CHEF - The Chefs' Warehouse

[craigatk]

I was just going to post something but wow what great insight from Ross812. Thanks for sharing.

 

Generally my view on distribution is that there are a lot of smaller regional/sub-regional distributors out there which are usually family controlled/private and run old-school with inefficient business processes and low on technology adoption. I don't know much about food distribution, but I guess it doesn't vary that much. It is hard to grow much organically in distribution because there are already competitors servicing those customer accounts you want to acquire, so cutting margins and price-wars are one of the only ways to get in, but it's not a war you will do well with.

 

Instead of focusing on organic growth, there have been a number of distributors who have executed very well on this generic growth by acquisition game plan.

 

1. Search out and acquire selectively family-controlled private distributors in key markets with targeted customer segments and sometimes complimentary product lines. This is a highly fragmented industry generally and there are lots of targets.

 

2. Send in new management, take over customer accounts, offer those customers better selection (expand product line to full line card)

 

3. Improve operations and controls - especially by implementing technology for strategic pricing, wireless warehouses, financial controls/reporting, improved sales management, delivery route optimization, etc. Generally this is where the hidden margin is within distribution and where the best companies excel.

 

A quick look showed me that they have been following this game plan and executing fairly well. The question is how many more markets are they trying to get into and can they continue executing going forward.

 

It's their specialization in a specific niche that protects them from large competitors like Sysco. It's their ability to efficiently and quickly deliver hard-to-source ingredients from a deep one-stop-shop catalogue that protects them from smaller regional/privately owned distributors.

 

I still have no opinion on valuation.

 

 

EDIT: Forgot to say that this is one of the most important parts... is that you want to be the distributor that can offer everything your customer might need. This also gives a bit of a moat as the moment you back order an urgently needed item, or don't have something they are looking for in your catalogue, is the moment they call your competitor. This is why larger distributors who have mastered efficiency in their operations and offer the most number of product lines/items can actually make better gross margins. The best way to truly be a one-stop-shop is to have a very targeted and specific customer niche that you are trying to serve, because those types of accounts will need lots of the same things and need it in the same way.

 

[LC]

Ross, thanks for the info.

 

Full disclosure: I met a gentleman at the pub last night who was less than excited about Chef's warehouse. Knew personally gentlemen at Sysco, had met Chris P over a long period of time, etc. Very familiar with the industry. Also, very inebriated. Attempting to read through the slurred lines was difficult, but he did allude to the  fact that, "I wouldn't put your kids college fund in it".

 

So I didn't really get any details, and I'll take it with a grain of salt. He could be a disgruntled employee as Ross alluded to, but I have his contact info and if I learn any new insights into the industry, management, or CHEF's, I'll post them (and will also hold off any investment until then).

[KCLarkin]

"I wouldn't put your kids college fund in it"

 

That's what makes it interesting. I want to find stocks that can grow EPS at 15% but are universally despised. The fact that someone was willing to pay $30 for this in January and the stock is down 40% for reasons that I consider purely temporary means it is reasonable that someone might pay $30 once those issues are resolved.

 

I am still having a hard time getting conviction though due to competitive industry and low ROE.

[ItsAValueTrap]

The fact that someone was willing to pay $30 for this in January and the stock is down 40% for reasons that I consider purely temporary means it is reasonable that someone might pay $30 once those issues are resolved.

 

I don't know if that's a great argument because there are many stocks that have that kind of volatility.

 

There are many pump and dump scams that will exhibit wild price swings on the way to 0.

[KCLarkin]

I don't know if that's a great argument because there are many stocks that have that kind of volatility.

 

Yes, that's true if you take this out of context from the rest of the thread. I just find it interesting when a good company drops 40% because of temporary problems. In my experience, good things usually happen. With CHEF, I see 3 ways to win:

 

1. Earnings normalize in 2015 (20% EPS growth)

2. Underlying EPS growth of 15% for next several years

3. Multiple expansion after earnings normalize

 

But as mentioned, my conviction level is not high at this price. If it drifts down to $15.40, I will be very interested.

