2023-12-16 02:05:52 ET
Summary
- I recommend a buy rating for UTZ Brands, as I expect it to benefit from the secular growth in the Snacks industry.
- The company's multi-brand portfolio approach allows for continuous innovation without diluting each brand.
- UTZ's expansion strategy through acquisitions positions it for potential share gains as it expands nationwide.
Overview
My recommendation for Utz Brands (UTZ) is a buy rating, as I expect the business to ride along the secular tailwind in the Snacks industry. It should be able to continue using its acquisition strategy to expand into other parts of the country. The current SKU rationalization and supply chain improvements are near-term headwinds to the business, but I see them as the right move for long-term growth and margin expansion.
Business
UTZ has two portfolios, namely Power Brands, which account for the bulk of sales, and Foundation Brands. The focus here is on Power Brands, where the portfolio has higher growth, better margins, more scale, and more potential for further product enhancements. Within Power Brands, it includes brands like utz, Herdez, Fridays, Golden Flake, etc. As for the Foundation Brands portfolio, they tend to be more regional brands like Bachman, Tim's Cascade, and private label products.
Why this opportunity exists
I believe the market is missing out on this opportunity because they are focused on the near-term performance instead of the medium-term potential. The market seems to be pricing in the impact of the SKU rationalization (growth slowdown). Specifically, if we look over the past quarters, the business growth has slowed significantly from a high-teen percentage to just 2.5% in 3Q23, reaching $372 million in revenue. I believe the slowdown in growth was primary due to SKU rationalization, which hurt growth as volume got impacted. However, profitability has improved due to this initiative, as seen from the y/y improvements in gross and EBITDA margin. I believe the market is not pricing in the post-SKU rationalization growth rates and improved profitability. This can be seen from the multiple that the market is attaching to UTZ (below its historical average).
Financial review
Over the past year, UTZ reported revenue of $351.4 million, $362.9 million, and $371.9 million in 1Q/2Q/3Q23, with y/y growth coming in at 3.1%/3.6%/2.5% for each of the quarter. The low-single-digits growth are weak when compared to FY22 growth of high-teens. EBITDA came in at $40.4/45.2/52.1 million for 1Q/2Q/3Q EBITDA, where margin has improved to mid-teens from low-teens in FY22. UTZS ended the quarter with $60 million in cash and $943 million in debt.
Snacks sector enjoys secular tailwinds
I believe Snacks is a category that has a large addressable market and is poised to continue growing organically and via share gains within the overall food industry. To give a sense of how big the market is, consider that the entire US snack food industry is worth around $93 billion and is expected to continue growing at 7% over the next few years. I believe there are several fundamental shifts in snacks consumption these days relative to the past. For instance, there are more entertainment choices at home today (Netflix and video games). These forms of entertainment tend to drive more snacking frequency, similar to why people buy popcorn in cinemas and hotdogs in sports games. While these are not like-for-like examples, they point to a similar habit: snacking while enjoying. In addition, there is another secular trend within the broader Snacks category that benefits UTZ. A survey has found that millennials are more inclined towards salty snacks. With the big bunch of these millennials forming a larger pie of the incoming earning group, I expect this positive demographic trend to continue driving salty snacks demand.
Multi-brand approach is a competitive advantage
Another survey observed that snack eaters would look for exciting flavors to choose a snack as a treat. As such, limited edition and seasonal flavors tend to be trendy. I believe this is in favor of the UTZ multi-brand portfolio approach as well. Unlike smaller peers that focus on a single brand strategy, UTZ is able to tap into multiple brands to continuously roll out limited edition or special flavors on a portfolio-wide basis without significantly diluting each brand. Regarding this multiple-brand approach, it also shields UTZ from being overly exposed to a single brand. New flavors and innovations are always a risky move, as resources are invested ahead of time before results are seen. With a multiple-brand approach, even if one flavor fails to become a hit or trend, UTZ still has multiple other brands to fall back on.
