CHEF - The Chefs' Warehouse

[Guest hellsten]

CHEF is one of Allan Mecham's new holdings. 4% of Arlington Value Capital's holdings.

 

Company presentation:

http://files.shareholder.com/downloads/ABEA-64GECD/3399786819x0x762560/fa668c8f-0715-4c02-9502-e42ffa81755b/CHEF_June_2014PPT_wFinancials.pdf

 

• $212 billion U.S. foodservice distribution industry with more than 16,500 distribution companies

• Top three competitors control 37% of the overall market

• Specialty food distribution remains highly fragmented with CHEF representing the only scaled national competitor

• >30,000 SKUs vs 1,785 for average distributor (source of differentiation and growth)

• One stop shop for chefs. Approximately 20,000 unique customer relationships.

• Top 15 metros in terms of opportunity represent $900 million+ of potential revenue.

• High-quality sales force is a key differentiator compared to broadline competitors

• Net sales: 25.5% CAGR between 2009 and 2013

• Gross profit: 24.7% CAGR between 2009 and 2013

• Adjusted EBITDA: 30.1% CAGR between 2009 and 2013

• History of strong organic growth

• History of consistent gross profit margins

• Track record of successful acquisitions

• Focus on continuous improvement in operating leverage

• Judicious usage of free cash flow

[craigatk]

Considering that I work in the distribution industry, I really enjoy reading about leading distributors and their business plans. I came away extremely impressed with the focus and strategy. I have no opinion on the valuation (at present) but it seems with a quick read of their annual report also that they have some very good management and have been executing very well. Thanks for the post!

[Fat Pitch]

In order to shop here you need to be a proven "in the industry" chef correct?

[thomcapital]

FWIW management (the Pappas) are also involved with restaurant stock LUB...

[craigatk]

In order to shop here you need to be a proven "in the industry" chef correct?

 

They have target segments that are discussed in their presentation (it's wider than restaurants only... they had healthcare, cruise ships, etc. Think any large volume user of food products --- they mentioned "Disney" as a customer-- imagine who is the supplier for Disneyworld/Land/Disney Cruise Lines, etc. and how much volume that is as an account per year) but generally wholesale distribution only sells to businesses, depending on jurisdiction (and implication on regulations or taxation) that can be strictly or informally enforced.

 

If you wanted, you could probably setup an account with another corporate registration and just have a story about developing a food franchise restaurant theme or a catering business and I'm sure you could start ordering. Just be prepared for their aggressive outside salesrep to show up at your home or business and start to ask questions!!

[craigatk]

FWIW management (the Pappas) are also involved with restaurant stock LUB...

 

Thanks, want to check these guys out more! very interesting so far.

[Laxputs]

Looking at the changes in holdings from the "400% man", Arlington Fund, qoq.

 

http://www.sec.gov/cgi-bin/browse-edgar?company=+Arlington+Value+Capital&owner=exclude&action=getcompany

 

CHEF is a new holding and one of the few micro-cap stocks. Haven't dug any deeper than that...just throwing that out there.

[Parsad]

Looking at the changes in holdings from the "400% man", Arlington Fund, qoq.

 

http://www.sec.gov/cgi-bin/browse-edgar?company=+Arlington+Value+Capital&owner=exclude&action=getcompany

 

CHEF is a new holding and one of the few micro-cap stocks. Haven't dug any deeper than that...just throwing that out there.

 

Hi Laxputs,

 

Already an existing thread, so I merged yours into the original.  Cheers!

[Guest roark33]

I just don't see the attraction of this company.  The scale advantages of Sysco, US Foods and Performance Food Group, just don't exist when you are selling into such a niche market. 

 

I can only see this as a buyout target by Sysco or PFG, but it is just so small, I can't imagine them even bothering with it. 

 

Any more insightful thoughts?

 

[Ross812]

I just don't see the attraction of this company.  The scale advantages of Sysco, US Foods and Performance Food Group, just don't exist when you are selling into such a niche market. 