[HJ]

So I didn't really get any details, and I'll take it with a grain of salt. He could be a disgruntled employee as Ross alluded to, but I have his contact info and if I learn any new insights into the industry, management, or CHEF's, I'll post them (and will also hold off any investment until then).

 

LC, Please keep us posted on anything that you find on the industry or the management.  Curious mind wants to know...

[LC]

My mind is curious as well. Hopefully the gentlemen will be as candid when beer is replaced with coffee.

[mattone]

I started digging into CHEF a few weeks ago and it looks pretty interesting.  The readings on this board have been very helpful.  I have a few questions:

 

- CHEF doesnt include transportation costs in the GM line whilst other distributors do (SYY).  Some early sellside showed that it is about 9-10% of revenue - including that in the GM line, their margins are similar to SYY - hence no advantage on GM.  Anybody else look into this?

- SYY bought European Imports ltd (based in Chicago) in early 2012 when it was runrating $124mm in revenue.  It looks like EI is a comp to CHEF (CHEF bought EI's San Francisco branch and I believe EI bought CHEF's Arizona asset).  Anybody know how EI has been doing post-acquisition?  Is there something inherent in SYY's business that they cant scale specialty distribution?  I understand that CHEF has an advantage on breadth-of-offerings/delivery-times/service but is this less of a moat than appears?

- does anybody have the roadshow presentation (or any earlier ir presentation)?  on their site they show only recent ir presentations.

Thanks.

[HJ]

Here's an article on a private transaction within the business:

 

http://online.wsj.com/news/articles/SB10001424052702303647204579543512012597966#livefyre-comment

 

CCMP, mentioned in the article, took over the management of BGCP post Bear Sterns bankruptcy, BGCP is the entity that owned the Class A Units that CHEF redeemed prior to its 2011 IPO. 

 

http://www.sec.gov/Archives/edgar/data/1517175/000095012311034731/g26721sv1.htm

 

[KCLarkin]

I understand that CHEF has an advantage on breadth-of-offerings/delivery-times/service but is this less of a moat than appears?

 

It is a niche not a moat. I think this is a pretty narrow moat business but there are certain dynamics that will protect the business.

[Guest roark33]

If you step back from the financials and just think about the business, I think there are obvious problems. 

 

Think about a city like Cincinnati, where CHEF entered through its purchase of Queensgate.  There are really only a handful of upscale restaurants.  NY and San Fran foodies would be surprised, but there just aren't that many.  There just isn't enough operating leverage in a city like Cincinnati.  Less operating leverage means, lower margins...If you look at their S-1 and trace the financials, that's roughly what you see.  In certain cities, this company will work well, NYC, San Fran, LA, maybe Chicago, but this national growth plan just doesn't cut it.  The broadline distributors have a much bigger customer base and therefore can venture into these territories and still have sufficient operating leverage.  NYC and San Fran are so much different than other cities.  I have visited Cincinnati often (family there) and have never been to a place that charged anything more than $50, and that was the fanciest steak house in the city.  The margins just aren't there.  The mom and pops work in these cities because the are very low cost, they run old trucks, old warehouses, employ family members, but I just don't think the business scales as well.

 

If you think about it another way, they have spent roughly .5 sales multiple on their acquisitions and they project another $900m in addressable market gains.  If they had to spend 450m in cash to get that 900m in revenues--at 3% net margins, that's a 6% after-tax ROI.  That's not horrible, until you realize that they have only hit 3% net margins once in the past 5 years.  In other words, if you get perfect execution, you get 6% after-tax returns.  This isn't a perfect example because maybe they won't have to buy that entire revenue portion, but....

 

Another way, their revenues have grown by $493m since 2009 when they had $9m in net income on $271m of revenue.  Since 2009, they have spent roughly $177m on acquisitions.  2013 Revenue was $674, so revenues have increased by $403m, but net income was $14 in 2013.  So, for the $177m they laid out in acquisitions, they got a lousy $5m extra in net income.  That's a 2.8% return...and this doesn't even take into account the extra A/R and inventory they are financing. 