Potential for share gains as UTZ expands nationwide
Prior to its expansion through acquisitions, UTZ primarily served the Northeast and Mid-Atlantic regions of the United States. Since 2011, UTZ has made several acquisitions, including buying Zapp's which is a New Orleans style flavors, Golden Flake which is a deep south US flavour, and Truco which gives it more exposure to Mass and Club retail channels. This acquisition strategy makes a lot of sense and works well for UTZ multi-brand approach. Firstly, building a consumer brand is tough and even if UTZ were to pour in large amount of dollars, it might not even work. Hence, I think acquiring a brand/flavour that the region loves is the best way to expand across the country. Secondly, UTZ is already well-adapted to a multi-brand portfolio strategy, as such, they already have a framework in place that integrate new brands without much frictions. Importantly, with UTZ broad manufacturing and distribution networks, acquired brands would immediately see synergies as they can be sold across footprints that UTZ have presence in. With this strategy in place, it effectively means that UTZ has a way to penetrate into every part of the country, which I believe has ample opportunity for share gains.
Margin outlook
The problem with acquisition is that you get both the good and the bad of the acquired brand. As such, UTZ has to keep undergoing SKU rationalization to ensure that the Power Brand's high growth, higher margin, and high innovation potential status are not disrupted. I believe this is exactly what is happening with UTZ right now. That said, while the SKU rationalization has hit volume and sales growth this year, I view it favorably as the reductions are focused on lower-margin private label products.
After this SKU rationalization is complete, UTZ will be able to concentrate on Power Brand items, which have higher margins and more potential for geographic expansion, and unlock incremental capacity. In addition, management has highlighted in the 3Q23 earnings call a few operational difficulties linked to the supply chain network optimization measures that have already been implemented. While this seems like bad news, I think it is good for the long term, as management is also learning from these lessons to better optimize the business.
Valuation and risk
Author's valuation model
Over the past quarters, the business growth has slowed significantly from high-teens percentage to just 2.5% in 3Q23, reaching $372 million revenue. I believe the slowdown in growth was primary due to SKU rationalization that hurt growth as volume gets impacted. However, profitability has improved due to this initiative, as seen from the y/y improvements in gross and EBITDA margin.
According to my model, UTZ is valued at ~$17.90 in FY24, representing a 29% increase. This target price is based on my growth forecast of 5% and 7% in FY24 and FY25. My assumption is that growth will trend back towards the broader snack industry growth rate as UTZ finishes its SKU rationalization initiatives. SKU removals will hurt growth, as such growth is not going to inflect to industry levels immediately. However, as the SKU rationalization initiative ends and supply chain improvements are complete, margins should expand from here.
UTZ is now trading at 14.4x forward EBITDA, at the low end of its historical trading range, which is understandable considering the weak growth outlook and margin headwinds. However, as I mentioned above, these are short-term headwinds but good for the long term. As UTZ growth accelerates and margins improve, I expect valuations to improve accordingly. For modeling purposes, I am assuming UTZ trades back to 15x forward EBITDA in FY24, a modest increase within 1 year, followed by a possible mean reversion.
To ensure that my valuation assumption is sensible, I compared it to other packaged food peers in the industry. Using consensus estimates, UTZ is the best performer in terms of EBITDA growth over the next 2 years, outpacing peers growth of high-teens (cumulative over 2 years). As such, UTZ deserves to trade at a premium to peers who are trading at 12x forward EBITDA.
Risk
The inherent risk is that, by all means, salty snacks are not healthy. If the upcoming generations become more health conscious, it could be a major headwind to the business. Furthermore, UTZ's expansion into regions of the US with lower distribution and household penetration is a central tenet of my thesis. The company's ability to grow could be hindered if its brands don't do well in expansion geographies or if it has trouble gaining shelf space there.
Summary
I recommend a buy rating for UTZ. I expect UTZ to continue riding on the Snacks industry's secular growth. I believe the Snacks industry is poised to enjoy sustained growth trends due to evolving consumption habits along with the rising preference for salty snacks among millennials. Despite near-term challenges like SKU rationalization and supply chain enhancements impacting short-term performance, these strategic moves are vital for long-term growth and margin expansion.
For further details see:
Utz Brands: Secular Tailwind With Share Gains Potential