AMNF - Armanino Foods Distinction

[rpadebet]

I wanted to do a quick write up about a very simple consumer non cyclical business I came across with amazing ROA & ROE, Good Margins, Minimal debt, above average growth in revenues and good capital allocation. To top it off, it is trading very cheap compared to its less growing, more leveraged, mid-large cap comps.

 

I cant take credit for the idea as I found it on the restricted section of VIC (Value Investors Club). Since I am not a member I couldn't access the write up there, so did my own research on it. As I learnt about this company, I couldn't help but noticing that this is a Buffett type company, but too small for him or most of his institutional followers. But for a personal account it could do wonders.

 

This is nano/micro cap company which currently has a market cap of 48 mill with about 33 million shares outstanding ($ 1.45 price as of today).

 

Business and Revenue:

The company makes and sells frozen Pesto food, sauces etc to distributors and large supermarkets under the brand Armanino. It is based in California. Nothing sexy or complicated about the business, but they seem to have managed to grow revenues almost magically at >10% rates for a long time (which includes the crisis years as you know). Their growth rates if you compare against their large cap competitors (which are struggling to grow revenues) is well above average. In 2012 they had 28 mill of revenues and in 1H 2013 they had 13.9 mill.

 

Margins

Growing Revenues is one thing, but maintaining high margins and growing in the consumer business is as most of you know very very difficult. This company has consistently had about 35% Gross margins on its products. SG&A and operating expenses come to about 17%-18% of revenues recently. They have been growing their operating margin from about 12% in 2009 to about 16-17% recently. This performance indicates they have some sort of pricing power or moat, which is very surprising to me at least.

The only off putting to me here was their high tax rate of about 36%. This implies a Post tax income of about 3-3.2 mill.

They don't seem to do lot of Capex, but recently they seem to have invested quite a bit in some new machinery which as per management was done to build the international part of the business. Given their high growth in revenues, their working capital also grows and thus Free cash flow though adequate, isn't a very good measure for this growing business.

 

Balance Sheet

Cash and Cash Equivalents are about 2 mill. Working capital ex cash about 3.7 mill. PPE (gross) 7.7 mill, PPE (net) 1.25 mill. they have a small amount of goodwill and other Long term Assets, Bringing the total Assets employed to about 10 mill and total tangible assets to 9.6 mill.

 

Their Long term debt is about 1 mill currently which they have been steadily paying down over the years. Finally their book value of Equity is 6.5 mill

 

Return Analysis

As you probably noticed, this business seems to generate 3-3.2 mill of Post tax income on assets employed of about 9.6-10 mill. This a Return on Asset of 30% or greater. Return on Equity is even better at close to 50%. How is this possible? Well if you are familiar with the Dupont Analysis, then this can be explained via high profit margin combined with high turnover (i.e. Sell many products at high profits, kind of like Coke does).

 

I checked some of the marquee consumer food products names and not many even come close to this performance.

 

Capital Allocation

Given all the good things happening above, if you expect some sort of risky capital allocation going on in this business, then you would be wrong. Yes they want to grow internationally and management suggests they are not growing fast enough there and wouldn't for some time, that is precisely why they invested in some new machinery to help make better products for the international market. The management is very conservative when it comes to capital allocation historically and prefers to return cash to shareholders over investing in the business for new growth.

 

They have had 51 consecutive quarterly dividends. Last year was 1.2 cents and this year in june they raised it 16.67%% to 1.4 cents a share, giving a current yield of about 3.85%.

 

As if this wasn't enough, these guys seem to have a history of declaring special dividends each year (they paid Special Div of 1.2 cents in Sep Quarter last year) and that makes the potential annual dividend yield a bit more than indicated. They paid the Dec Cash dividend in december itself instead of Jan this year, probably to help the owners avoid the tax increase.

 

If you are worried they might have to cut their dividend because they are running such a low cash retained business, you have to notice that they made about 10 cents a share last year and paid 0.6 including the special div. The dividend seems to be amply covered by the operating cash flow alone.

 

 

Valuation

Coming to valuation, we know that Consumer Food products businesses trade at a above average PE ratio compared to the market. In today's world the sector average is 20 and the good ones are 25 ish. I don't know about most investors, but I think a fair price for such a business is 20 PE ignoring the above average growth. 25 if you want to pay for the growth. I want it free personally. And I do challenge you to find a low levered consumer business with similar ROE and ROA trading at PE below 20.

