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Simply Good Foods: Good Enough To Buy


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Shares in The Simply Good Foods Co. (SMPL) haven’t yet recovered from the market sell-off in March. The company did post solid Q2 results (Fiscal year ends in August), but the market’s reaction was tepid following their reported numbers. SMPL has been trading in a narrow range between $16 to $20 a share.

That said, out of the 11 analysts following the company, everyone has a “buy” recommendation. The mean price target for SMPL is $25 a share. However, price targets range from $35 at the high-end to $22 at the low-end. At a recent price of $18.5, that implies a possible return of 22%, 35%, and 89% for the low, mean, and high targets, respectively.

While we don’t believe the company has competitive advantages, their path to growing revenues looks interesting. As consumers become more aware of the nutritional contents of their snacks and meals, SMPL is set to benefit from such tailwinds.

The creation of shareholder value depends on how good management can lever their selling and marketing expenses to build brand awareness and have operating leverage work in their favor. We believe at current prices, the stock is a good bet to make.

Simply Good Foods stock chart

The Big Picture

Source: company filings

The Simply Good Foods Co. was formed as a result of the merger between Conyers Park Acquisition Corp. (a special purpose acquisition company) and Atkins Holdings in 2017. Through this merger, Atkins Holdings became a public company trading in the Nasdaq under their new corporate name and with the ticker symbol SMPL.

Although the company sells “low sugar, low carb, and protein-rich” snacks, bars and ready-to-drink shakes, all manufacturing and distribution activities are outsourced to third parties. This puts the company in a peculiar position, as management focuses entirely on marketing and brand development instead of manufacturing. SMPL’s three main banner brands are Atkins, Quest, and SimplyProtein.

The advantage of this business model is the low CAPEX needed to maintain operations. For example, in its short history as a public company (2017-2019), SMPL has spent 3.7M in CAPEX while generating a total of $129M in operating cash flows. Net PP&E on the balance sheet is less than 1% from total assets at only $2.4M, from a total asset base of $1.1B.

While we don’t have much operating history from SMPL, so far, we like what we see. Revenue growth has been accelerating at a fast pace, fueled by organic growth and acquisitions. In the consumer packaged food industry, where revenue growth is somewhere between low to mid-single digits, SMPL has managed to grow its top line by double digits for 8 consecutive quarters. 2019 was a stellar year for the company, driven by unexpectedly strong point-of-sales results, with net sales, adjusted EBITDA, and gross profit increasing by double digits organically.

Since the company outsources all manufacturing and distribution, COGS should remain at a constant level. At least, that is what has happened for the last three years. With a constant gross profit margin, management is doing an excellent job in controlling “fixed” costs such as G&A. So, while gross profit has grown at a 3-year CAGR of 16%, total operating expenses have expanded at a 3-year CARG of only 12%. The positive spread between both has resulted in the expansion of operating income margins from 14.4% to 16%.

The reduction of selling and marketing expenses for 2019 was the result of the sudden increase in sales. Because of the huge surge in demand (driven by marketing campaigns), the company had some supply constraints, which led to the delay of new product launches until new capacity was contracted.

In November of 2019, the company completed its $1B acquisition of Quest Nutrition, a healthy lifestyle food company, with a combination of cash, equity, and debt. At the time of the acquisition, the combined entity was set to achieve nearly $900M in sales, almost doubling their amounts of revenues. The company also expects to achieve $20M in cost synergies.

SMPL’s Q2 results were their first full quarter after the acquisition of Quest and results did not disappoint, beating analysts’ estimates in both revenues and EPS. The company is also on track to achieving its cost synergies targets.

Source: Investor presentation

The biggest risk

We believe the strength in SMPL’s operating model, which is the outsourcing of their manufacturing and distribution of their products, is also the biggest risk to the business. For example, the supply disruption the company faced in 2019 when a sudden demand surge was not matched with supply, caused constrains in their supply chain. Because the company doesn’t control the manufacturing output, they are at the mercy of their contracted third-party manufacturers. Also, as the company reaches a greater scale, the benefits from economies of scale on unit production costs would not be enjoyed by the company. That is, although management might be allowed to negotiate better terms as they reach more volume, it would have a limit, as their third-party contractors would not sacrifice their own margins.

At this point, however, there is still so much uncertainty around COVID-19, that relying on third parties for manufacturing and distribution is a high-risk uncertainty. As investors, we do not know who these third parties are, and how healthy their balance sheets are. If the second wave of COVID-19 causes works stoppages, these firms might not be able to sustain such headwinds, putting SMPL’s supply chain in danger. It is something investors should be aware of.

The Bottom Line

It is still early to know if the acquisition of Quest is going to create long-term shareholder value, but as of their second-quarter results, things were looking on track.

That said, the market for healthy snacks is consolidating, which could harm SMPL’s M&A strategy. For example, recently Hershey (HSY) and Kellogg (K) have been venturing in the healthy snacks market with the purchase of SkinnyPop and Pirate’s Booty in the case of Hershey, and RxBar in the case of Kellogg. As competition for M&A opportunities heats up, there is a high probability that SMPL might pay a high multiple to acquire growth.

The company’s Atkins brand has a high level of awareness by the U.S. consumer, with 83% recognizing the brand. The company also states in their annual report, according to surveys from Health Focus International, that 73% of consumers are looking to lower their carbohydrate intake. They also believe that over 50% of current customers are self-directed low carbohydrate eaters (not on a diet program) which means market acceptance for their products as a healthy choice, and not as a strict regime, is growing.

Currently, analysts’ price targets range between $22 to $35 a share:

Source: tikr.com

With shares trading at $18.5, there is potential upside opportunity. Since there is a decent amount of analysts following the company, and the overall consensus views SMPL as undervalued (the lower price target still implies 22% of upside), we believe it is a good measure to use and a good bet to make.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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