Category: Sectors

Business Strategy and Outlook

Lamb Weston, the largest provider of frozen potatoes to North American restaurants, has secured a narrow moat, based on the firm’s cost advantages and entrenched restaurant relationships. The North American commercial potato market is highly concentrated with only four players: Lamb Weston (42%-43% share), McCain (30%), Simplot (20%), and Cavendish (7%-8%). Lamb Weston and Simplot both secure their raw potatoes solely from the Idaho and Columbia Basin region, an area ideally suited for growing potatoes, with very high yields. These firms secure potatoes at a cost 10% to 20% below the average price per pound. There is minimal unused land and water resources in this fertile area, so it is expected this advantage to hold for at least the next 10 years. Further, as the dominant player, Lamb Weston maintains a scale advantage. Given the high fixed costs in this capital-intensive industry, scale benefits are meaningful. Lamb Weston’s long-standing strategic partnerships with its customers provide another facet of the firm’s competitive edge. French fries are the most profitable food product for restaurants, and a key menu item. 

Lamb Weston is facing many headwinds that will dampen its earnings near term, but its long-term prospects should remain intact. The omicron variant will cause the traffic recovery in full-service restaurants (19% of sales) to pause, but consolidated sales should return to prepandemic levels in fiscal 2022, given resilience in quick-serve restaurants (58%) and retail (16%). Inflation, shortages, and a poor-quality potato crop should impair margins the next several quarters, but profitability should be fully restored by fiscal 2024. 

French fries are an attractive category, as consumers across the globe are increasing consumption, with volumes up low single digits in developed markets and up mid to high single digits in emerging markets. Lamb Weston is investing in additional capacity in China and the U.S. to meet this growing demand. While capacity utilization was uncharacteristically low during the pandemic, as herd immunity increases, French fry demand should recover, absorbing additional supply.

Financial Strength

When Lamb Weston separated from Conagra in November 2016, the firm initially reported net debt to adjusted EBITDA of 3.7 times, but leverage fell to 3.0 times last year (even considering the impact from the pandemic), and it will moderate to a very manageable 2.1 times by fiscal 2024. In addition, it can be guaranteed about the Lamb Weston’s ability to service its debt, with interest coverage (GAAP EBITDA/interest expense) averaging 7 times the past three years, and our forecast calling for a 8 times average over the next five years. As Lamb Weston’s business is capital intensive, the primary use of cash is capital expenditures, which averaged 9% of sales the three years before the pandemic, as the firm expanded capacity to meet strong customer demand. The industry began to operate at a more level utilization rate (mid-90s expected even before the pandemic hit in 2020, after 100% experienced the previous two years) causing capital expenditures to moderate to 4%-5% of sales during the pandemic. Investments should increase to 11% and 17% of sales in 2022 and 2023, respectively, as Lamb Weston expands capacity in China and the U.S. and range from 5.5% to 6.0% over the remainder of the decade. Dividends should be another significant use of cash, and It is expected for dividends to increase at a high-single-digit rate annually, generally maintaining a long-term pay-out ratio in the low-30%s, in line with management’s target. Lamb Weston has made a few small tuck-in international acquisitions in recent years, and is suspected that this may continue, but analyst have not modelled future unannounced tie-ups, given the uncertain timing and magnitude of such transactions. Instead, Analyst have opted to model excess cash being used for share repurchase, which is viewed as a prudent use of cash when shares trade below our assessment of its intrinsic value.

Bulls Say’s

• Lamb Weston’s geographical and scale-based cost advantages should help ensure the firm remains a dominant player in the industry. 
• Lamb Weston is a valued supplier of restaurants’ most profitable food product, and restaurants are hesitant to switch so as not to disrupt supply and quality. 
• French fries are an attractive category, as per capita consumption is increasing in both developed and developing markets.