 

Where is this trading at right now? Trailing PE of 15.4, even below the S&P forward PE!! We know how much earnings there are scheduled to grow!

 

So where would I value it?

I am not paying for growth. So putting an average 20 PE over 10 cents EPS, I get a price of $2. A bullish growth investor would probably pay 25PE over 11 cents EPS, or $2.75.

 

Given the current price of $1.45. A conservative valuation indicates an upside of 38%. 90% upside if you are bullish and want to pay for growth. I don't know when price will catch up to value, but I see value going up each time they grow their revenues. I don't mind waiting as long as it takes for this to happen because while you wait, you get paid 3.85% dividend at least and a chance for a special dividend every now and then.

 

Thanks for Reading

 

 

 

 

 

[Palantir]

Interesting idea, nice to see a solid writeup. Taking at 20x earnings, I get 57.8M, which is only 25% higher than it's current price.

 

 

I personally prefer FCFE as a proxy, roughly they generate 2.2M in FCF, assuming no growth, capitalize that at 7%, I get 31M, so it doesn't really strike my at cheap, but my framework could be all wrong!

 

 

[siddharth18]

Thanks for posting this. This has been covered in the past here and here - when the price per share was around $1.05. I did like the business for the most part - conservative/family managed company with decent capital allocation track record.

 

From the annual report you will notice that they do rely for a lot of their volume on just 1-2 distributors. This may not be a deal breaker but you have to keep that in mind before you take a plunge into this.

 

A very good acquisition target for sure tho (as whopper discussed).

 

[LC]

Yep, this has come across my eyes a few times. Solid company, everything you mention is pretty much spot on. How much larger they can get before bumping into the larger branded food companies is the question. Best case scenario is a sale of the company to someone bigger.

[rpadebet]

Thanks for the posts.

 

siddharth18: thanks for the links. Didnt realize it was already written up elsewhere. It would have cut out my research work to have known abt it before. I should have googled :).

 

LC: agreed. I think being taken over by one of the majors is high probability. I don't want that to happen, because then I have to find a replacement. I hope this goes on for sometime before that happens.

 

Palantir: I used some old numbers and rounding in my calcs. my bad. Trailing 12m earnings I see is 3042mill. 20 times is 60.8 mill ish and current market cap is more like 47 mill than 48 mill i indicated. So 30% upside at 20PE ;)

Regarding FCF, I prefer using that most of the time. But in this case as it is a growing business, I couldn't break out the Capex into Maintenance and Growth parts. Although it seems like their US business doesn't require much maintenance. And working capital has also been growing, which reduces Operating Cash flow. I don't know if this is because they are expanding internationally or because they are being squeezed by their distributors.

[fareastwarriors]

This company is like 20 minutes away from me but I never even heard of it. Interesting converstation guys, love to hear more.

[rpadebet]

The thing I am unable to wrap my head around is the gross margin and operating margin levels. Their size seems to suggest a competitive advantage or presence of some sort of moat. The sustainability of those margins are key to the valuation here.

 

Maybe someone on the west coast who has seen or used their products could help add some color with respect to that :)

[ItsAValueTrap]

I don't know if I'm a foodie, but part of me is against what they do.

 

They have two main lines of business:

1- Selling frozen food at the retail level.  I don't have a problem with that.

2- Selling frozen food to restaurants.  They are an enabler of lazy cooking.  As far as I can tell, most of Armanino's business is this type of wholesale business.

 

A restaurant can make fresh pesto from scratch and it will taste a little better.  Arguments for using frozen pesto are:

A- If the restaurant doesn't have high volumes of dishes with pesto in it, then it gets a lot more expensive to make it from scratch.  It's more efficient if they make a large batch of pesto at once.  If they have a lot of items on their menu, then they won't need a lot of pesto and it is arguably more expensive for them to make it from scratch than it is to use frozen pesto.

If they were smarter, they would reduce the number of items on their menu.  Most restaurants have too many items on their menu.  They can create value by doing a small number of things very well.

B- Some people are just lazy!

C- Some people just want idiotproof cooking.  They want to heat pre-made food and serve it.  Sometimes pre-made food tastes just as good as fresh food (e.g. ice cream, Momofuku's steamed buns, etc.).  I don't have a problem with that.  But I see frozen pesto as a form of cutting corners.

 

That being said, this is a wonderful business.  I would probably be buying shares if the price were a little lower.