 

I can only see this as a buyout target by Sysco or PFG, but it is just so small, I can't imagine them even bothering with it. 

 

Any more insightful thoughts?

 

I finished reading the 2013 AR last night. Think of CHEF as a roll up in specialty food distribution. They don't need the scale of Sysco or PFG because they are not in the same market. Comparing SYY to CHEF is like comparing Carmax to a Lexus dealership or WMT to Macy's. They both sell the same kinds of product but to a completely different market.

 

That said, margins in the specialty food distribution market are still that of a typical food distributor (2-3%). This is a low margin high volume business. The key to CHEF is the network effect allowing them to bolt on acquisitions and expand offerings within their distribution channel. As they add more products, they become more attractive to their customers as a supplier.

 

As a high end restaurant owner, you may need to source ingredients from many suppliers; CHEF aims to be a one stop supplier of hard to source ingredients. Their pricing actually makes them a value option for customers as well because they add a flat (%) markup to the cost of ingredients. As they become larger, they can source ingredients at more attractive prices.

 

I am going to look into their reports further, but after a few hours of study I will say management looks to be very prudent in how they allocate capital. They are run by their 54 year old founder Christopher Pappas who owns 13.5% of the company. They buy back stock when they don't see opportunities and run a pretty conservative balance sheet. There is a lot to like here.

 

I've watched Bidvest Food Service grow at rates of ~20% for the passed 5 years with a market value 10x that of CHEF. There is no reason CHEF cannot continue to grow in the between 18-30% for the foreseeable future. 22x forward PE may be hard for some value investors to swallow, but to me it seems reasonable for a quickly growing company in a stable industry. When and if salaries start to pick up in the US, you are going to see revenue GRs from CHEF in excess of their current 22%. 

[jouni1]

thanks for sharing your thoughts! it might indeed be hard for a small restaurant operator to get lots of high-quality cheeses, salumi etc. at least time consuming. somehow mecham makes it easy to trust this business model.

 

OT: makes me sad to see the thread starter is a guest. was always looking forward to new topics by him.

[elevensecsrt4]

Interesting company i will add it to my annual report reading list!  Thanks

[Ross812]

I bought some CHEF this morning after mulling it over this weekend. My wife (who has worked at the corporate level for several national restaurant brands) said the biggest problem for restaurants when it comes to distributors is not being able to receive shipments in a timely manner. I.e. You receive shipments on Friday and after a big weekend you have to send someone to the supermarket to buy avocados and 12 pounds of tuna steak.

 

More sku's offered by the distributor means more volume can be purchased per customer and a greater number of deliveries go out; instead of one delivery on Thursday or Friday another truck can stop by on Saturday or Sunday and replenish ingredients in real time.  Adding additional customers compounds the network effect; CHEF's advantage.

 

CHEF is further aided by their niche. In the special foods category, you cannot send someone out to pick up prime dry aged cuts of beef and saffron from the supermarket can break the bank. A big night at the restaurant can mean your hottest menu item is not available for the rest of the week. A small distributor either cannot make a delivery, may not have the inventory, or charge a premium for off schedule deliveries. 

 

CHEF's earnings have come under pressure lately as center of plate (prime cuts of meat) from their latest acquisition of Allen Brothers meats is proving difficult to price effectively. Management said they expect Allen Bros. to be integrated in their real time pricing software in the next 3-6 months and margins should recover without issue. (It was difficult to apply Chefs cost+ pricing structure to center of plate items because the price of meats from various sources moves around so much. They kept with their cost+ strategy and ate the growing pains rather than jerking around their customers). Management is excited about the center of plate options they are offering because they have observed customers who buy center of plate items to order 2-3x as many side items.

 

Management is expecting margins to improve 180bps over the next year as their pricing software is implemented. This could very well be what Allen Mecham was seeing in CHEF. A 180bp increase means earnings go up 25% and revenue should increase conservatively at 18% (its been about 21% excluding the Michael's and Allen Bros acquisitions). Stock analysts are accounting for 20% revenue growth at static margins and predicting FY'15 earnings of $0.79. If management fixes the margin problem, which they have done numerous time is the past, FY'15 earnings could be closer to $1.0.

