2023-07-06 04:36:31 ET
Summary
- Utz Brands remains on track to deliver on its full-year guidance, with the company's distribution capacity providing opportunities for increased distribution and margin accretion.
- UTZ's go-to-market strategy of Independent Operators ensures long-term sustainability and reduces pressure on the balance sheet, allowing for potential expansion through the purchase of additional brands.
- The company's focus on productivity and margin expansion through cost reductions and SKU optimization is expected to drive future growth.
Thesis
Utz Brands ( UTZ ) owns a portfolio of packaged foods brands. Among the many varieties of salty snacks that the company manufactures are potato chips, vegetable snacks, bar and party mixes, tortilla chips, and more. I discussed previously that I saw a 19% upside in UTZ shares, which playing out well until the 1Q23 report came out, which drove a 10+% drop in share price. Given that UTZ has maintained a healthy performance despite falling short of consensus expectations, which I believe were anchored by the strong growth in FY22, I do not think this share price reaction is warranted. In fact, management remains on track to deliver on its full year guidance, and they even raised the low end of the EBITDA guidance. My recommendation to buy remains unchanged.
Distribution capacity to drive distribution gains
UTZ 1Q23 results support the idea that growth is moderating, validating investors' concerns. However, I am willing to take bet on the growth opportunities that are available to UTZ, which would be the new growth driver moving forward. To be more precise, I anticipate future opportunities for increased distribution. This growth opportunity will also be margin accretive. UTZ's route density is a significant competitive advantage because of its direct-to-store distribution capabilities. As management continues to optimizes it SKUs for better productivity and margin, it opens up space to distribute higher growth and margin accretive SKUs like On-the-Border and Zapp's. From a different angle, I anticipate that UTZ will continually discover new brands and optimization opportunities to drive periods of growth, with minimal additional cost due to the established nature of the underlying distribution network.
GTM approach ensures growth sustainability
Touching more on UTZ distribution capabilities, the way it is structured deserves highlight as it ensures long-term sustainability. UTZ's go-to-market strategy, known as Independent Operator [IO], fosters mutually beneficial relationships with vendors, rather than the traditional employer-employee dynamic. In the latter arrangement, the worker's only goals are to "get the job done" and "get paid," leaving them with little incentive to "drive quality results." They probably won't help out any further than necessary. However, this is not the case with the IO method, as the route owners have greater incentive to complete the task at hand. During covid, when they have the most incentive to go out and deliver (because they won't get paid otherwise), the UTZ IO approach really shines. This method also reduces pressure on UTZ's balance sheet, freeing up funds that can be used to expand through the purchase of additional brands. I anticipate that UTZ will proceed with the IO transition by selling its owned routes (thereby generating capital for M&A).
Margin
I anticipate that, going forward, management will maintain its emphasis on productivity as a primary factor in margin expansion. The group has decided to save 4% of COGS through increased productivity in 2023, with the hope of maintaining this rate into 2024. This improvement is huge at 4% at the gross margin line easily equates to more than that at the EBIT line due to fixed cost expenses. If we assume a $1 to $0.75 ratio, 4% would translates to 3pt increase in EBIT, or >50% increase based on LTM EBIT margin. The company plans to achieve these cost reductions through increased efficiency in production, better management of logistics, and smarter purchasing. All of which are hard to due diligence, unfortunately, and the only way to track is via quarterly results. Long-term margin should also be higher as UTZ completes its SKU rationalization (which is a headwind for the year) as it would lead to a better mix and improved margins.
Valuation
I adjusted my model to reflect the slower growth forecast, but I am optimistic about margin expansion due to productivity gains and SKU optimization. I maintained my belief that UTZ should trade at 31x forward earnings because the lower growth but higher margins balance out the negative/positive impact. As the expect earnings is now a lot higher, so is my expected upside.
Own estimates
Risks
Changes in consumer taste will have an impact on UTZ just as they do on other businesses in the food and beverage industry. If people started eating fewer salty snacks (in line with the current trend toward a healthier diet), it could slow down the natural growth of UTZ. It would force management to rely more heavily on M&A to grow, which could significantly reduce the company's long-term growth rate.
Conclusion
Despite the recent drop in UTZ's share price, I believe the reaction is unwarranted. The company has maintained a healthy performance and remains on track to deliver on its full-year guidance. UTZ's distribution capacity, with its direct-to-store capabilities, presents opportunities for increased distribution and margin accretion. The go-to-market strategy of Independent Operators ensures long-term sustainability and reduces pressure on the balance sheet. Management's focus on productivity and margin expansion through cost reductions and SKU optimization is expected to drive future growth.
For further details see:
Utz Brands: Distribution Capabilities Should Continue To Drive Growth