[rpadebet]

ItsAValueTrap: I think you just might have helped me understand the moat here. Or maybe I am just looking too hard for it  :)

 

I overlooked the food services portion of their business. I was thinking of only the retail aspect. If they are indeed selling to local restaurants then I think that explains their pricing power and competitive advantage. If I think as a restaurant owner who uses the frozen pesto sauce in the food I prepare, I know my customers are used to and expect a certain kind of taste/flavor in my food. If I change the ingredients, I risk tinkering with that flavor, so why would I do it unless my current supplier is charging me an exorbitant amount. So this is how I think Armanino is able to raise or maintain prices without being replaced by a lower cost competitor. Could it be that the secret sauce is really the frozen sauce here!

 

But like I said, I maybe over thinking this.

[ItsAValueTrap]

I don't think they sell to restaurants directly.  They go through distributors. 

 

Costco is one of them:

http://www2.costco.com/Browse/Product.aspx?Prodid=11756827&whse=BD_823&Ne=5000001%204000000&eCat=BD_823|9897|10783&N=4033918%204294891061&Mo=0&No=0&Nr=P_CatalogName:BD_823&Ns=P_Price|1||P_SignDesc1&lang=en-US&topnav=bd

 

Here is another:

http://www.foodservicedirect.com/index.cfm/S/491/CLID/4113/N/116290/Armanino-Frozen-Basil-Pesto.htm

 

You can buy 38 pounds of this stuff for $148.85.

 

2- I really don't think that they have a moat.  Is frozen pesto interchangeable?  They might be really good at freezing it well.  How you freeze something matters.

 

On the other hand, restaurants can switch to fresh pesto if the price got out of hand.  Fresh pesto would be superior.

 

I know my customers are used to and expect a certain kind of taste/flavor in my food

A lot of restaurants change their ingredients all the time.

 

Taco Bell used to have real green onion in fries supreme, but then they took it out and replaced it with some dried crap that's just not the same.  I'm sure that you can find many other examples.

[fareastwarriors]

I don't think they sell to restaurants directly.  They go through distributors. 

 

Costco is one of them:

http://www2.costco.com/Browse/Product.aspx?Prodid=11756827&whse=BD_823&Ne=5000001%204000000&eCat=BD_823|9897|10783&N=4033918%204294891061&Mo=0&No=0&Nr=P_CatalogName:BD_823&Ns=P_Price|1||P_SignDesc1&lang=en-US&topnav=bd

 

Here is another:

http://www.foodservicedirect.com/index.cfm/S/491/CLID/4113/N/116290/Armanino-Frozen-Basil-Pesto.htm

 

You can buy 38 pounds of this stuff for $148.85.

 

2- I really don't think that they have a moat.  Is frozen pesto interchangeable?  They might be really good at freezing it well.  How you freeze something matters.

 

On the other hand, restaurants can switch to fresh pesto if the price got out of hand.  Fresh pesto would be superior.

 

I know my customers are used to and expect a certain kind of taste/flavor in my food

A lot of restaurants change their ingredients all the time.

 

Taco Bell used to have real green onion in fries supreme, but then they took it out and replaced it with some dried crap that's just not the same.  I'm sure that you can find many other examples.

 

 

3.92/lb is not particularly cheap for meat balls... I would think there might be some kind of bulk discount..

I can buy ground beef at 2.69/lb at my local Trader Joes and sometimes cheaper during sale time at Safeway.

[ItsAValueTrap]

Apparently fresh basil goes for anywhere from $5 to $20/lb (from small growers).

 

http://forums.gardenweb.com/forums/load/market/msg0708495822433.html

[petec]

At first glance this looks like the kind of idea I love but I am always concerned when a margin increase and a P/E increase coincide.  Both *really* have to be sustainable or you can get killed.  looking at the longer term graphs, 2009-12 seems to be an odd period for this company on both counts.

[bookie71]

Quote

I know my customers are used to and expect a certain kind of taste/flavor in my food

A lot of restaurants change their ingredients all the time.

.

A client with a very successful upscale Italian restaurant told me he was very particular where he buy's his ingredients because of this fact and he will pay more to get the right taste. 

[rpadebet]

Quarterly report out. Record quarter again.

 

http://seekingalpha.com/news-article/7894102-armanino-foods-of-distinction-inc-reports-highest-quarterly-sales-and-income-in-its-history

[fareastwarriors]

rpadebet,

 

Any additional thoughts on the quarter/thesis?

[rpadebet]

rpadebet,

 

Any additional thoughts on the quarter/thesis?