 

22x F.PE for a company growing revenue at 21.5+% and a long runway is fairly valued, cheap if you consider it is a boarder line consumer staple. At 17.5x F.PE this is a 75c dollar in a owner operated company with fantastic growth prospects and a defensive industry.           

[KCLarkin]

22x F.PE for a company growing revenue at 21.5+% and a long runway is fairly valued, cheap if you consider it is a boarder line consumer staple.

 

If I remember correctly, high end restaurants were pretty empty during the last recession. Any thoughts on what happens to CHEF during a recession?

 

[Ross812]

22x F.PE for a company growing revenue at 21.5+% and a long runway is fairly valued, cheap if you consider it is a boarder line consumer staple.

 

If I remember correctly, high end restaurants were pretty empty during the last recession. Any thoughts on what happens to CHEF during a recession?

 

I would assume they would have some difficulty but their business is scalable. As long as they are able to run full trucks during a recession they still have an advantage over their competitors. I suspect they went public in 2009 to take advantage of the cycle and buy out struggling small distributors. Also, they have 20k customers all over the US so unless there is a really deep recession, not all areas will be affected to the same degree. 

[KCLarkin]

There are a few temporary drags on earnings. Once these are removed, the PE ratio looks more reasonable:

- New Chicago warehouse: 3m hit to P&L in q3/q4

- New Bronx warehouse - redundant capacity as they shift to new facility

- Inflation (unable to pass on unexpectedly high protein inflation)

- Various one-time charges

 

The new Chicago warehouse will be a major facility and will add meaningful revenue and profit once it is fully ramped.

 

The stock is down 40% YTD because the company has lowered guidance two or three times this year. It still looks a bit expensive -- based on my normalized earnings I would buy a big position at around $15.40. But SYY and UNFI are also very expensive, so I think buying at the current price is fully justified.

 

This seems to be a pretty classic roll-up. They can issue shares at 14x EBITDA and buy businesses at 8x EBITDA. As a roll-up, CHEF could easily grow EPS at 15% for the next 10 or 15 years (see UNFI as a good comp). Roll-ups tend to end badly but CHEF seems to have enough organic growth to keep them out of trouble for now.

 

Inventory turnover would seem to be the key metric for this low margin, high inventory business. I would expect their inventory turns to improve with increasing scale but I don't see any evidence of this happening.

[Guest roark33]

Personally, I have never understood publicly traded companies with lots of related persons transactions.  Just smells fishy, always...

 

Warehouse and Office Leases

 

We lease two warehouse and office facilities from two entities that are wholly-owned by two of our directors and one of their “family members” (as such term is defined in the NASDAQ Listing Rules), who is also a former member of our Board, pursuant to long-term operating lease agreements. Our subsidiary, Dairyland USA Corporation, subleases a warehouse and office facility in the Bronx, New York from The Chefs’ Warehouse Leasing Co., LLC, a New York limited liability company that is wholly-owned equally by Christopher Pappas, John Pappas and Dean Facatselis, a “family member” of each of Christopher Pappas and John Pappas and a former member of our Board. The Chefs’ Warehouse Leasing Co., LLC leases the facility from the New York City Industrial Development Agency and subleases the facility to Dairyland USA Corporation pursuant to a sublease agreement dated December 29, 2004, which supplements a separate sublease agreement dated December 1, 2004 between Dairyland USA Corporation and The Chefs’ Warehouse Leasing Co., LLC. The December 1, 2004 sublease contains general terms regarding the sublease arrangement and expires on June 29, 2030. The December 29, 2004 sublease provides more specific terms regarding the economic terms of the sublease arrangement and expires on December 31, 2014. The annual base rent under the sublease arrangement equals the amount of rent payable by The Chefs’ Warehouse Leasing Co., LLC to the New York City Industrial Development Agency plus an amount necessary to allow The Chefs’ Warehouse Leasing Co., LLC to service the indebtedness it incurred to finance the completion of the facility. The annual base rent under the sublease arrangement was initially $950,000, which has been subject to cumulative annual increases of 3.5%. Dairyland USA Corporation paid The Chefs’ Warehouse Leasing Co., LLC $1,250,969 under the terms of the sublease arrangement in fiscal 2013. The aggregate amount of all periodic payments under the sublease agreement due on or after the beginning of fiscal year 2014 through December 31, 2014 is approximately $1,294,753, plus annual taxes and operating expenses.

