2023-07-25 20:09:41 ET
Summary
- Sales hit a new record in 2022 and are expected to increase by a further 10.12% in 2023.
- Both gross profit and EBITDA margins have significantly improved in recent quarters thanks to an easing of inflationary pressures.
- The company is profitable as cash from operations is enough to cover interest expenses and capital expenditures.
- The company's balance sheet is very strong as long-term debt is very low compared to cash and equivalents and inventories.
- This represents a good opportunity for investors interested in obtaining significant capital gains.
Investment thesis
The current status of Lifeway Foods ( LWAY ) is, in my opinion, not as disastrous as what the current share price might make investors think. The company's sales set a new record in 2022 and continued to grow through the first quarter of 2023, and profit margins have shown strong improvements over the past three quarters thanks to strong volumes and lower milk prices and transportation costs. Furthermore, the company's debt is very manageable as it holds enough cash and equivalents and inventories to pay it off in full.
The company is now investing in advanced promotional software, AI-powered marketing, and operational tool optimization in order to maintain stable margins in the long term, which should ultimately lead to continued share buybacks with which to keep rewarding shareholders, and thanks to strong cash from operations, it should be possible to cover these investment expenses through operations without drawing on more debt.
But despite this, the risk of a potential recession, as well as a potential sale of the company, is keeping investors on the sidelines. But I strongly believe that the company is prepared for a recessionary scenario thanks to a strong balance sheet, which makes me believe that the current share price decline of 73% from all-time highs represents a good opportunity for more patient, long-term investors. Nevertheless, I strongly recommend reading this article about a potential sale of the company that could eventually materialize.
A brief overview of the company
Lifeway Foods is the leading U.S. manufacturer of kefir and fermented probiotic products whose main product is drinkable kefir. The company was founded in 1986 and its market cap currently stands at $88 million, employing around 300 workers worldwide. 42.57% of the company's shares outstanding are owned by insiders, which means the management is the main beneficiary of the good share price performance.
The company sells its products through its own brands but also supplies private labels, and it keeps releasing new products on a regular basis in order to adapt its kefir-based and probiotic-based products to the preferences of a broader range of consumers. In March 2023, the company launched a wide range of new flavors for its kefir brand at the Natural Products Expo West 2023, including guava, organic strawberry banana, organic black cherry, and seasonal flavors rainbow cake and campfire smores. The company's products are sold in the United States, Mexico, Ireland, and France as it entered the French market in 2021 due to Europe's strong demand for kefir products, and the management plans to launch the company's products in an increasing number of countries abroad in the future.
The company's kefir products are rich in probiotics, vitamin D, and proteins that help to support gut health, immunity, and mental well-being, and demand should increase as the global population becomes more aware of the health impact of the products they consume.
Currently, shares are trading at $6.06, which represents a 72.92% decline from all-time highs of $22.38 on March 30, 2015. This is, without a doubt, a very significant drop in the share price, aggravated by more moderate expected revenue growth, recessional fears, margin volatility, and fears of a potential company sale that could result in capital losses for investors if done at the wrong time.
Revenues keep increasing, but growth is expected to slow down
The company has managed to increase its revenues for three consecutive years as it has reported positive growth rates for 14 consecutive quarters. In this regard, revenues increased by 8.93% in 2020, 16.70% in 2021, and 18.90% in 2022. Furthermore, revenues kept increasing during the first quarter of 2023 as they grew by 11.16% compared to the same quarter of 2022, boosted by increased volumes and product price raises.
Revenues are expected to increase by 10.12% in 2023, and by a further 1.99% in 2024 as the global kefir market is expected to grow at a CAGR of 6.4% through 2028. Furthermore, 35% of new Lifeway Foods consumers are repeating their purchases, which reflects the high capacity of the company to retain them. But the recent increase in revenues coupled with the current drop in the share price has caused a sharp decline in the P/S ratio to 0.650, which means the company generates revenues of $1.54 for each dollar held in shares by investors, annually.
This ratio is 46.33% lower than the average of the past decade and represents an 81.07% decline from decade-highs of 3.434 reached in 2013, which means investors are placing much less value on the company's sales not only because of lower medium-term expectations but also as a consequence of a recent margin contraction that, despite having shown a significant improvement in the last few quarters, is at risk of worsening again due to a potential recession as a result of the recent interest rate hikes.
Margins are improving, but a potential recession could have another negative impact
Overall, the company has achieved positive gross profit and EBITDA margins over the years except on a few occasions, and despite a contraction during 2021 and 2022, the trailing twelve months' gross profit margin currently stands at 20.25%, and the EBITDA margin at 5.20%.
Furthermore, the company reported a gross profit margin of 21.70% during the first quarter of 2023 (vs. 16.4% during the same quarter of 2022) as it raised the price of its products in order to offset inflationary pressures, and the EBITDA margin also improved to 5.87%. An increase in demand for the company's branded kefir products has also helped in this improvement as they increased by 21% in total dollars and by 9% in volumes. Also, profit margins are expected to keep stabilizing as the price of milk and transport is stabilizing, and the company's trailing twelve months' cash from operations has dramatically improved during the past quarter as it stood at $7.66 million, which is enough to cover annual capital expenditures of around $5 million and interest expenses of slightly over $0.30 million.
