Fizzy Water

The story behind National Beverage is an easy one.

I first wrote about National Beverage in 2016 (see here).  You can see financials below:

 20162018Growth
Revenue70597538.00%
Operating Income93204119.00%
Margin13.19%20.1% 

National Beverage is a simple story.  National Beverage owns La Croix and a variety of generic beverages that are low margin and no growth.  La Croix, on the other hand, is a high growth and high margin beverage product.  As La Croix has become a larger part of National Beverage, the financials have come to reflect this story.

La Croix, if you are unfamiliar with the brand, is a carbonated water beverage with only natural flavors added.  Sparkling water is a fancy term to describe bubbly water with a little flavor added.  This beverage is almost better described by what it isn’t.  It is the anti-soda beverage, none of the caffeine, sugar, aspartame, or a host of other ingredients in your Diet or classic Coke.  It’s the “healthy” version of Coke.  (Maybe we could sneak some into Buffett’s hand at the next annual meeting.  Talk about product placement).

I had a variety of original concerns when I first came across National Beverage in 2014.  My first concern was how big the category of sparkling water could be.  My taste preferences aside (I originally hated all flavors equally), I couldn’t see people bringing this product home consistently by the caseload (no sugar, no caffeine, why bother?).  Even with a “cult” following, if the sales volume stayed relatively small, it was questionable whether the overall company could be profitable to the extent that the 2014 valuation required (almost 30x EBIT in 2014).  Furthermore, even if La Croix became extremely profitable and the category grew in the near term, would this beverage be just a fad?  I remembered how Coke bought Vitamin Water at the height of its popularity and valuation only to see both decline dramatically in the subsequent years.  Assuming all of these concerns were eased, would La Croix maintain its dominance over the category?  The beverage giants had basically ignored La Croix and the entire category as not being worthy of their attention in the early years.  However, if Pepsi or Coke did decide to launch a full frontal attack on La Croix, would its brand prove durable?

In 2016, I revisited National Beverage.  Sales had continued to climb and profitability had risen dramatically as the high margin sales of La Croix began to dominate the low margin sales of other products for National Beverage.  I had to admit my taste preferences should not dictate my investment decisions.  2016 was interesting for National Beverage because there was a short report published accusing National Beverage of inflating sales, governance misconduct and a whole host of other accusations.  When the accusations were found baseless, mainly through a few more quarters of consistent sales data, the stock price doubled.  Fast forward to 2018/2019; revenues and operating margins have continued to increase, but a recent lawsuit claiming that La Croix uses “cockroach insecticide as a natural flavor” (see basic rebuttal here) has once again caused the stock price to decline.  I have a hard time even commenting on this lawsuit given its absurdity, so please see the link in the previous sentence for the basic rebuttal “538”.

At current stock prices, National Beverage is worth roughly $2.75B, with roughly $130 trailing free cash flow (and $200m in operating income). This valuation appears reasonable, especially if you assume a few key points.

First, I still believe that National Beverage is more profitable than the financials indicate given their continuance of lower-margin beverage products.  As sales from La Croix continue to grow, I believe National Beverage will continue to phase out other products and replace capacity with La Croix, thus increasing the profitability.  In 2016, operating margins were around 13%, but in 2018 operating margins have almost doubled and now come in at over 21%.  Second, the sales of La Croix are still in the early stages.  La Croix has done very little to monetize La Croix outside the 8-can package sizing of the grocery aisle.  Single-serve and other package sizing options are either in their infancy or non-existent, especially in comparison to the ubiquity of other brands.  National Beverage’s sales have grown 38% in the past 2 years, despite slowly phasing out some of the sales from the lower-margin products.

Both of these points, continued sales and margin growth are key reasons why the valuation looked compelling to some in 2014 or 2016, while completely absurd to others.  With 20% annual sales growth and doubling of operating margins, a company can become much more profitable in the short term and “grow” and even exceed its current valuation.  La Croix’s brand has allowed it to earn outsized profits.  La Croix was the first-mover and, for quite some time, the only real mover in the sparkling water category.  This brand power allowed La Croix, in Buffett’s words, “to earn good returns on the net tangible assets employed in the business.”   In fact, over the past three years, National Beverage has paid out over $250m in dividends (counting the 2018 declared dividend to be paid in 2019).  National Beverage has needed little capital to grow from despite more than doubling its net income during that period.

The central question regarding this lawsuit is whether it will have a long term effect on the La Croix brand and therefore its sales.  We can see from the most recent quarterly sales numbers that the accusations contained in this lawsuit and repeated by various media outlets have had some short-term impact on the sales of La Croix.  The larger question is whether this is a short-term impact or a longer-term impact.  Only time can truly answer this question.  

Concerns

I have the following two concerns.  First, La Croix doesn’t have caffeine, sugar or a sugar-like product, i.e. aspartame.  In other words, it’s not addictive.  If your business depends on recurring sales, you would prefer an addictive substance.
The second concern is competition.  In their first assault on La Croix’s moat, some competitors thought they could improve on the La Croix product.  Some added a version of aspartame (still without calories) or actual sugar.  These imitators wanted to one-up La Croix, but all of them failed.  La Croix’s real benefit was its simplicity, sparkling water and natural flavors.  No calories, no sweeteners, not anything at all (no flavor either if you ask me).  This first onslaught on the moat of La Croix failed.  Alas, the competitors regrouped and corrected their strategic error.  People didn’t want an improved La Croix, they just wanted La Croix or some knock-off that tasted the same with the exact same ingredients (or as close as you can get with “natural flavors”).  Competitors’ follow-up attempts were exact copycats, most notably, Bubly (a product from Pepsi).  These exact copycats are pretty good, relatively speaking.  The competitors now just need to give people a reason to try out the alternatives.  First, competitors will discount the price.  This will happen occasionally and might give some people a reason to try an alternative.  Second, this “cockroach lawsuit,” however overblown and outrageous it might be, is probably the sort of thing to push someone over the edge to give Bubly or any other copycat a chance.

These are concerns.  Concerns are thoughts that you need to put into a variable or metric and follow-up to see if these concerns are playing out.  Sales are going to dip in the past quarter due to the negative media attention of this lawsuit, but if sales continue to dip or do not reverse in the near future, these concerns (or others) may become problems for the La Croix brand.

I don’t think an investment in National Beverage is your typical lay-up or one-foot hurdle.  I have real concerns about the competitors and the potential “fad” nature of La Croix.  However, if you can get comfortable with the upward trajectory of the sales and continued profit growth, National Beverage is certainly one to have on your watchlist.

One side note: I find this fact really telling about National Beverage and its management team.

Share Count 2017: 46,921,000

Share Count 2018: 46,923,000

The share count for FIZZ basically never changes.  This happens rarely in companies.  The majority owner of National Beverage owns almost 75% of the company.  He isn’t interested in giving out shares wily-nilly because each share he would give out comes directly out of his pocket (well, 75% of it).  The majority owner appears to look at spending the company’s money as primarily spending his own money and therefore has done so in a prudent manner.  I expect this to continue in the future.

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