 

I just don't get it, but I enjoy the discussion...

 

My personal opinion is that you can sell a small local distribution company to an intelligent buyer for a reasonable price or you can embark on a roll-up strategy and take that company public and sell it at an inflated price to the dumb public.  Let me review the def 14a to see if the insiders have been selling.....?

 

 

 

 

[KCLarkin]

There just isn't enough operating leverage in a city like Cincinnati.  Less operating leverage means, lower margins...If you look at their S-1 and trace the financials, that's roughly what you see.  In certain cities, this company will work well, NYC, San Fran, LA, maybe Chicago, but this national growth plan just doesn't cut it.

 

I agree with most of your post but I think this is a bit simplistic (especially the "maybe" around Chicago -- Alinea is possibly the best restaurant in the US.)

 

Off the top of my head, NA Foodie cities include:

- NY

- SF

- LA

- CHI

- LV

- Miami

- Toronto

- Vancouver

- Montreal

- New Orleans

 

I'm also not sure if your simple ROI calculations make sense. At the very least, I think you need to add most of the Amortization back to Net Income. Also, some of their larger acquisitions were done in 2013, so the Net Income doesn't include the full benefit of those acquisitions (Allen and Qzina).

 

[KCLarkin]

http://seekingalpha.com/article/2512365-chefs-warehouse-over-eating-at-the-m-and-a-table

 

This article pretty much sums up my thinking on this one. CHEF is a bit like "two-face" from Seinfeld. I like the depressed earnings due to growth OPEX. I don't love the low quality growth. Interestingly, he gets fair value at $15.44 which matches my buy target of $15.40.

 

I am very tempted at this price.

 

[KCLarkin]

ROSS812, I just bought a small position (~1%). I will build this up if drops into the $15.50 range. Let me know if you find anything interesting or have further insight related to CHEF.

[Homestead31]

Hi - i've been lurking for a bit, but i'm just joining the conversation now b/c i just joined the boards today.  i'm excited to be a part of the exchange of ideas here.  there is really some great stuff!

 

as for CHEF - i have a few quick thoughts...  first, i think this is very attractive.  what hasn't been mentioned is that distribution in general is a great business b/c once your network is built out, capex is minimal.  think about it - how much does it cost to keep a warehouse running?  almost nothing.

 

Capex from 2011-2013 was $2M, $3.1M, and $11.7M.  This year it is estimated to be $32M, and next year will likely be somewhere around $20 - $25M (my very rough guess).  After that, assuming they steady state for a little while and digest their recent expansions capex should be in the mid teens.

 

management has indicated that they believe they will be able to do $1-1.5 billion in sales when the current growth initiative is complete, and that they can achieve 7% EBITDA margins (they did 7.5% in 2011).  7% might sound high b/c as was mentioned previously they are moving into less attractive geographies than target rich geographies like NYC etc, but at the same time they will have significant leverage embedded in their warehouse build out.  ie - if you build a warehouse, it costs the same to maintain whether it is half full or completely full.  so maybe they can do 7% margins. 

 

as a base case lets assume they can't though, and lets assume they can only hit the low end of their sales target of $1B.  At 6.5% EBITDA margins, if you give them a 12x EV/EBITDA (which is low for this very low capex business) that gets you a share price appreciation of 57% assuming steady state capital structure and cash balance.  it is entirely possible that they take on more debt making the EV a bit less attractive, but if they are taking on debt, that means they are doing acquisitions which means they are growing faster which means the market gives them a higher multiple.

 

as a downside case lets assume they finish up their current spending in a year or 2, but see no sales benefit and they come in slightly below FY'14 revenue guidance at $800M.  Lets stick with that same 6.5% margin (they did 6.6% last year when they were starting to spend on expansion so 6.5% seems reasonable), and lets give them a 10x EV/EBITDA because even though they aren't growing, this is still a business where an awful lot of cash flows through b/c capex is almost non existant.  that gets us a return of -6%.