 

Not much to add, seems like it is just chugging along fine. Domestic sales seem strong but revenue growth seems to have moderated over the past few quarters and they are still trying to get the international sales to grow with new products. Anyone's guess how that would turn out. Operating earnings still seem to be maintaining a healthy growth rate though.

 

The thing I like about this company is it doesn't change much. It just sits there in one corner and compounds at a healthy rate. Other businesses in my portfolio provide me all the excitement I need.

 

 

[rpadebet]

Another Dividend increase

 

http://www.armaninofoods.com/Press_Releases.aspx?id=43

[ItsAValueTrap]

The thing I like about this company is it doesn't change much.

 

But it does.  They've had to shut down some of their product lines in the past.

 

They also had a bout of diworseification.  e.g. they used to be in the restaurant business.

[rpadebet]

The thing I like about this company is it doesn't change much.

 

But it does.  They've had to shut down some of their product lines in the past.

 

They also had a bout of diworseification.  e.g. they used to be in the restaurant business.

 

Fair point. Good to keep an eye on for similar changes going forward.

But wasn't the diworsefication attempt under previous management. Current management seems to be content focussing on core business.

[ItsAValueTrap]

But wasn't the diworsefication attempt under previous management. Current management seems to be content focussing on core business.

 

The last CEO died in 2009.  The former COO is now the CEO.  I do think the current CEO is focusing on the core business and won't diworseify.

 

Here's a writeup I did of the company with a small amount of information on the company's past:

http://wp.me/p1mOGr-r3

[rpadebet]

Like clockwork - another 12.5% dividend increase. In someways this is cheaper than when I initially wrote about it last year

 

http://seekingalpha.com/pr/11007755-armanino-foods-of-distinction-inc-raises-its-regular-quarterly-dividend-by-12_5-percent

[Guest Schwab711]

I think you have a case of a no-moat, well-run company here. I was just looking at this @ the $1.90 level it's currently trading. I love the margins, business seems steady/repeatable (depending on footprint you definitely have regional-macro risk). Their COGs is low enough that I don't think others could compete with a reasonable risk/return profile but as mentioned, that does not mean AMNF has pricing power or a moat. Somewhat dependent on choices of regional restaurants (and I guess consumers). I think it's likely the same percentage or higher switch to frozen food instead of fresh at restaurants because successful restaurants need to avoid waste! AMNF will likely experience unchanged demand due to competition because of restaurant choices. Simply put, it's likely cost effective to use frozen food where possible (I think there's a reason McDonald's does).

 

With that said, the market is at a high valuation level and this isn't a Moody's business. Do I really want to waste precious resources on a 'good investment'? I'm thinking of a very small allocation just to get my feet wet, although I hate the idea of investing when not completely confident - I'd rather watch a strike then swing out a down-and-away slider.

 

Anyone have thoughts on margins, returns, business/moat? I know my opinion of the business doesn't match the margins but this has to be just a well-run business given any logical review of the business model, right?

 

2013 AR - Returns:

ROE 45.89%

ROTE 48.39%

ROIC (ex-cash) 31.55%

ROA 30.46%

RNWC 51.58%

GMROI 4.91

 

These numbers are incredible! Low inventory and receivables for the market cap. I may break my own rules for this one. Dividend is the perfect amount to maximize returns!

[ItsAValueTrap]

I'm pretty sure they have lots of competitors in their space.

 

I think it's likely the same percentage or higher switch to frozen food instead of fresh at restaurants because successful restaurants need to avoid waste!

I don't think that the reason is to reduce waste.  The appeal of frozen pesto is that it's convenient.  It doesn't taste the same as fresh though (apparently).

 

Chipotle is an example of a restaurant that executes the fresh food model very well.  They make their ingredients from scratch.

Chipotle used to be owned by McDonald's.  McDonald's does a lot of pre-made, frozen stuff.

 

Both models are viable.  Obviously Chipotle does not make pesto because it's TexMex/fake Mexican/Mexican, not Italian.

 

2- One of the advantages of pre-made food is that you have lower capex needs for the kitchen, and the kitchen runs more efficiently.  Tim Horton's takes this to an extreme.

 

3- I do agree with you that there's no moat and that management is excellent.

 

*I owned this briefly.  I may have made a mistake in selling.

[Guest Schwab711]

Does the consistently high returns scare off anyone? The returns just don't seem to match the business model on a smell test... If it weren't for the business model I would buy this anytime it trades at or below 10x operating income.