2023-03-18 04:38:08 ET
Summary
- LDSVF has been gaining market share, driven by its focus on premiumization and expansion in emerging markets.
- I expect margins to continue improving with North America being the primary driver of this expansion.
- The company's FCF generation profile remains steady, and with the strong balance sheet, management should continue to return capital.
Description
Lindt & Sprungli ( OTCPK:LDSVF ) manufactures a wide range of chocolate and confectionery products. They sell its products in its own specialty stores and boutiques, as well as in retail outlets and through catalog sales. My analysis of LDSVF's FY22 results confirms my conviction that the company is a compelling long in the staples sector due to its superior growth and margin outlook compared to competitors. LDSVF increased organic sales by nearly 11% in 2022, with volume growth of almost 3% and margin expansion of nearly 90 basis points. I believe that the FY23 forecast of 6-8% top-line growth and 20-40bps of EBIT margin is very doable, as this expansion of the margin is supported by the continued narrowing of the profitability gap between North America and Europe. LDSVF's robust free cash flow generation profile and low leverage should also for generous share repurchases. As of FY22, the company still has about CHF750 million available for a share buyback, which is equivalent to about 3% of the market cap. In addition, I want to point out that LDSVF is a fantastic dividend distributor, with a DPS that has increased from CHF500 to CHF1300 from 2011 to 2022, or 2.6x. This reassures me that the company's management is looking out for the interests of its shareholders and that the company places a premium on maximizing its return on capital. Future EPS growth should remain in the high single digits, and when combined with a dividend yield in the low single digits, this should result in a return in the low teens before taking into account any potential valuation shifts. Bears might object to LDVSF's 40x forward P/E, but I think the premium is justified by the company's promising margin expansion, solid financial position, and promising future prospects.
Market share
Following management commentaries over the recent years, it seems that LDSVF momentum of gaining market share has been positive. I believe this is a function of management foresight in reinvestment into the business, and I expect this to continue given that the premium chocolate market is expected to grow faster than normal chocolate . If we drill down into the LDVSF numbers, we see that organic growth was 10.8% for FY22, for a three-year CAGR of 5.6%, which is just a hair below the management's 6%-8% target for medium-term growth. As a whole, I find the chocolate industry appealing, with healthy signs of volume inelastic growth and sensible market leaders (no major news of large chocolate players slashing prices to compete, based on my knowledge), as such, I believe LDVSF should have no issues continue growing organically. Based on the links presented above, I would infer there is a continued trend towards premiumization, which is right up LDSVY's alley (LDVSY is mostly premium), as such contributes to the narrative that LDSVY can continue to capture share. In addition to gaining a larger share of the market, LDVSF's premiumization enables it to maintain its pricing power for the long-term, unlike regular chocolate. This may not be the most fair test, but consider the pricing power differential between a Chanel bag and a regular handbag.
In addition, I believe the company has substantial addressable market share potential from a distribution standpoint, as premiumization opportunities and geographic expansion in emerging markets give the company a great deal of growth potential. For instance, Delfi Ltd ( OTCPK:PEFDF ) is a healthy growing business and the largest chocolate producer in Indonesia. In order to break into Indonesia, which opens the door to other emerging markets in Southeast Asia, LDVSF could either partner with or acquire PEFDF, using shares (since LDVSF valuation is so high).
Margin
Boosted by a 320bps increase in margin in the North American division, LDVSF's EBIT margin reached 15%, an increase of 90bps. In the medium term, between 20 and 40bps of margin expansion is expected (and FY23 is within this range). I expect North America will once again be the primary driver of this expansion as it will be responsible for closing the sizable margin gap between it and Europe. Aside that, cost-cutting measures, organic operating leverage, store-footprint optimization, and reducing the size of the Russell Stover business, which has been a stumbling block, should help to close the gap over time. Although I expect North American margins to approach Europe in the near future, they will still fall short of Europe's margin, where LDVSF is particularly strong.
Capital returns
Once again in 2022, LDVSF FCF generation profile remains steady. Over the years, management has returned a large amount of capital to shareholders through buybacks and dividends thanks to robust FCF and robust top-line growth. For what it's worth, I think the balance sheet is still solid and there's plenty of cash on hand for share repurchases (as mentioned above).
Summary
Based on my read of LDVSF FY22 results and future prospects, I believe that the company is a compelling long-term investment in the staples sector. The company's superior growth and margin outlook compared to competitors, as well as its robust free cash flow generation profile and low leverage, make it an attractive, in my opinion. Furthermore, the company's focus on gaining market share through premiumization and geographic expansion, as well as its strong dividend distribution track record, reinforce my confidence in the company's management and long-term potential. While the premium valuation may deter some investors, I believe it is justified by the company's promising future prospects and potential for continued growth.
For further details see:
Lindt & Sprungli: Positive On Organic Growth And Capital Returns Profile