2023-07-10 04:57:41 ET
Summary
- Westrock Coffee Company's shares are expected to continue underperforming in the market due to recent negative developments, leading to a downgrade from a 'hold' to a 'sell'.
- Despite sales growth, the company's bottom line results have been mixed and profitability expectations for the current fiscal year have been revised lower; shareholders have also been diluted to accommodate capital for long-term growth.
- The company's stock is considered expensive compared to similar enterprises, making it a less attractive investment prospect despite potential for future growth.
When you make an investment, you should always be of the mindset that the picture for the company that you buy into could ultimately change. Ideally, the change will be for the better. But there are often cases where the opposite is the case. One company that has experienced some changes over just the past couple of months that investors should pay attention to is Westrock Coffee Company ( WEST ). For the most part, the developments provided by management are negative in nature. And these negative developments do, unfortunately, make the stock more expensive than it otherwise would be. Given these changes and in spite of some rather promising developments, I would argue that the stock is no longer a solid ‘hold’ candidate like I believed it to be. Instead, I would say that shares likely will continue to underperform the broader market for the foreseeable future. Because of this, I've decided to downgrade WEST stock from a ‘hold’ to a ‘sell’.
Realigning expectations
Back when I last wrote about Westrock Coffee Company in early April of this year, I consider the company an interesting prospect because of its focus on coffee and tea products. Top line growth had been rather impressive over the prior few years and it operated in a market that I believed to offer attractive upside in the long run. Despite these favorable attributes, shares of the company looked expansive on an absolute basis. This led me to conclude that there probably were better opportunities on the market. But because of the historical growth that the company had exhibited, I could not bring myself to rate it anything more bearish than a ‘hold’. Since then, shares have taken a beating, plunging 13.4% at a time when the S&P 500 has risen by 7%.
There have been a few different factors that have driven shares of Westrock Coffee Company lower. For starters, when the company announced financial results covering the first quarter of its 2023 fiscal year , performance was rather mixed. On the positive side, sales for the company continued to grow, shooting up from $186.4 million in the first quarter of 2022 to $205.4 million in the first quarter of this year. The largest chunk of this sales increase came from the company’s Beverage Solutions business. This is the segment of the company that engages in the production and packaging of both branded and private label coffee in bags, fractional packs, and single serve cups. Revenue for this segment shot up to $181.2 million. That represents an increase of 22.1% compared to the $148.4 million the company reported one year earlier. This increase, management asserted, was driven largely by a $24.7 million contribution because of higher shipment volumes. Specifically, the sale of coffee and tea products in single serve quantities shot up 44% year over year.
Even though it was nice to see revenue rise, bottom line results have been somewhat mixed. On the positive side, the firm's net loss improved from $11.6 million to only $4.8 million. Operating cash flow also improved. Based on the data provided, it went from negative $38.4 million to negative $25.1 million. But if we adjust for changes in working capital, we would have seen it worsen from $0.6 million to negative $5.6 million. Meanwhile, EBITDA plummeted from $11.4 million to only $8.5 million.
These mixed results are one thing. But another problem is that management recently changed guidance for the current fiscal year. Previously, they were forecasting year over year EBITDA growth of between 10% and 25%. Now, management expects EBITDA to range between being flat and up only 10%. Using midpoint estimates for this, this means that, instead of $71.5 million worth of EBITDA for the year, the company should generate only about $63.1 million for that metric. No estimates were provided for other profitability metrics. But based on my estimate, this should translate to adjusted operating cash flow of around $15.8 million for the year.
Another interesting development that the market seems to have disliked came on June 30th. In addition to amending its existing credit agreement to grant it more access to capital, the company announced that it had locked in a $75 million equity investment from HF Capital and the Herbert Hunt family. This investment involved the company issuing 7.5 million shares at $10 each. That will result in gross proceeds of $75 million. This is a rather significant amount of dilution. On top of this, prior to the news breaking on this deal, the stock was trading at $11.15. That means a discount for these incoming investors of 10.3% compared to where the stock traded at previously. This on its own is problematic since the market typically perceives such discounted terms for incoming investors as weakness. From the day prior to the announcement being made through today, the stock is down 5.3%.
Although this stock issuance is painful for existing shareholders, it's worth noting that the proceeds will help the company significantly. According to management, when combined with the credit agreement amendment that the company announced, the extra cash that it now has access to will empower it to complete the previously announced Phase 1 and Phase 2 expansions of its Arkansas-based extract and RTD facility. These expansions will consist of high speed can and glass bottle lines, a multi serve bottle line, and bag-in-box and bulk lines. On top of this, the company will be able to afford two additional can lines and a product development lab and FDA certified pilot plant. The last of these will be focused on developing coffee, tea, and other beverages like dairy and plant-based milks. In the long run, this should help the company considerably.
The problem, however, is that current guidance clearly indicates that the picture will be weaker this year than previously forecasted. So these projects are really only going to help the company beyond that point. And the magnitude that they will help is uncertain. In the meantime, shares of the company are quite pricey as you can see in the chart above. In the table below, meanwhile, I compared the company to five similar enterprises. Using the price to operating cash flow approach, four of the five companies ended up being cheaper than Westrock Coffee Company. And when it comes to the EV to EBITDA approach, three of the five businesses ended up being cheaper than our prospect.
Company | Price / Operating Cash Flow | EV / EBITDA |
Westrock Coffee Company | 56.3 | 21.1 |
Adecoagro S.A. ( AGRO ) | 3.0 | 4.0 |
SunOpta ( STKL ) | 14.2 | 22.9 |
B&G Foods ( BGS ) | 19.7 | 15.7 |
Mission Produce ( AVO ) | 18.6 | 215.5 |
Vital Farms ( VITL ) | 230.9 | 16.0 |
Takeaway
At this point in time, it's clear that the picture facing Westrock Coffee Company could be better. Sales continue to increase, but bottom line results have worsened in some respects. Management has revised lower profitability expectations for the current fiscal year and shareholders have just been diluted in order to accommodate some much-needed capital that will be used for capturing additional long-term growth. If shares of the company we're on the cheap right now, I believe that it could make for a great prospect. But because of how pricey the stock is, I believe that there are better candidates to be had at this moment.
For further details see:
Westrock Coffee Company: Shares Likely Warrant Further Downside (Rating Downgrade)