Sometimes it is worth casting the net
wide.
Individual investors rarely take a big step back and assess the full basket of stocks that make up an industry sector, but it can be useful to get a feel for the entities that comprise a sector and their relative valuations. On the ASX there are 76 entities that are classified as
Consumer Stables and
57 of these fall under Food & Beverages. The Australian food and beverage industry is an important pillar of Australia's economy and is Australia's largest manufacturing sector. Its annual turnover is $50 billion, which is more than 18 per cent of the total Australian manufacturing turnover. The industry is also a major employer. These entities have been presented below, split into profitable (blue) and unprofitable (yellow) entities and ranked by size (market capitalisation). These stocks range from the mighty Treasury Wine Estates (worth $8.8b AUD) and A2M (worth $4.3b AUD) down to the tiny New Zealand Coastal Seafoods (worth $7m).
Let's take a deeper look. One of the most interesting correlations that investors can pry into is
business characteristics (size, growth, etc.) versus
valuation multiples that the stock trades at (earnings multiple, revenue multiple etc.). The idea is that if we can find a useful predictor of valuation we can identify valuation trends and ultimately opportunities. It should be no surprise to most that investors are willing to pay a premium (i.e. a higher valuation multiple) for stocks that are of higher quality. But what is quality?
Quality takes many forms and can vary across industries. In almost all stocks, investors are willing to pay more per dollar of earnings (or revenue) for a company that is growing. Growth is one of the clearest signals of company health. It suggests a company has competitive advantages and is taking market share from competitors (if growing faster than the industry average). Growth also suggests strength or appeal in a product or service. Of course, the caveat applies that high growth without operating leverage or attractive unit economics is immaterial. If we plot top-line growth as a compound average growth rate (CAGR) across FY2018 to FY2021 as the independent variable (x-axis) versus a revenue valuation multiple (LTM TEV/Rev) as the dependant variable across all ~50 ASX F&B entities... a pattern emerges.
Higher growth entities are typically rewarded with a higher valuation multiple. In this case, the valuation multiple chosen is a revenue multiple (Rev x Rev-Multiple = Valuation). Revenue has been chosen here rather than an earnings multiple because 27 of the F&B entities are not yet profitable, and thus a revenue multiple (rather than an earnings multiple) is the next best proxy and is applicable across the
entire set. Halo Foods emerges as a clear outlier with a revenue compound annual growth rate of 188% across FY18 to FY21 yet a LTM TEV/Rev multiple of circa 0.8x (note the LTM MC/Rev multiple is even lower). Halo is bucking the trend. Why? As mentioned earlier, there are many factors that determine a valuation multiple and are indicators of quality: margin, growth, scale, competitive advantage, management etc. However, I argue that Halo's measures of quality are relatively high. None of the above factors should materially explain Halo's meagre (small) revenue multiple. Instead, Halo's share price has been artificially held down by an invisible hand: the enormous share overhang of the ex-CEO (and his wife) [noting that it appears that James Gong and Vivienne Cheung were unceremoniously removed from the business which helps explain the reason behind this drawn-out selling].
Once this overhang is cleared, I expect a major rebound in the valuation multiple (revenue multiple) as per the F&B trend above. As a comparison, ASX:MBH (Maggie Beer Holdings) has the next highest revenue growth rate across FY18 to FY21. Maggie Beer has grown the top line from $8.6m to $53.8m over those 3 years, versus Halo from $2m to $51m over the same period. Both are very impressive feats. Maggie Beer also reported a small NPAT of $1.86m in FY21, unlike Halo. Maggie Beer Holdings valuation is $190m, with an FY21 revenue multiple of circa 3.5x versus HLF at 0.8x (TEV/rev).
Given that Halo is on the cusp of profitability (improving margins, operating leverage kicking in & recently reporting positive group EBITDA), let's take a deeper look at the profitable entities of the ASX F&B sector.