Company Profile 

Lamb Weston is the world’s second-largest producer of branded and private-label frozen potato products, such as French fries, sweet potato fries, tots, diced potatoes, mashed potatoes, hash browns, and chips. The company also has a small appetizer business that produces onion rings, mozzarella sticks, and cheese curds. Including joint ventures, 52% of fiscal 2021 revenue was U.S.-based, with the remainder stemming from Europe, Canada, Japan, China, Korea, Mexico, and several other countries. Lamb Weston’s customer mix is 58% quick-serve restaurants, 19% full-service restaurants, 8% other food service (hotels, commercial cafeterias, arenas, schools), and 16% retail. Lamb Weston became an independent company in 2016 when it was spun off from Conagra.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Business Strategy and Outlook

Philips is a one-stop shop for imaging-related devices with an established footprint in many hospitals, which positions it to benefit from long-term healthcare trends like the transition to nonor minimally invasive procedures, increased hospital demand for efficiencies or detection of sleep apnea. Through several divestitures and acquisitions Philips has transformed itself from an industrial-medical conglomerate into a healthcare company and primary supplier across hospitals, which facilitates the introduction of new products and the displacement of smaller suppliers with more depth in a single product line, but lack of breadth. In many of its underlying markets the company operates an oligopoly where significant market share is controlled by a few players. Several of the company’s products require proprietary software or service, which provide stability to cash flows and help to lock in the customer. In addition the company has carried out several divestments and acquisitions, which is supposed to have reinforced the company’s positioning. The company continues to narrow its business focus, with the sale of its domestic appliances business in 2021. 

It is alleged the company has room to improve its margins through improved operations management and cost efficiencies. Philips has made inroads on this front with a manufacturing footprint consolidation, where it has moved from 50 factories to less than 35 in five years. In D&T Philips has a large installed base built during many decades, which is suspected, has potential for improved service retention rates through remote monitoring, product sophistication and risk-sharing agreements. In connected care, Philips had a significant product recall on its sleep apnea installed base in 2021, which is assumed will result in a permanent loss of market share against Resmed. It is foreseen a long-term conversion pathway in toothbrushes from manual to electric, as a large percentage of the population still brushes manually. It is expected.6 the monitoring market will be a long-term beneficiary of COVID-19 due to hospitals realizing the need for efficiencies in patient management when hospital occupancy is high.

Financial Strength

As of September 2021, Philips had EUR 3.8 billion in net debt, which represented a 1.3 net debt/EBITDA ratio. Debt is denominated in euros and U.S. dollars, with an average interest rate of 2.0% and an average duration of around eight years. It is counter thought, Philips’ indebtedness level will be problematic given its relatively stable cash flow generation, and it is alleged, the company will have additional room for acquisitions, investments and dividends/buybacks. In the first quarter of 2021 Philips announced the sale of its domestic appliances business for EUR 4.4 billion. The proceeds will strengthen Philips’ balance sheet even more, giving the company more room to reinvest in the healthcare business, where it holds a stronger competitive position.

Bulls Say’s

• Philips’ large installed base in imaging devices and existing footprint in many hospitals is an advantage that allows them to cross-sell and introduce new products with less effort than other smaller players.
• Philips is a market leader in large unpenetrated markets such as sleep obstructive apnea and electric toothbrushes, where there are significant growth opportunities ahead.
• The firm’s divestments are reducing the conglomerate perception Philips has among investors, which will provide more visibility on cash flows and future growth opportunities.

Company Profile 

Philips is a diversified global healthcare company operating in three segments: diagnosis and treatment, connected care, and personal health. About 48% of the company’s revenue comes from the diagnosis and treatment segment, which features imaging systems, ultrasound equipment, image-guided therapy solutions and healthcare informatics. The connected care segment (27% of revenue) encompasses monitoring and analytics systems for hospitals and sleep and respiratory care devices, whereas the personal health business (remainder of revenue) includes electric toothbrushes and men’s grooming and personal-care products. In 2020, Philips generated EUR 19.5 billion in sales and had 80,000 employees in over 100 countries.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Business Strategy and Outlook

No-moat MGM Resorts is facing material near-term headwinds from COVID-19 as well as elevated operational risk in Macao from government plans to increase supervision of casinos. Still, we think MGM has a healthy liquidity profile to see it through this turmoil and remains positioned for the attractive long-term growth opportunities in Macao (22% of pre-pandemic 2019 EBITDAR), U.S. sports betting, and Japan (accounting for an estimated 10% of 2027 EBITDAR, the first year of likely operation). 

