Middleby is Killing It
Board: Middleby Corp.
Cross-post from behind the pay wall.
Well, you don't need me to tell you that Selim & Co. killed it again in Q4. All you have to do is look at your stock ticker. As I type this, the shares are up about 13 percent to a couple of bucks shy of $300 apiece. Crazy.
The market cap has swelled to about $5.7 billion. Automated services including Yahoo will show a price/earnings ratio of about 39 until they plug in the new denominator, which brings it down to about 36 (298/8.21). Still very high by historical standards, which we'll get to presently.
Middleby is is not only firing on all cylinders, it's adding new cylinders to the engine as it goes. The biggest news from the conference call was the accelerating momentum of the automated kitchen of the future, which, you may recall, was installed in all Chili's stores mostly in 2012. Selim disclosed that another casual dining chain of similar size has begun a similar chain-wide installation. He expects the bulk of it to be delivered in the back half of 2014. The Chili's installation took six quarters, all told.
Selim did not identify the chain now adopting the kitchen of the future, but there aren't many possibilities. Chili's is among the top five casual dining chains in the country by revenue. The others are Applebee's, Olive Garden, Red Lobster and Buffalo Wild Wings. Selim said the current KOF customer, like Chili's, will be outfitting 1,200-1,500 stores. So far as I can tell, the only single chain with that many stores is Applebee's. So either that's the customer or Darden has placed an order for more than one of its brands, say Olive Garden and Red Lobster, or Buffalo Wild Wings is expanding really fast.
In any case, it's a big order. Here's the math: $30,000 per store times, to be conservative, 1,200 stores, equals a $36 million order, the revenue to be recognized over the course of several quarters. At 1,500 stores, it's a $45 million order. That may not sound like that much in the context of a company with a revenue run rate of more than $1.4 billion in 2013, but Selim suggested this is just the beginning. There is an opportunity to retrofit 15,000-20,000 casual dining restaurants with the kitchen of the future in the U.S. alone in the next several years. Some 20 chains are looking at it. That doesn't count fast-casual or fast-food chains, which are also beginning to look at it, nor does it count the international opportunity.
"It could be hundreds and hundreds of millions of dollars for us over the next few years," Selim said.
This is just one of the burgeoning opportunities in the commercial food service and food processing segments, nearly all of them built on Middleby's industry-leading technological innovation. The waterless steamer and waterless steam table introduced late last year are just beginning their adoption cycles. They promise to be extremely popular wherever water supply or cost are issues, which applies, increasingly, to much of the world. Middleby's ventless cooking technology is now being offered across a broad array of products. This, too, promises to be popular wherever traditional (and expensive) restaurant duct work is not available. And, of course, the Viking acquisition opens up an entirely new market in high-end residential cooking equipment. For the first time, Middleby's technological innovations will be available to the home. The potential here is enormous.
Selim's laser-like focus on the needs of his customers is separating Middleby from its largest competitors (Illinois Tool Works, Manitowoc) by means of these technological innovations. He talked on the call about a "fire oven" that will cook a pizza in 90 seconds. For larger, automated operations, the third generation WOW conveyor oven, which also cuts pizza cooking times over its revolutionary predecessors, is now rolling out.
The Viking acquisition, the largest in Middleby history, is now mostly digested. The company has taken over most of the company's widely disparate distributors, which was a labor-intensive process requiring lots of individual negotiations. Viking's operating margins were up to about 15 percent in Q4 and should achieve the goal of matching company-wide operating margins of 20 percent or more by the end of 2014, one year ahead of schedule. Selim sounded as if he expects profitability to grow rapidly at Viking now that the complex integration process is largely completed. The entire line of products has been overhauled, the no-quibble warranty has been added and the market has responded enthusiastically so far.
International operations continue to grow by double digits, with Latin America leading the way in Q4 at more than 20 percent. A recovering Europe was also in double digits. Asia grew in the high single digits because of retrenchment by at least one major customer due to food safety issues (this is likely KFC, which was hit by a tainted chicken scandal in China). The flip side of this coin is that increased focus on food safety in China represents an opportunity for Middleby's food processing technologies. Smithfield Foods, one of the largest food processors, was acquired by China's Shuanghui International Holdings for $7.1 billion (including debt) last year. Selim pointed to this as an example of China trying to acquire the technology to improve food safety, an auspicious sign for Middleby's food processing segment.
So, big picture, everything is humming. Selim predicted 2014 would be a lot like 2013 for Middleby and its customers.
Now let's talk value. Middleby reported net income of $2.62 per share in Q4, $0.37 more than the Capital IQ consensus estimate of $2.25. Revenues were $377.4 million, compared to the consensus estimate of $364.86 million. This represents the final quarter where the previous year comp does not include Viking, so let's look at 2013 as a whole.
Net sales were $1.43 billion, which represents a 38 percent increase over 2012 ($1.038 billion). Net income was $8.21 a share, which represents a 27 percent increase over 2012 ($6.49). These growth numbers make today's earnings multiple seem reasonable. However, if you back out Viking's sales of $231.7 million to get apples-to-apples year-over-year comps, the company-wide revenue increase is cut by more than half.