 

9

 

 

From January 1, 2015 through June 29, 2030, the aggregate amount of all periodic payments due under the sublease agreement is approximately $9.3 million. In connection with this sublease arrangement, Dairyland USA Corporation and two of our other subsidiaries are required to act as conditional guarantors of The Chefs’ Warehouse Leasing Co., LLC’s mortgage obligation on the distribution center. The mortgage payoff date is December 2029 and the potential obligation under this conditional guarantee totaled $9,950,336 at December 27, 2013. On July 1, 2005 the Company entered into a consent and release agreement with the mortgagee in which the entity guarantors were conditionally released from their respective obligations. The Company and the entity guarantors continue to be in compliance with the specified conditions. The Chefs’ Warehouse Leasing Co., LLC has the ability to opt out of its lease agreement with the New York City Industrial Development Agency by giving 60 days’ notice. This action would terminate the sublease agreement dated December 1, 2004 and cause the concurrent reduction in the term of the sublease arrangement with Dairyland USA Corporation to December 2014. Dairyland USA Corporation does not have an option to acquire the facility under any of the agreements governing this facility.

 

Dairyland USA Corporation also leases a warehouse and office facility in Hanover, Maryland from Candlewood Road Property, LLC, a Maryland limited liability company that is wholly-owned by Christopher Pappas, John Pappas and Dean Facatselis, pursuant to a lease agreement dated September 14, 2004. Candlewood Road Property, LLC is the owner of the property. The lease expires on September 30, 2014. The initial annual base rent under the lease agreement was $360,000 and is subject to cumulative annual increases of 3.5%. In fiscal 2013, Dairyland USA Corporation paid Candlewood Road Property, LLC $478,199 in rent under the terms of the lease. The aggregate amount of all periodic payments under the lease agreement due on or after the beginning of fiscal year 2014 through the end of the lease is approximately $367,982, plus annual taxes and operating expenses.

[elevensecsrt4]

I would tend to look over these type of transactions that deal most with the founder or early directors of the company, nonetheless these types of transactions should not be "needed" by a public company per say, but they are there.  I am hoping it is leftover agreements that were established when the company was private... but nonetheless you are right they are definitely there. and require more research to validate motives. My hope is that they gradually dissolve these over time as they expire, lease to other companies or sell outright, consolidate warehouses or grow to need a bigger facility.

 

I'm still working through the annual report and conference calls before I initiate a position, but I am with you on the small letdown of reading them...it slows down the research process for me to evaluate motives and or priorities. :(

[hardcorevalue]

If this is a story partly reliant on logistics and speed of delivery then there are concerns about Amazon Fresh and their same day delivery expanding.

[KCLarkin]

Personally, I have never understood publicly traded companies with lots of related persons transactions.  Just smells fishy, always...

 

Good find. It seems like those transactions occurred several years before the company went public though. There are plenty of valid reasons for private companies to engage in those types of transactions. I'd be more worried about them if they occurred immediately before or after going public. Any thoughts on any distortions to the financial statements this would cause?

