Nomad Foods: Attractive Valuation, But Risks Remain

seekingalpha11-21 08:23

Nomad Foods is the largest frozen food (excl. ice cream) company in Europe, trading at less than 9x forward earnings.The company has shown consistent free cash flow generation and has a portfolio of ...

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While the company never overpaid for acquisitions, the balance sheet is stretched.At 4.5x EBITDA leverage, rating agencies rate the debt as speculative. Interest expenses equal roughly one third of the average yearly free cash flow.The frozen food industry in Europe is dominated by private label and is highly competitive. Consumers are shifting to cheaper private label goods given the inflationary environment.Nonetheless, current valuations offer a favorable risk-reward for investors who are comfortable with the risks involved.   Katrina Wittkamp  Nomad Foods (NYSE:NOMD) is a consumer staples company that doesn't get the attention of its larger peers. Founded in 2014 as a SPAC, it has acquired several frozen food brands and is now the second-largest frozen food company in Europe. As its main markets are in Europe, North American investors might not be familiar with its brands like BirdsEye, Findus and Iglo. However, as a European, I grew up with the brand's Captain Iglo and its popular cream spinach and fish sticks. The company owns iconic brands in the frozen food industry that have been around for generations. Second-Largest Frozen Food Company (Nomad Foods Investor Presentation) With a household penetration rate of 65% in its main markets and €3.9 billion in retail sales, it's only behind Unilever when it comes to frozen foods. However, if we exclude ice cream, Nomad Foods is by far the largest frozen food company in Europe, selling 50% more than the nearest competitor. It's therefore surprising that it's trading at the current valuations of less than 9x forward earnings. As the markets are climbing from all-time high to all-time high, I am actively searching for defensive stocks trading at reasonable valuations in order to lower my risk. Nomad Foods is one of the most attractively priced companies in the food space, but its lower valuations come with risks, which we're going to cover in this article. But let's first start with the positive, which got me interested in the stock. Since its listing in 2014, Nomad Foods delivered consistent free cash flow every year, and had a stellar year in 2020, when many companies struggled with the implications of the COVID pandemic, highlighting its defensive business model. Its net cash from operating activities grew from €282 million in 2016 to €430 million in 2023. Revenues and adjusted EPS followed suit and have risen at 6% and 10% CAGR for the last few years. While these growth rates likely wouldn't impress growth investors looking for the next Apple, for a defensive consumer staple company in the seemingly stagnant food industry, that's pretty impressive. Revenues and Earnings (Nomad Foods Presentation) It's not surprising that the growth didn't solely come organically, as Nomad Foods is always looking for the next deal. Nomad Foods Is A Serial Acquirer That leads us to the first risk. The company only exists for a decade and has a huge appetite for further growth. Nomad Foods made its first acquisition with Iglo in 2015, and acquired more companies thereafter. Acquisitions (Nomad Foods Investor Presentation) In the last few years, it acquired Goodfella's Pizza, Aunt Bessie's, Findus Switzerland, and more recently expanded into Eastern Europe with the acquisition of the Fortenova Group in 2021. Nomad Foods never overpaid for these acquisitions, in my opinion, but it has left its balance sheet stretched, compared to other consumer staple companies. Nomad Foods reported €2.1 billion in debt, and €334 million cash, leaving it with €1.77 billion net debt. That's a lot of liabilities for a company that's expected to generate roughly €250 million in free cash flow a year. Even though Nomad Foods is the leader in frozen food in Europe, it's facing a highly fragmented environment, where cheaper private labels make up 54% of the market. Especially when it comes to frozen vegetables, there's very little brand equity, as shoppers often opt for the lowest cost product. As consumer wallets are stretched by rising inflation, private labels are further gaining market share. That's a risk many consumer staple companies are facing these days, but if you're highly leveraged like Nomad Foods, that's a threatening development. Fitch is rating the company's debt speculative with a BB rating, as Nomad's EBITDA leverage stood at 4.5x at the end 2023. That leaves the company with high interest expenses. Net finance costs stood at €87 million in 2023, a big expense for a company this size. Needless to say, the relatively low valuation comes with risks, and that's reflected in a more volatile share price. From 2016 to the heights of the COVID pandemic in 2021, when people stayed at home and craved convenient frozen foods, the share price gained more than 400%. Once investors woke up to the fact that heightened demand from the pandemic wasn't here to stay and competition intensified in an inflationary environment, the shares lost roughly 50% in value. If you're comfortable with the risks just mentioned, it offers a great entry point at a double-digit earnings and FCF yield. It's one of the cheapest food companies available right now, excluding the ones with erratic cash flows, which I am not interested in.   