We see solid Macao industry visitation over the next 10 years, as key infrastructure projects that alleviate Macao’s congested traffic (Pac on terminal expansion and Hong Kong Bridge in 2018, light-rail transit at the end of 2019, and reclaimed land in 2020-25) come on line, which will expand the region’s constrained carrying capacity and add attractions, thereby driving higher visitation and spending levels. As MGM holds one of only six gaming licenses, it stands to benefit from this growth. Further, MGM Resorts has expanded its room share in Macao to 8% from 3% with its Cotai property, which opened in February 2018. That said, the Macao market is highly regulated, and as a result, the pace and timing of growth are at the discretion of the government.

In the U.S. (78% of pre-pandemic 2019 EBITDA), MGM’s casinos are positioned to benefit from a multi-billion-dollar sports betting market, generating an estimated mid-single-digit percentage of the company’s 2024 sales. That said, the U.S. doesn’t offer the long-term growth potential or regulatory barriers of Macao; thus, we do not believe the region contributes a moat to MGM. Still, there have been very minimal industry supply additions this decade, and this should support solid industry Strip occupancy, which stood at around 90% in pre-pandemic 2019.

We expect MGM to be awarded one of only two urban gaming licenses in Japan, with a resort opening in 2027, generating attractive returns on invested capital in the teens.

Financial Strength

MGM entered 2020 in its strongest financial health of the past 10 years, in our view. This was illustrated by its 3.7 times debt/adjusted EBITDA in 2019 versus 13 times and 5.7 times in 2010 and 2015, respectively. It was also buoyed by MGM having recently exited an investment cycle, where the company spent $1.6 billion on average annually during 2015-19 to construct and renovate U.S. and Macao resorts versus the $271 million it spent on capital expenditure in 2020. We believe MGM has sufficient liquidity to remain a going concern even with zero revenue for a few years. The recent sales of underlying casino assets (Bellagio in November 2019, Circus Circus in December 2019, and MGM Grand/Mandalay Bay in February 2020) provided it with around $6.9 billion in cash. The company recently entered into leaseback asset sales of Aria, Vdara, and Springfield, raising over $4 billion in cash in 2021. Also, MGM is set to receive $4.4 billion in cash for its ownership in MGM Growth Properties, which is scheduled to be acquired by Vici in the first half of 2022. The firm has taken further action to lift its liquidity profile by reining in expenses, tapping its $1.5 billion credit facility (which has since been paid), suspending dividends and repurchases (which have since been reinstated), and raising debt. MGM has $1 billion of debt scheduled to mature in 2022.

Bulls Say’s

• We expect MGM to be awarded one of only two urban Japanese gaming concessions due to its strong experience operating leading resorts in Las Vegas and its successful record of working with partners 

• MGM is positioned to participate in Macao’s long-term growth opportunity (22% of pre-pandemic 2019 EBITDAR) and has seen its room share expand (to 8% from 3%) with the opening of its Cotai casino in February 2018.

• MGM’s U.S. properties are positioned to benefit from the expansion of the multi-billion-dollar domestic sports betting market

Company Profile 

MGM Resorts is the largest resort operator on the Las Vegas Strip with 35,000 guest rooms and suites, representing about one fourth of all units in the market. The company’s Vegas properties include MGM Grand, Mandalay Bay, Mirage, Luxor, New York-New York, and CityCenter. The Strip contributed approximately 49% of total EBITDAR in the pre-pandemic year of 2019. MGM also owns U.S. regional assets, which represented 29% of 2019 EBITDAR. We estimate MGM’s U.S. sports and iGaming operations will be a mid-single-digit percentage of its total revenue by 2024. The company also operates the 56%-owned MGM Macau casinos with a new property that opened on the Cotai Strip in early 2018. Further, we estimate MGM will open a resort in Japan in 2027.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Business Strategy and Outlook

