2023-07-17 18:52:24 ET
Summary
- Lamb Weston Holdings, Inc. has seen incredible momentum on the back of strong pricing and solid execution, a trend which has been going on for years.
- The company continues to grow capacity and made a savvy deal for its European joint venture as well.
- This is very encouraging from an operating performance point of view, although the current Lamb Weston Holdings valuations are too demanding to see any appeal here, at least in my eyes.
In the fall of last year, I concluded that shares of Lamb Weston Holdings, Inc. ( LW ) appeared to be hot potatoes after the company acquired the remaining stake in its European joint venture. Even as the consumer staple business posted strong growth, a 30-times earnings multiple was a bit too demanding for me in the prevailing interest rate regime.
Fast forwarding in time, shares have seen strong returns, aided by very strong earnings growth as multiples have fallen to 25 times earnings here. While this looks encouraging, margins come in at historically high levels, making me wary of a normalization of these.
Shedding Some Perspective
Lamb Weston was spun off from its former parent company Conagra Brands, Inc. ( CAG ) all the way back in 2016, and solid performance since that period in time means that its equity valuation now surpasses that of Conagra.
The company focuses on the production and distribution of frozen potatoes and related products such as fries, curlies, hash browns and sweet potatoes. Holding a 20% market share in the global frozen potatoes market at the time, the company generated $3 billion in sales, largely from North America and Europe. By focusing on innovation and automation, the company has been a consistent grower in what essentially is largely a commodity product.
With earnings trending around $2.50 per share around the time of the spin-off, and the company operating with a 3.5 times leverage ratio, valuations looked largely fair at $40 in 2017. This however was based on EBITDA margins of 22%, as I feared that these would normalize to the high-teens, in which case leverage would increase and earnings per share would fall a bit. Moreover, net capital spending of $200 million, needed to fuel growth, was substantial and created a drag on cash flow.
What Happened?
Ever since the spinoff, shares have risen to the $90 mark ahead of the pandemic as shares traded in a $50-$80 range all the way to the fall of 2022, as the company was recovering from lower demand during the pandemic as restaurants were closed). This was followed by a big run higher to current levels of $113, just a few dollars shy of its highs.
In the summer of 2021, the company posted its results for the fiscal year, which to an important extent were impacted by the pandemic. Full year sales fell 3% to $3.67 billion, with EBITDA down 6% to $748 million, as margins normalized to 20%. Operating earnings fell 15% to $475 million, with net earnings down at a similar pace to $2.16 per share, all while net debt fell further to $1.95 billion, less than 3 times EBITDA.
In the summer of 2022, the company posted a 12% increase in 2022 sales to $4.10 billion, with volumes up 3% and pricing and inflation responsible for the remainder of growth. EBITDA actually fell 3% to $726 million amidst inflationary trends as earnings per share fell to $2.08 per share.
This resulted in sky-high valuations at $80 over the summer as the company announced a strong guidance for 2023 with sales seen up to levels as high as $4.7-$4.8 billion and EBITDA seen at $840-$910 million, for earnings between $2.45 and $2.85 per share. When I looked at the shares in October I was negatively surprised by quite large volume declines, driven by inflationary pressures, as the business traded around 30 times earnings, too much of a premium to get involved.
Taking advantage of the operating strength, the company announced an EUR 700 million deal to acquire its remaining equity stake in the European joint venture Meijer Frozen Foods, with pro forma net debt seen at $2.9 billion. At 1.5 times sales, the deal looked cheap, although the margins of the JV were coming in much lower than Lamb Weston itself.
Advancing Ahead
Since October of last year, shares have risen 38% in the time frame of far less than a year, from already high valuations. The good news started in December 2022 when the company announced a convincing 14% increase in the dividend, with the quarterly payout of $0.28 per share resulting in an annual dividend of $1.12 per share.
In January, Lamb Weston announced a 27% increase in second quarter sales to $1.28 billion as various profit metrics more than doubled, with the company hiking the full year guidance on various fronts. A month later, Lamb Weston closed the acquisition of the joint venture with Meijer Frozen Foods.
In April, Lamb Weston posted a 31% increase in third quarter sales as volumes trends were flattish, with growth driven by pricing. On the back of the strong performance, the company hiked the full year sales guidance to a midpoint of $5.3 billion, although this included about a $300-$325 million contribution from the joint venture with Meijer Frozen Foods. Adjusted net earnings are seen at $664 million, or $4.57 per share, and EBITDA is seen just shy of $1.2 billion. Growing this EBITDA number is key, as capital spending of $700-$725 million for the year results in net capital investments of around $500 million.
Net debt is reported at $2.5 billion, mostly the result of net capital investments, as this still results in a very reasonable leverage ratio of around 2 times.
Amidst strong pricing power and lower energy prices, Lamb Weston has grown third quarter EBITDA margins towards 25% of sales, a very strong result. Nonetheless, investors are happy to continue to attach high multiples to this business with the company trading at 25 times earnings, and this comes after earnings have essentially doubled over the past year!
Concluding Remark
The truth is that I am very impressed with the performance of Lamb Weston Holdings, Inc. here, having shown very strong growth (driven by pricing) as well as a savvy deal to buy out the remaining equity interest in its European joint venture.
Given all this, I am extremely cautious on Lamb Weston stock here given the premium valuation, although the underlying operating performance is very strong. Remember that current multiple are high and so are margins, as this was just a $50 stock in March 2022, little over a year ago. What I am trying to say is that I am fearful of a normalization of margins, which together with a lower earnings multiple (in all likelihood) could create a double whammy for Lamb Weston Holdings, Inc. shares.
Given all this, I am impressed with the stock, but look forward to above average volatility displayed by the stock in the past in order to initiate a position if shares trade at more modest multiples amidst more reasonable margins.
For further details see:
Lamb Weston Holdings: Don't Get Fried