[Ross812]

I would overlook the personal transactions. Chef's Warehouse was a private company in New York since 1985. Christopher Pappas, John Pappas (I believe Chris's brother), and Dean Facatselis were all founding members of Chef's Warehouse and Dairyland USA. Both Dairyland and Chef's were founded in 1985, Dairyland services NYC from the Bronx and is a Subsidiary of Chef's. Christopher is the CEO of Chef and ownes 13.5% of the co, John Pappas owns 8% (he sold 1M shares 4% of co last September at 19) and is a director; it also appears he potentially opened a restaurant in the Hamptons recently, Facatselis was a founding member and was the CFO till 2007, he sold most of his shares (about 2.5M shares) in 2011 at around 14. All three men are in their 50's so they were in their early to mid 20's when starting the company together.   

[Ross812]

There are a few temporary drags on earnings. Once these are removed, the PE ratio looks more reasonable:

- New Chicago warehouse: 3m hit to P&L in q3/q4

- New Bronx warehouse - redundant capacity as they shift to new facility

- Inflation (unable to pass on unexpectedly high protein inflation)

- Various one-time charges

 

The new Chicago warehouse will be a major facility and will add meaningful revenue and profit once it is fully ramped.

 

The stock is down 40% YTD because the company has lowered guidance two or three times this year. It still looks a bit expensive -- based on my normalized earnings I would buy a big position at around $15.40. But SYY and UNFI are also very expensive, so I think buying at the current price is fully justified.

 

This seems to be a pretty classic roll-up. They can issue shares at 14x EBITDA and buy businesses at 8x EBITDA. As a roll-up, CHEF could easily grow EPS at 15% for the next 10 or 15 years (see UNFI as a good comp). Roll-ups tend to end badly but CHEF seems to have enough organic growth to keep them out of trouble for now.

 

Inventory turnover would seem to be the key metric for this low margin, high inventory business. I would expect their inventory turns to improve with increasing scale but I don't see any evidence of this happening.

 

Thanks, I forgot about the $3M in charges for the Chicago warehouse. I didn't see the redundant Bronx facility. Would you figure 1M in rent per year so maybe add 250k into EBITA once this is resolved? I figure the onetime charges are kind of an ongoing concern from Q to Q for a company like growing so quickly. Protein inflation should be more easily passed on as they bring Center of Plate offerings into their software.

 

I would agree that most roll ups end badly which happens when the acquirer issues stock at a higher multiple that the business they are buying. Eventually they start to run low on targets, growth slows down and a the associated lower multiple means they cannot issue inflated stock to acquire new business which means things go from bad to worse.

 

Successful acquisitions have to improve the target companies performance by either increasing sales and/or reducing costs or accelerate market access for the target or buyer's products. I believe this is why CHEF will be successful. If CHEF enters a market through an acquisition of a company offering 8000 products and expands the offering to that companies customers 4 fold, sales increase organically. Chef increased market access in the case of Michaels and Allen Bros. Allen Bros can now has distribution in NYC and San Francisco where their main market was strictly Chicago in the past.

 

I only have deep knowledge of Bidvest Food Service. Bidvest focuses on vertical integration along with scale to decrease costs and allow their targets to run more efficiently. Bidvest will often pay a premium for a local distributor with great management and build the infrastructure around them to cut costs then expand. This seems to be what Chef does as well though they do not have the clout for the kind of vertical integration Bidvest achieves. I think the key metric for CHEF is the operating margin. I would expect margins to fall (depending on the acquisition size) after an acquisition then return to normal as they integrate it into their operations.

 

I would watch inventory turns as well. Do you have any thoughts on how the center of plate acquisitions affect inventory turns? Inventory turns have fallen from 15 to 9 in the passed few years which seems resonableas Allen Bros and Michaels have increased sales quite a bit and may not hold the inventory (perishable meats) associated with Chef's distribution centers... UNFI has inventory turns in the 6-7 range, just reading the paragraph about the co it seems like they deal with a lot of perishable items. Where would you expect inventory turns to be for CHEF?     

