the coming quarters.
In addition to strong demand in retail channels, the company continues to see good momentum in demand from QSRs, which are also less expensive than full-service and casual dining restaurants. These end-market demand trends and benefits of price increases should offset the lower volume from full-service restaurants due to softening demand in that channel.
Margin Analysis and Outlook
The company has demonstrated its ability to maintain its margin despite adverse inflationary costs through price increases over the past few quarters. In the third quarter of fiscal year 2023, the benefits of price increases more than offset inflationary raw material cost headwinds. Furthermore, lower trucking and freight costs and the favorable renegotiation of any multiyear global contracts also aided in gross margin growth. As a result, there was an 860 bps Y/Y increase in gross margin to 31.7%.
Looking ahead, I remain optimistic about LW's long-term margin growth potential. The company has been focusing on improving its product and customer mix by exiting certain lower-priced and lower-margin products and increasing the production of higher-demand and higher-margin products like retail fries, premium fries, and batter-coated products. This strategy has helped LW increase its gross margin over the past few quarters, and I expect this trend to continue.
In addition to improving product and customer mix, LW is also benefiting from other tailwinds such as better availability of labor and input materials, the carryover impact of price increases from the recent quarters, and cost synergies from the Lamb Weston/Meijer acquisition. These factors should contribute to improving efficiency, productivity, and cost reductions, ultimately leading to increased gross and operating margins.
Valuation and Conclusion
The company is currently trading at a 24.38x FY23 consensus EPS estimate of $4.50 and a 22.03x FY24 consensus EPS estimate of $4.98, which is below its historical 5-year average forward P/E of 27.71x . The company is seeing positive earnings revisions and I expect this momentum to continue moving forward. I believe the stock has good revenue and margin growth prospects which combined with lower-than-historical valuations make it a good buy.
For further details see:
Lamb Weston Can Continue To Outperform