 

As an upside case, lets assume they hit $1.2B in sales and hit the 7% margin guidance.  Putting a 14x on this (not crazy based on history here and at SYY, as well as for other low capex distributors in general) gets you to 152% return. Also note that as an upside case i said $1.2B in sales, where management has indicated that upside could be $1.5B.

 

 

i suppose the downside case is possible b/c as was mentioned previously in the thread there just aren't that many great foodie cities.... however, i think this is very unlikely.  first, the use of the term "high end restaurant" needs to be qualified a bit.  there are serious restaurants that are really high end out there, and there are chain restaurants like TGIFriday's and Apple Bees, and there is a whole lot in between.  CHEF doesn't have to cater to only the highest of the high end, and there are plenty of chefs out there in mid sized suburbs in the midwest etc who take real pride in the food they serve their customers.  there is an obvious relationship between the density of these restaurants, the population, and margins, but its not as if america is a food desert outside of the handful of major cities that were mentioned previously.  importantly, the "foodie" movement is only growing as consumers become more conscious of the farm to table movement etc.  (google growth of foodie movement)

 

on my quick and dirty operating model i have them getting to $68M in FCF in 2017 (my model allows for mid single digit organic growth, and acquired sales growth on a P/Sales basis of .5x inline with historical transactions - this growth does rely on tapping the revolver - and gets me to a bit over 1.2B in sales in 2017).  it is reasonable to think this company could trade at 15x FCF... which gets you to equity value of more than $1 billion vs current market cap of ~$400 million.

 

....now, all that being said, i'm probably wrong about something somewhere.  maybe margins or growth or something doesn't work out the way i think it can.  that's totally fine b/c in my view the margin of safety here is huge.  With downside pegged at a couple hundred bps and upside of more than 100%, i think the risk reward is compelling.

 

this is a great business in disguise b/c of temporary increased growth spending.  importantly, and also ironically, it is so cheap at the moment b/c the stock was previously a growth crowd darling...  then when it time to actually PAY for that growth, the growth crowd quite predictably all headed for the exits at the same time, and the momentum crowd jumped in, etc etc.  its tough to catch a falling knife, but as has been said by more accomplished investors than myself, you can't have comfort and value at the same time.

 

i realize this is one of my first posts, so i feel like i need to put a disclaimer on this - i'm not one of these guys that pumps up sexy story stocks.  most of what i like is pretty dirty.  however, i think CHEF is an exceptional opportunity and have sized it as such in my portfolio.

 

i hope this wasn't too forward for my 3rd post...  and i look fwd to discussing more. 

[KCLarkin]

Has a base case lets assume they can't though, and lets assume they can only hit the low end of their sales target of $1B.  At 6.5% EBITDA margins, if you give them a 12x EV/EBITDA (which is low for this very low capex business) that gets you a share price appreciation of 57% assuming steady state capital structure and cash balance.  it is entirely possible that they take on more debt making the EV a bit less attractive, but if they are taking on debt, that means they are doing acquisitions which means they are growing faster which means the market gives them a higher multiple.

 

Great analysis and contribution LWC! My only concern with your base case (and the CHEF growth story in general) is potential dilution. They aren't generating enough cash to fund their current growth. They have some room for more debt but I suspect they will need to issue additional shares before they hit $1.5B.

[Homestead31]

i suppose it is possible, but i think it is unlikely.  First, any near term growth can be funded by their $140M revolver which w/ the exception of a small letter of credit is un-drawn.  Their 3 most recent acquisitions were done at P/S ratios of .4, .5, and .55, so in theory they could buy somewhere between $225 - $325 million in sales right there...

 

but more importantly than the revolver is the fact that they have already grown significantly so they have a wider base on which to build more growth.  in other words when they were only in one city, there was only one city producing cash to fund growth.  now there are several cities producing cash to fund growth.  by my estimates in 2-3 years they'll be producing $50-60 million in FCF, which can be used to internally fund growth. 

