National Beverage: It’s All About LaCroix

National Beverage (FIZZ) is beverage company full of a hodgepodge of brands.  You can check out the portfolio of brands at their website (http://www.nationalbeverage.com/).  As with most investments, I would like to focus on the key points here.  FIZZ basically has two product groups.  First, the legacy brands, which includes its carbonated soft drink portfolio and juice brand (Shasta, Faygo, Everfresh).  These are typically considered off-brand, i.e. not your national names, Pepsi, Coke, Dr. Pepper.  I will refer to these as Legacy CSD beverages.  Second, FIZZ owns LaCroix (the sparkling water).  We are going to ignore the Legacy CSD beverages and focus on LaCroix.  

Here are some of the important numbers:

  • The revenue run rate for full year 2016 is approximately $800m, consisting of approximately $400m LaCroix and $400m for the Legacy CSD beverages.
  • Legacy CSD business does approximately 7% operating margins based on my research from Cott Beverages (another “off-brand” CSD beverage company.
  • At around 17% operating margins, this implies LaCroix is doing around 27% operating margins.
  • If you apply 27% operating margins to roughly $400m of revenue for LaCroix, you have around $108m in operating income.  

LaCroix brands grew top-line revenue at 45% last year.  If we assume that the brand will grow 25% next year (not a far flung assumption), this gives you approximately $135m in operating income at 27% operating margins.  What is this worth?  Let’s be honest, I am unsure.  Monster is worth about 30x operating income, but their margins are better due to their single-serve offerings whereas LaCroix is currently sold primarily in 8 packs.  Dr. Pepper Snapple Group (DPS) trades around 15x its operating income (on an enterprise value basis), but the growth profile with DPS is much less attractive than FIZZ or Monster.  

I don’t think it is unrealistic to put a 15x multiple on that $135 operating margin number to come to a $2B valuation.  With 47m shares outstanding, this equates to a $43 stock price.  

As a stand alone company, LaCroix has just begun to explore the options for growth beyond the grocery stores.  In C-Stores, restaraunts, single-serves, all of which are higher margin options, the growth potential is certainly there.

For a strategic buyer, a $43 price would be too low considering the following two main points.  One, the cost savings in distributions are significant.  Second, LaCroix has not “used” a real marketing budget in terms of promotion.  In some ways, this grass roots love of the product has propelled its story, but incremental marketing dollars could drive significant revenue growth in the near future.  

Three Potential Positives:

  1. Growth continues.  If the LaCroix brand continues to grow, this company is going to be worth more than $43.  
  2. If a strategic buyer wanted to acquire a high growth brand to offset its own CSD weakness, the stock is worth more than $43.
  3. If Nick Caporella (CEO and 74% owner) does any sort of insider purchase, tender offer, or special dividend, the stock will be worth more than $43, at least temporarily.  

Three Potential Negatives:

  1. If the SEC decides to investigate the accusations of off-balance sheet revenue and/or expenses, the stock will be in the doghouse for quite some time, even if the allegations prove to be false.  
  2. If growth of the LaCroix brand slows.  The perception will either turn towards the fad nature of the product or increased competition as a reason for why LaCroix should no longer be considered a high growth brand/company.
  3. If Nick does absolutely nothing as the price drifts lower, the narrative could change to a belief that the allegations are true.

Without a crystal ball, I don’t have the ability to probability weight any of these options.  (Sidenote: I think most probabilities people assign to potential outcomes are not worth the paper they are written on).  That being said, I think it is “more likely” that Number 1 or 3 in the potential positives will happen over the next 3-6 months.  FIZZ has approximately $130m in cash, with another $30m coming in cash flow this quarter (ending Oct 30), and access to 100m in revolving credit facility.  Since Nick and insiders own approximately 75% of the company, the public float is only 11.75m shares.  Nick could theoretically do a self-tender offer for approximately 18% of the outstanding public float at $55 per share for $117m.  Doing this would leave FIZZ with $43m in cash on its balance sheet and zero debt.  I specifically used this amount because this is the same amount of dividends FIZZ paid out in 2010 and 2012 when the cash pile built up.  Assuming Nick did not tender any of his own shares, this would leave insiders owning approximately 78.5% of FIZZ.

As discussed above, these are my notes on FIZZ.  I have followed the company for a few years now, but have not previously owned shares in the company.  A short report last week from Glaucus led me to take another look.  The short report basically throws a lot of mud at the wall hoping that some will stick.  The problem I have with this report in particular is that the focus should almost exclusively be on the value of the LaCroix brand.  Anything else at this point is just a distraction.  The sales of LaCroix can be verified by third-party data providers and any large beverage company understands the cost profile of this brand.  The biggest remaining question is whether competition will eat into LaCroix’s growth or if the sparking water trend is a fad.  Investing is often about boiling down a lot of information into a few questions.  If you can figure out which questions to ask, you have a large head start in finding the right answers.  Over the long-term, I am more confident that the competition will not hurt FIZZ, but I am unclear if sparkling water consumption is merely a fad.  In conclusion, I do not have a strong view on the value or margin of safety when buying shares in FIZZ at the current price levels.  You don’t have to swing at every pitch.  

[I wrote about FIZZ this past December, but the numbers are a little dated given the tremendous growth the company has experienced so far in 2016.  You find read notes here: fizzdecember2015notes].

Footnote:

As a footnote, the competitive angle from Coke and Pepsi are a great lesson in inertia from large companies.  Munger has praised the benefits of scale, but also discussed its shortcomings:

“Another defect of scale – flush, fat, stupid bureaucracy. The great defect of scale, of course, which makes the game interesting – so that the big people don’t always win – is that as you get big, you get the bureaucracy. And with the bureaucracy comes the territoriality – which is again grounded in human nature. And the incentives are perverse. For example, if you worked for AT&T in my day, it was a great bureaucracy. Who in the hell was really thinking about the shareholder or anything else? And in a bureaucracy, you think the work is done when it goes out of your in-basket into somebody’s else’s in-basket. But, of course, it isn’t. It’s not done until AT&T delivers what it’s supposed to deliver. So you get big, fat, dumb, unmotivated bureaucracies.”

Coke and Pepsi, with their corresponding brand offerings–Dasani and Aquafina sparkling waters, have tried to enter into this market, but have so far made two huge errors.  Aquafina includes sugar (and therefore calories) in their drink.  The rise of LaCroix has been tied to its natural and healthy side-by-side comparison to soda drinks.  Since Aquafina included sugar, this almost immediately disqualifies their product from making a solid push amongst their target audience.  Dasani, on other hand, did not include sugar, but used “natural flavors” sourced from genetically engineered crops (GMOs).  This might not strike you or I as not particularly troubling, but this alone presents a big barrier to Dasani from placement in Whole Foods, which is almost certainly LaCroix’s biggest stomping ground.  Neither Dasani nor Aquafina sparkling waters are found any Whole Foods that I surveyed (I called 10 locations in 4 different states).

 

Note: This post falls into our “Investment Journal” category. We plan to share bits and pieces of the notes we compile from our day-to-day research on companies and investment ideas. These investment journal posts are meant to be potential starting points for readers who may be interested in learning more about the stocks we discuss here. We may write multiple investment journal posts on one stock as we continue our research, and this research eventually may lead to a more comprehensive conclusion, which we will communicate to you as this develops. These notes may also end up as a dead end. Either way, these are just designed to be unfiltered notes/thoughts on investment ideas as we have them.

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Matt Brice is the portfolio manager of The Sova Group, LLC, an investment firm that manages separate accounts for clients. Matt can be reached at matt@thesovagroup.com.

 

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