Organic growth in the commercial food service segment was 12.6 percent in Q4 and 11.1 percent for all of 2013. Including the acquisitions of Celfrost and Wunderbar, the commercial food service segment grew by 14.7 percent in the quarter and 13.9 percent for the year.
Facing difficult comps from a big order in Q4 2012, the food processing segment actually declined slightly in Q4, by 2.2 percent, but increased 19.7 percent for the year. Excluding the revenue from Baker Thermal Solutions and Stewart Solutions, acquisitions completed in 2013, growth in the food processing segment was 8.3 percent in 2013.
As you will note from David Gardner's post earlier today and Tom Engle's page posts, I am in the minority here on the subject of Middleby's valuation. So far, I have been wrong, as it has continued to climb higher, not only in terms of price per share but also in terms of its expanding P/E multiple.
The latter, in my view, cannot and will not go on forever. There will be another bear market at some point -- and, five years into the current bull market, I would suggest sooner rather than later, although exactly when is anybody's guess -- and Middleby's multiple will one day be back where it has historically been, which is somewhere between a half and two-thirds of where it is today. It is my theory that once Viking's base is added to the previous year's comps, which will happen beginning with the next earnings report, the growth numbers won't look so spectacular and the froth may come off the P/E. Even with all cylinders firing, organic growth here should be in the teens. Customary, smaller acquisitions could pump it slightly higher, but, barring another giant acquisition, we will not be seeing revenue growth of 35-40 percent per quarter as we have over the past four.
Which leads to a more philosophical discussion. The reason I am in the minority here is because I am not describing the Rule Breaker attitude, which is best left to David G., who embodies it. He points out that Middleby stock has nearly doubled from the original RB rec nearly a year ago, meaning that anybody who listened to me suggest that it was expensive then would have foregone a quick double by abstaining from buying. Moreover, as I have previously confessed, I did just that myself back in the aughts, waiting over a year after Tom Gardner's three Middleby recs in Hidden Gems for a better value point before finally holding my nose and jumping in. Nevertheless, I should also point out that the P/E multiples back then were nowhere near where they are today. I was holding out for something in the teens while it was in the 20s. Today I would be holding out for something in the 20s while it's in the 30s.
Tom Engle has written that P/E multiples should be expected to rise as a company grows. This is true in the early stages, as a company is being discovered, but it reverses itself as the company grows into a mid-cap and large cap. Shareholders of Intuitive Surgical, another Rule Breaker, can tell you all about the pain of multiple contraction. Earnings may grow, but the share price does not.
As many of you know, there are two very different ways of looking at valuation. When you have one foot in each world, as I do, it can be something akin to a bi-polar experience, a little like listening to Democrats and Republicans talk past one another. You get the feeling these views represent different systems of brain wiring and are not, on the whole, reconcilable.
Value investors generally believe the market today is significantly overvalued. They believe this is largely because the Federal Reserve has artificially depressed interest rates while providing excess liquidity in the form of quantitative easing. They believe this combination has given all this liquidity nowhere to go but the stock market, since fixed-income instruments are offering historically paltry yields. They believe the effect has been to inflate the price/earnings multiple of the market as a whole. They would argue that the inflation of Middleby's multiple is one example of this phenomenon. They argue that the longer this goes on, the more likely it is to end badly.
I don't want to speak for David G., but my guess is he would urge you not to worry too much about the price, just find great businesses, jump aboard and hold on tight. I could not agree more with the latter sentiment. I bought my first shares of Middleby in March 2005, belatedly following Tom G's multiple recs in Hidden Gems, so it is now nearly a nine-year holding and, as of today, nearly a nine-bagger. I have neither bought nor sold a share since 2008, and yet in that time it has grown of its own accord, passing Baidu today to become my largest position. This is, I believe, the best single stock pick of Tom Gardner's career, one he recognized extremely early in its development, and an insight that has more than covered every penny I have spent on Motley Fool publications in my lifetime.
Nevertheless, I would still point out that we are now in what many consider the frothy stages of an extended bull market. In his forthcoming annual letter to shareholders, Warren Buffett quotes the late money manager Barton Biggs as saying: "A bull market is like sex. It feels best just before it ends."
So, perhaps against the advice of investors much more accomplished and credible than myself, I would urge caution here when it comes to hopping aboard this train. Middleby is a great company with a great CEO. It is a worthy long-term holding, at least so long as Selim is in charge. But there is some irrational exuberance in the price here, in my opinion. It will be available at lower multiples at some point. I can't tell you when.
I do hope Tom Engle comes along with an updated page post to give you his thoughts. Based on both experience and performance, his and David G.'s opinions should be given much greater weight than mine.
To all existing and especially long-time Middleby shareholders, I will be raising a glass of Stoly tonight to Tom Gardner. We owe him, big-time.