[KCLarkin]

First, any near term growth can be funded by their $140M revolver which w/ the exception of a small letter of credit is un-drawn.  Their 3 most recent acquisitions were done at P/S ratios of .4, .5, and .55, so in theory they could buy somewhere between $225 - $325 million in sales right there... >:(

 

They need to fund organic growth too. They need a lot of working capital for all the inventory they carry.

[muscleman]

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%.

 

This reminds me of John Malone, who do not care about EPS, and focuses on scale. The question is how would we decide which is the right price to buy?

[Homestead31]

inventory actually doesn't concern me here - they turn it over pretty quickly - these are consumables after all.

 

in 2010 and 2011 YE inventories were 6.7% and 8.1% of COGS respectively.  that jumped significantly in 2012 and 2013 to 11.4% and 12.9%.  Part of the jump is because some of the new businesses they have entered just have slower inventory turns - for example, the meat business that ages steaks for ~30 days is a drag on historical inventory turns. that is not something that will go away.  however, part of it is surely just related to expansion - basically have more inventory on hand for when customers come online, even though they may not have come online yet.  that should revert as the new geographies mature, but i haven't modeled in any benefit from that... i'm conservatively sticking with 12.9% inventories / COGS for my working capital assumptions.

[Ross812]

Efficiency                         TTM 2013-12 2012-12 2011-12 2010-12 2009-12

Days Sales Outstanding 35.58 36.07 37.83 36.02 40.03 — — — — — —

Days Inventory             39.16 38.28 33.02 24.97 24.56 — — — — — —

Payables Period          24.09 24.63 32.92 33.40 35.20 — — — — — —

Cash Conversion Cycle 50.65 49.71 37.93 27.59 29.39

 

DIO increased due to the meat processing acquisitions. Any idea why DPO has been falling? On a side note, DPO is consistent with SYY and UNFI. DSO has been falling which means they have been doing a better job collecting on accounts.  Its hard to find a good comp for CHEF. Hard to source specialty non perishable ingredients and aged products (beef) require inventory on hand rather than SYY or CORE who can work with their suppliers as orders come in. UNFI seems like a good comp in this regard with a CCC of around 50. It will be interesting to watch if DIO stays around 38 as they digest the center of plate acquisitions (no pun intended!). Looking at this data it seems like 60-70 days of average COGS would be needed as working capital. ~17.5% of COGS or 100M.

 

Edit: ~50 days of COGS make up working capital presently ~80M. I would imagine a prudent CFO would reserve ~25M from the credit facility to fund future growth. Ex: 15% growth on 80M is 12Mm then another 10-15M as a buffer against AR/AP problems.

[KCLarkin]

Edit: ~50 days of COGS make up working capital presently ~80M. I would imagine a prudent CFO would reserve ~25M from the credit facility to fund future growth. Ex: 15% growth on 80M is 12Mm then another 10-15M as a buffer against AR/AP problems.

 

I suspect they would want and need a large buffer on their credit facility. They would want to maintain flexibility for recessions, opportunistic acquisitions, etc.

 

Regarding their cash conversion cycle, it is really impossible to see what is happening to their underlying business. Each business they acquire will have very different profile (for example center of plate will have different suppliers which will have different payment terms, smaller markets may have lower inventory turns, new markets might be less efficient). Ideally, you would see the CCC improve as they implement their IT system for new acquisitions and increase their market penetration. But to get clean numbers, you would need details on "same store" CCC which are not publicly available.

[AzCactus]

Anyone have an idea of why this is down so much today ?

[AzCactus]

As a follow up I never usually care when any of my holdings are down on a given day it just seems strange given that there's no news and the market is barely moving. 

[KCLarkin]

It's back in my buying range after the sell-off in the last hour. I assume the weakness is related to the Sysco earnings call but I haven't listened to the call yet, so can't be sure.