Among these entities, the net profit margin of the group varies between 0 and 10% (with the exception of CBO and FFI). That's important to note in and of itself. The ASX F&B industry is not a technology sector. Margins are low-moderate across the board due to competition and the significant capital outlay required. But, it can be a rewarding sector to invest in, as a stable, growing industry, leveraged to trends of premiumisation, sustainability, population growth and the opportunity to market ANZ's pristine qualities to the wider world (particularly Asia).
Across the sector, earnings multiples (LTM TEV/EBITDA) tend to congregate around the 10-20x mark). This implies that once Halo reaches a group EBITDA of circa $5m (the last half reported normalised positive EBITDA of $1.1m, up 223%), we might expect a fair valuation of $50m to $100m (versus a market cap of $30m today — remarkably, $30m is the same valuation as when the company IPO'd over 3 years ago and had merely $2m in revenue and no track record of growth!).
Among profitable entities, the sector also exhibits a correlation of P/BV with net profit margin. As is to be expected, entities with a higher profit margin are rewarded with a higher valuation multiple of price to book value. Note: For the chart below, P/BV is plotted not P/ tangible BV, which is why some entities are below 1 P/BV (but all are higher than P/ tangible BV). As an example, MBH trades on just over 1.8x P/BV. Halo has a book value of $51 million and thus trades on a P/BV multiple of 0.59x. If HLF also traded on 1.8x P/BV (once crossing the chasm into profitability), Halo's corresponding valuation would be $92 million (1.8 x $51m) versus $30m today.
So, we've seen that valuation multiples in the F&B sector correlate with measures of quality, such as growth and net profit margin. What if we could get a complete picture of overall business quality?
What if we ranked the 50 entities in the F&B sector by 4 metrics of quality: a) profit growth, b) net profit margin, c) revenue scale, and d) revenue growth and used this to generate an overall ranking of business quality? These rankings are presented below. Halo is ranked as the 4th fastest growing stock (top-line), the 23rd biggest entity (by FY21 turnover), the 32nd best net profit margin (negative at this stage) and 49th when it comes to net profit growth. The poor ranking on net profit growth is related to the movement of NPAT from -$0.29m in FY18 to -$8.20 in FY21. If you take FY19 or FY20 as the starting point, the result is not nearly as bad and if you look forward (where NPAT has improved Half On Half for the first time, things are looking very good, but that is beside the point). Ultimately, that positions Halo as #29 from 50 on the overall quality rank.
What if we could now plot this quality rank against the original revenue valuation multiple (LTM TEV/rev)? The result is a nuanced view of the ASX Food & Beverage landscape, split into multiple pockets/categories. Firstly, a tale of two distinct halves is revealed: profitable stocks (mature value, mid-growth, and high-growth) and the unprofitable players (high growth, concept stocks and under-performers) trend differently.
Profitable stocks show a positive correlation with the revenue multiple while unprofitable players interestingly show an inverse scattered correlation. This is due to a few different pockets of stocks. On the right-hand side in yellow, concept stocks with minimal revenue, show up with a high revenue-multiple, because they have a blue-sky valuation on no/minimal track record. Small low-quality stocks are valued on hopes and dreams. Meanwhile, on the left side, in blue, different stocks in different life stages, show up in pockets: mature quality stocks such as BGA & ELD trade on low revenue multiples, as do lower quality, declining legacy businesses such as UMG. But mid-sized, mid-quality stocks trend to higher valuations above 2x revenue. Fast-growing, emerging players such as MBH trade above 3x revenue.
What I find most interesting are pivot points. One could argue that all other businesses are already fairly valued in their respective pocket of the valuation-quality spectrum, but the opportunity for the investor lies where there is change. The map above continues to change. Emerging stocks are moving to the left and declining stocks are moving to the right. The opportunity lies where the market misjudges quality. The opportunity lies where companies transition from the scattered right-hand side mix of yellow into the structure of the left-hand side of profitable blue. From all of the ASX F&B entities, HLF interests me most because Halo Foods is on the cusp of one such transition. Halo Foods is on the cusp of a transition into profitability. A transition into the higher quality end of town where valuations tend towards 1-2x revenue (10-20x EBITDA) or more.
Halo Foods looks set to have a ticket to parties in the blue-end of town soon — therein lies the opportunity.
T.E.P.