In October 2020, Bed Bath & Beyond put forth an updated strategy to revitalize its brand and regain customer confidence by focusing on its core properties. As such, the company divested peripheral brands such as Cost Plus and Linen Holdings in order to focus on the Bed Bath & Beyond, Buy Buy Baby, Harmon Face Value, and Decorist labels. To help elevate its brand perception, it has combined its online and in-store inventory management with its new “omni-always” initiative in the hopes of capturing more e-commerce business and avoiding the long restock times and uneven inventories that previously plagued the firm. Additionally, it’s investing heavily in both its digital and brick-and-mortar platforms, with a revamp to the website for a more frictionless checkout process and a remodel of its physical stores to offer a cleaner and more enjoyable shopping experience. The firm has attempted to rely less on its iconic blue coupons by giving consumers a good everyday value (it is concluded discounts will persist to some degree over the long term). It also plans to right size by shuttering underperforming Bed Bath stores, shrinking the total store base to around 1,000 by the end of 2021 (from 1,500 at the end of 2019). In contrast, management expects 50% sales growth at the baby label by 2023 via new markets, with the brand already set to deliver $1.3 billion in sales in 2021. It is seen total sales declining in 2021 as the footprint continues to contract before stabilizing at a low-single-digit growth rate in 2023.

Longer term, it is conjectured the 2030 operating margin to reach 5%-6%. This improvement is primarily supported by gross margin gains (which reach 37.7%, below the 38%-plus corporate goal) from a greater focus on private label, including the introduction of 10 new owned brands. It also benefits from a lower promotional cadence thanks to SKU rationalization and the utilization of more robust inventory management processes. However, it is foreseen these gains to be offset by higher investment as the home furnishing landscape remains highly fragmented and competitive, limiting profitability to levels that are structurally lower than in the past.

Financial Strength

Bed Bath & Beyond’s cash position is solid and efforts to reduce the firm’s debt load resulted in a positive net cash position at fiscal year-end 2020. Before the firm’s $1.5 billion debt raise in 2014, it had been debt-free since 1996 (excluding acquired debt), using cash generated from operations to fund new store openings and a handful of small bolt-on acquisitions. The firm has access to liquidity through its $1 billion credit facility, which expires in 2026 and captured another $600 million-plus in cash through the sale of Personalizationmall.com, Linen Holdings, Christmas Tree Shops, One Kings Lane, and Cost-Plus World Market brands. It reduced gross debt in 2020 (with long-term debt at $1.2 billion at November 2021 versus $1.5 billion at the end of fiscal 2019) and plans to continue paying down its debt, aiming to reach a gross debt ratio of 3 times by 2023. There is ample cash on hand (roughly $509 million as of Nov. 27, 2021) to cover near-term expenses like operating lease obligations.

Over the past five reported fiscal years, the firm has produced cumulative free cash flow (cash from operations minus capital expenditures) of $2.1 billion. However, it is anticipated this level to be tempered over 2021-23 as Bed Bath spends around $375 million annually to improve new stores, existing stores, its supply chain, and technology in this time frame. Free cash flow to equity has averaged about 4% of revenue during the past five reported years, which is decent for a mature company that is still spending to remain competitive, but it is likely this level to decline as secular headwinds weigh on performance and necessary investment levels pick up. Despite the higher spending ahead, Bed Bath has a plan to complete its share $1 billion in shares buy back by the end of fiscal 2021.

Bulls Say’s

• Less discretionary categories such as linens, towels, and cookware offer some resiliency amid macroeconomic cyclicality. Registries across bridal, baby, and gift have historically provided a steady stream of customers.
• The closure of numerous underperforming stores by the end of 2021 could help lift the profitability of the business faster than it can be anticipated as better performing stores make up a greater proportion of the fleet.
• With a push into expanding the representation of owned brands (already accounting for 20% of sales), gross margin metrics could expand faster than it can get forecast.

Company Profile 

Bed Bath & Beyond is a home furnishings retailer, operating just under 1,000 stores in all 50 states, Puerto Rico, Canada, and Mexico. Stores carry an assortment of branded bed and bath accessories, kitchen textiles, and cooking supplies. In addition to 809 Bed Bath & Beyond stores, the company operates 133 Buy Buy Baby stores and 53 Harmon Face Values stores (health/beauty care). In an effort to refocus on its core businesses, the firm has divested the online retailer Personalizationmall.com, One Kings Lane, Christmas Tree Shops and That (gifts/housewares), Linen Holdings, and Cost-Plus World Market.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.