This means that the company is currently highly viable and that it is generating excess cash as it reported a positive trailing twelve-month's net income of $2.6 million during the first quarter of 2023.
Regarding capital expenditures, the management has recently increased them as the company is heavily investing in growth capital, cost reduction programs, and facility improvements in order to achieve improved manufacturing efficiencies, so these costs should allow for higher cash from operations in the long term, as long as the demand for kefir products remains, at least, at levels similar to the current ones.
Long-term debt is manageable and the company has enough resources to fully deleverage the balance sheet
In August 2021, the company acquired certain assets of Glen Oaks Farms for $5.8 million, with which it introduced the brand to its portfolio. As a consequence, long-term debt increased to $7.5 million, but the management has partially deleveraged the balance sheet since then as long-term debt currently stands at $6 million.
Furthermore, the company currently holds $5.2 million of cash and equivalents and $9.3 million in inventories, which significantly reduces the risk that such debt entails for the company's long term. The increase in the price of the company's products has enabled said increase, which should eventually dilute the company's debt thanks to a higher dollar value of the company's inventories.
In this sense, the company has sufficient means to reduce its debt load to zero, which would free up over $0.30 million in cash that is currently used to cover interest expenses each year. This is why it is very important for the company to report enough positive cash from operations to cover both capital expenditures and interest expenses and generate some excess cash as it would increase the chances of a full balance sheet deleverage. Even so, it can be said that the management could prefer to maintain the current debt levels in order to allocate all the available cash (from the balance sheet and from operations) to continue reducing the total number of shares outstanding through share buybacks as the share price is well below the all-time highs, and high insider ownership suggests that the decision will be taken with caution.
Buybacks will likely keep in force
The total number of shares outstanding has been successfully reduced by 10.56% during the past 10 years and the company announced a share repurchase program of up to 250,000 shares in June 2020, which means that the management has a long tradition of carrying out regular share repurchases in order to reward long-term investors in some way.
This means that each share represents a growing slice of the company, whereby shareholders' positions are passively expanded by just holding the company's shares. In addition, strong cash from operations and a very healthy balance sheet suggest that share buybacks will continue to take place in the future, so investors can expect further declines in the total number of shares outstanding.
Risks worth mentioning
Despite the fact that the company is currently in a healthy financial situation, there are certain risks that I would like to highlight as there are macroeconomic and company-specific factors that add significant volatility to the company's shares.
- A recession could cause increased demand for private labels, which could have a significant impact on Lifeway Foods' operations. Although the company supplies private labels in order to absorb demand from more price-sensitive consumers, an increase in private label sales (at the expense of branded products) could have a significant impact on profit margins as private labels often offer lower profit margins than branded ones.
- As has been seen during 2021 and part of 2022, the viability of the company's operations is linked to the price of milk and transportation costs, so a new increase in the cost of either could once again cause a contraction in profit margins. Since we are at a time of large variations in inflation rates, further inflationary pressures could produce another contraction in profit margins in the foreseeable future.
- If cash from operations falls again as a result of a potential recession or cost pressures, the company could stop performing share buybacks, which are currently the only way that the management has to reward shareholders (and insiders).
- If the company's situation continues to worsen, the share price could continue to fall and the sale of the company could be made at the expense of capital losses for investors. Although a lower-than-usual P/S ratio suggests there is not much more room for deterioration in terms of equity valuation, the current complex macroeconomic landscape makes this, in my opinion, a real risk.
- Also for investors who are interested in buying Lifeway Foods' shares in the hope that another company will pay a higher price for their shares to acquire it, the risk that the company is finally not sold also exists, with which potential capital gains would essentially depend on the improvement of the company's prospects.
Conclusion
Lifeway Foods' situation, from a financial and operational perspective, in my opinion, is quite healthy. Sales reached a new record in 2022 and are set to reach new highs in 2023 as they kept increasing during the first quarter. The company has recently expanded into France and continues to launch new flavors of its products in order to reach a broader consumer base as the kefir industry is expected to continue growing globally. In addition, profit margins have stabilized at healthy levels in recent quarters thanks to the stabilization of milk prices and transportation costs as the company reported trailing twelve months' cash from operations which is enough to cover capital expenditures and interest expenses while generating some excess cash.
A debt significantly lower than the sum of cash and equivalents and inventories suggests that the risk that debt implies for the viability of the company is low, although a further contraction in margins derived from further inflationary pressures and/or a recessionary environment could cause another fall in profit margins, which would create difficulties in covering capital expenditures and interest expenses through operations, and this macroeconomic landscape marked by strong volatility comes at a time when there is speculation of a potential sale of the company. Despite this, both inflationary pressures and a potential recession represent headwinds, in my opinion, of a temporary nature as they are directly linked to the macroeconomic outlook, and a significantly lower than usual P/S ratio suggests that even in the scenario that the company is finally sold (which is not really clear), it should be bought at a higher price per share than the current one. Therefore, I believe that the share price decline of 73% from all-time highs represents a good opportunity to obtain significant capital gains in the medium to long term.
For further details see:
Lifeway Foods: Operational Performance Is Improving Significantly