2023-08-24 01:33:33 ET
Summary
- UTZ Brands has a stable and recession-resilient business model and has the potential to be a future dividend growth stock.
- The company's Q2 2023 quarterly report shows organic net sales growth and improving margins and is on its way to generating free cash flow in the second half of 2023.
- There are risks to consider, including high multiples and the high amount of debt on the balance sheet.
- At this moment in time, UTZ doesn't look like an attractive investment from a risk/reward perspective.
Investment thesis
UTZ Brands, Inc. ( UTZ ) has a stable and recession resilient business model, with their focus on growth. Before the company was publicly traded, UTZ already had more than 100 years of growth behind it. Looking at revenue the company has managed to grow their revenue at a rapid pace. UTZ has also a lot of room for future growth, since they're only operating in a small part of the US.
Geographic Classifications (UTZ quarterly results)
I have a personal preference for companies with an anti-cyclical character that can grow their dividend like clockwork. Think about other famous dividend growers in the consumer staple space like PepsiCo, Inc. ( PEP ) or the Procter & Gamble Company ( PG ). I think UTZ has the potential to become a solid dividend growth stock, but there are still some things that are need to be done to be a high quality investment.
On the April the 17th I wrote an article about UTZ from a dividend growth perspective. At that moment in time I gave this stock a "HOLD" rating. When the article was published the share price was $17.51, since then the price dropped significantly to $14.57 per share.
Since the stock price is down quite significantly it could be interesting to see if UTZ comes closer to attractive investment territory.
In this article were going to assess the financial metrics from their latest quarterly reports, so we can decide if UTZ is becoming a more attractive investment from a risk/reward perspective.
UTZ Q2 2023 quarterly report
UTZ has achieved an organic net sales growth of 4.3% year-over-year (13.6% in Q2 2022). The net sales growth is mainly driven by price increases (+6.0%), while their sales volume is in decline (-1.7%). At the moment their sales volumes are impacted by SKU rationalization. Their SKU rationalization is going to further optimize their portfolio mix to unlock manufacturing capacity to focus more on producing more profitable products.
Summary results (UTZ Second quarter results 2023) Net sales bridge (UTZ Second quarter results 2023)
It is also important to mention that the momentum of their power brands is continuing and is increased with almost 10% on top of 18% growth from last year. When I mention the power brands think about, Boulder Canyon, Zapp's and On the Border.
Retail Sales (UTZ Second quarter results 2023)
Their margins are slightly improving due to pricing actions and their productivity programs. UTZ is reporting their profitability with adjusted EBITDA. The adjusted EBITDA has increased by 7%, due to productivity benefits and lower delivery costs. However, their gross margin was a little bit lower than expected, because of higher inbound freight- and potato costs. In the earnings call they said these headwinds are behind them and things will improve in the second half of the year. To give a little bit more context, the month of April was their lowest gross margin month and from that moment in time their margins have improved every month thereafter.
The CEO Howard Friedman seems very confident that the second half of 2023 will be better. He expects a further increase in organic net sales combined with a higher sales volume and higher profitability.
Goals second half FY 2023 (UTZ Second quarter results 2023)
And last but not least, they expect to generate stronger cash flow to deleverage their balance sheet and to unlock further financial flexibility, which is in my opinion a major priority for the company.
At the moment their net leverage ratio is 5.1x, based on trailing 12 months normalized adjusted EBITDA of $177.4. Their goal is to bring down their leverage ratio to 4.5x at the end of fiscal year 2023. Since they use more cash at the beginning of fiscal year 2023 combined with a higher adjusted EBITDA, they should be able to achieve this. In conclusion, the latest quarterly results were decent and it looks like things will be even better at the end of the year.
Fiscal Outlook 2023 (UTZ Second quarter results 2023)
Risks to consider
Despite the fact that UTZ is on track to further grow their business there are still some things to consider before investing this company.
Valuation
As a dividend growth investor I always take the dividend metrics into account when it comes to my valuation.
Dividend metrics (Seeking Alpha)
Since the stock has dropped in price the yield has increased to 1.54%. This is one of the highest since they pay a dividend.
At the moment it is still questionable if UTZ has an actual dividend growth policy. UTZ has growth their dividend for 2 consecutive years (5.72% CAGR) and the company has announced the increases in 12/09/2021 and 12/08/2022. The increases were supported by the underlying growth of the business, so a potential dividend increase can be expected. If UTZ wants to hike their dividend, I hope the increase won't be too high, because in my opinion the company has some other important things to do with their cash.