[KCLarkin]

Thanks, I forgot about the $3M in charges for the Chicago warehouse. I didn't see the redundant Bronx facility. Would you figure 1M in rent per year so maybe add 250k into EBITA once this is resolved? I figure the onetime charges are kind of an ongoing concern from Q to Q for a company like growing so quickly. Protein inflation should be more easily passed on as they bring Center of Plate offerings into their software.

 

Management says duplicate rent on Bronx facility is 400k/quarter. They are hoping to get this off the books in Q1/Q2 2015. I'm not sure how material they are, but there were a bunch of legal expenses related to an audit of a past acquisition. These should be true one-offs.

 

There is a writeup on VIC that suggests the stock is trading at 14x to 15x their estimate of normalized earnings. I think this their analysis is a bit optimistic though.

[LC]

Not sure I like this play. Anyone have any deeper insight on the owners? Also this is a fiercely competitive business and what is to prevent a larger company (Sysco et al) from muscling them out? Also I would suggest doing some research on the customer profile.

[Ross812]

Not sure I like this play. Anyone have any deeper insight on the owners? Also this is a fiercely competitive business and what is to prevent a larger company (Sysco et al) from muscling them out? Also I would suggest doing some research on the customer profile.

 

I spent some time looking into the owners last night. Chris Pappas, the CEO, was a pro basketball player in Europe in his early 20's. The two Pappas (Chris and John) and Facatselis started Dairyland in 1985. They imported cheese from Europe and sourced milk and eggs to source to local restaurants in the NYC operating from the Bronx. They grew slowly over the next 20 years, sourcing more items and expanding throughout NYC, New Jersey, Connecticut, Washington DC and Maryland. They kept the name Dairyland in the Bronx but changed the name to Chef's Warehouse as they expanded their business.

 

In 2007 they were approached by Bear Stearns and sold them a minority share in the company working with the Private Equity branch Bear Growth to expand the business. In 2009 they went public and used the proceeds of the stock sale to pay off debt. Facatselis (co founder) stepped down as CFO and kept a seat on the board, he cashed out with 30M and left the board in 2011. John Pappas stepped down as the COO in 2011 and is still the vice chairman of the board; he sold about 1/3 of his shares for 12M dollars and appears to have started his own restaurant in the East Hamptons. Chris retains the majority of his shares and has been the companies leader from the beginning. This could be a case of Chris wanting to make the company something bigger and the other two founders leaving in their mid 50's with $30M to retire or take a less active roll and pursue other goals as is John's case. 

 

From reading Glass Door reports from CHEF current and former employees it seems CHEF has high stress sales jobs that pay well above average. Employees complained about bloated middle management, but seemed to have a positive view of the senior leadership. One employee who worked in the HQ office said that the big wigs like to party and eat out often. They complained moving up in the Co was based on getting along with the culture and not about being good at your job. Former employees may not look fondly on a old employer, but it sounds like CHEF may have a work hard play hard culture. Read some of Anthony Bourdain's stuff to get an idea of the culture the old guard management came up in.

 

New management and the BoD appears to be influence by Bear Stearns (now JP Morgan Chase). The new CFO spend 6 years with PFG food group and served as the CFO for an insurance company, one of the board members was a VP of food service for Pepsi, there is an PE investor, a local NY restaurant chain owner, a Wallstreet Human resource management company entrepreneur, and an expert in acquisition and mergers from Ernst and Young. 

 

I wouldn't worry about Sysco or other large competitors. CHEF sources ingredients for the high end. Sysco is not going to compete with quail eggs, 24k gold infused caviar, tomatoes flown in from southern Italy, 60 different kinds of olive oil, chickens raised in Pennsylvania free ranged and only fed natural proteins ect... Chef's customers are high end chefs, many of whom got their start in NYC and have opened up restaurants around the country. The founders have personal relationships with many of the famous chefs who are customers and word of mouth and the prestige of and having the best ingredients sets them apart from their competitors. Most great chefs study under other great chefs; the cream of the crop buy ingredients from Chef's warehouse, "the" NYC distributor for the high end. NYC is the center of the universe in the food world.