In my first article about UTZ, I used the Chowder rule to measure the attractiveness as a potential dividend investment. If we combine the current yield of 1.54% with the 5.72% dividend growth CAGR, it is still well below the 15% threshold. From this point of view the UTZ is scoring better than before, but it is far from attractive.
Secondly, the P/E ratio is still high. At the moment UTZ trades at a forward non-GAAP P/E of 26.45, which is well below its own 5 year average of 35.18. However it is a lot higher than its sector median of 18.22.
Analysts are estimating that the YoY revenue growth will be around 3% for the next 2-3 years. I find the numbers on the conservative side, but I still think that the current P/E ratio can't be justified based on given growth prospects. If we compare it to the dividend darling PEP, which is in my opinion a high-quality stock. PEP is trading at a forward P/E ratio of 23.82 and this company deserves more to be trading at a premium compared to UTZ.
UTZ Earnings estimates (Seeking-Alpha) PepsiCo earnings estimates (Seeking Alpha)
I know PEP isn't cheap either, but the company has more of an economic moat, is more profitable, has a way better balance sheet and the dividend metrics are much more appealing compared to UTZ. Comparing these two UTZ really relies on its growth story and I am aware of the fact that the path to growth can be a bumpy one, but at the moment UTZ is really a more risky investment compare to other investments in the consumer staple space.
If we compared the Factor grades on Seeking Alpha, PEP also seems to be the winner in this situation.
UTZ Grades (Seeking Alpha) PepsiCo Grades (Seeking Alpha)
Balance Sheet
What I think is the most concerning part of investing in UTZ is the balance sheet, because the 5.1x net leverage ratio is way too high.
Balance sheet highlights (UTZ earnings report)
At the beginning of the year UTZ had a net debt of $860.3 million, which grew to $931.10 million. I really dislike the fact that the leverage ratio is based on adjusted EBITDA, because there is a possibility that the current Net leverage Ratio overstates the ability to pay down debt. The company isn't generating any free cash flow, so bringing down debt isn't possible at the moment. As I said earlier UTZ is expecting progress on leverage reduction in the second half of fiscal year 2023 as they drive stronger free cash flow conversion.
Luckily, 70% of long-term debt is fixed at 4.5% via interest rate swaps and there are no significant debt maturities until 2028. Nonetheless, it is really important for the company to take action when it comes to deleveraging their balance sheet.
Assumptions FY 2023 (UTZ Second quarter results 2023)
During the latest earnings call the CFO Ajay Katar said their target on free cash flow for FY 2023 is $50 million. Giving the fact that the net interest expense alone is $55 million, which is really a lot, it will be hard to bring down debt on the short-term. Although UTZ still has $73.7 million cash on hand to do some other investments and paying dividends, but in my opinion their financial position needs to get better in order to stay financially flexible.
Conclusion
UTZ Brands still has the potential to be a good and resilient long-term investment. Based on their latest earnings report it is likely things will getting better in the second half of fiscal 2023. Higher sales volumes and higher margins should lead to free cash flow generation. This should lead to a better financial position for UTZ, as they can reduce their net leverage ratio. However, from a valuation point of view UTZ isn't a buy at the moment. The Chowder rule still gives us a relatively low score and despite the drop in share price and the P/E ratio is still too high if we compare this to their growth numbers. In my opinion there are better alternatives in the stock market when it comes to investments in the same industry.
Based on the current situation UTZ still isn't an attractive investment from a risk/reward perspective. The next months are going to be interesting for UTZ. Interesting questions for the upcoming quarters are:
- Can UTZ really keep up the pace in terms of growth? UTZ needs higher growth numbers to justify its P/E ratio.
- Has UTZ the ability to enhance their margins enough to be more profitable and generating strong positive free cash flow?
- How fast can UTZ bring down their net leverage ratio / pay down debt to better their financial position?
In my opinion you don't have to be in a hurry to buy UTZ shares, because I believe there will be better buying opportunities, especially when the fundamentals are improving. With this in mind UTZ gets a "HOLD" rating.
For further details see:
UTZ Brands: Still Unattractive Despite The Share Price Drop