Company Forward Earnings Yield FCF Yield EV/EBIT   Nomad Foods 11.23% 12.1% 10.2x   Kraft Heinz 9.84% 7.83% 19.1x   General Mills 7.18% 7.46% 14.0x   Nestlé 5.5% 5.3% 17.8x   Click to enlarge Nomad Foods is trading at a discount to other branded food companies, and some of it is justified, given its risk profile. While it's the market leader in frozen foods in Europe, it's less diversified throughout different product categories than competitors and its debt-funded acquisition strategy poses risks. At this point, I would like to see the company cut back on acquisitions and focus on debt repayment. It seems like management agrees that larger acquisitions are out of reach, but instead of repaying debt, management prefers buybacks and dividends to boost shareholder returns. The company just initiated a quarterly dividend this year, resulting in a 3.57% dividend yield at current prices. While it's only a 32% payout ratio, given the elevated debt, the dividend isn't as safe as one would expect from a company in a defensive industry. That said, it could lead to heightened demand for the shares, as investors in consumer staples usually prefer income. On top of the dividend, management is buying back shares. While cancelling shares at single digit P/E ratios is positive for shareholders, the $500 million share repurchase program till 2026, will likely leave very little room for repaying debt. The company has to deliver on free cash flow, otherwise the dividend and buyback program could be at risk and lead to further volatility in the share price. FCF Generation (Nomad Foods Investor Presentation) Management is confident they can deliver, as they expect nearly €1 billion in adjusted free cash flow over the next three years. That's over one third of the current market cap, highlighting the attractive valuation at which the shares are trading right now. While I am not fully convinced, they can achieve the expected growth given the challenging macro environment and intensifying competition, free cash flow at current levels would be sufficient to keep the dividend and buyback machine running. Given the low valuations, the current buyback program, if fully used, should result in 6% of the shares getting cancelled each year, which would result in mid-single digit growth rates, even if the underlying business remains stagnant. That's not too bad for a company trading at single digit P/E ratios. There's reason to be optimistic, even in an environment where consumers are pivoting to cheaper private labels. Latest Q3 24 Results Volume (Nomad Foods Investor Presentation) Volume has been stabilizing the last few quarters, as 3Q 24 saw another volume growth of 0.7%. Given the challenging macro environment, that's encouraging to see. Q3 24 Results (Nomad Foods Investor Relations) However, reported revenue came in only 0.8% higher last quarter, given the volume growth, that's rather disappointing. The company blames ERP (Enterprise Resource Planning) disruptions as a 2.5% temporary headwind. Q3 24 Results (Investor Presentation Nomad Foods) Gross margin improved from 28.4% to 32.3% in the last quarter, resulting in an 28% higher adjusted EPS. Management expects 90-95% adjusted free cash flow conversion at year-end. So far, adjusted free cash flow is lagging behind last year's free cash flow. Adjusted Free Cash Flow (Investor Presentations Nomad Foods) By now, you might have realized that Nomad Foods likes to communicate in adjusted numbers in their investor presentations. Companies like to exclude non-recurring items in their earnings, even though in many cases the similar expenses are recurring every year. Nomad Foods is no outlier, as many consumer staple companies provide adjusted numbers. However, adjusted free cash flow is a concept that goes one step too far for me. That said, it's a company with strong free cash flow generation that is more or less in line with the adjusted numbers. This year's results so far are encouraging. Volume has been stabilizing this year, and revenue, margins and profits are heading in the right direction. Net debt hasn't changed much compared to last year, given the ongoing share repurchases and initiation of the dividend, that had to be expected. The Overall Trend Is Positive Not too long ago, the situation for Nomad Foods different when it comes to volumes, which lead to the share price decline in the last few years. Volumes have been under pressure since inflation took consumers by surprise in 2021, but the company still managed to grow revenues by increasing prices. More recently, the company shifted to increase advertising spend, cut back on price increases, as well as focusing on categories outside its main categories of fish and vegetables, like chicken. Portfolio (Nomad Foods Investors Presentation) The company keeps innovating and more recently is heavily investing in marketing, although this leads to lower short term profits, that's encouraging to see for long term investors. Growth Platforms (Investor Presentation Nomad Foods) The company also doesn't shy away from entering new product categories. This could lead to further organic growth going forward. Nomad Foods entered the ice cream category with its acquisition of Fortenova, more recently it's introducing products like frozen fries entering categories they didn't have a presence before. Also, the launch of the successful plant-based green cuisine line a few years ago, shows the company not only relies on milking the existing cash flows of the acquired assets, but is preparing the brands for a successful future, in a world of ever-changing consumer preferences that's encouraging to see. Where does all of this leave us? Nomad Foods is attractively valued at less than 9x forward earnings. The frozen food category tends to have slightly higher growth rates than the general food industry, as consumers are increasingly choosing convenient alternatives. As it's mainly selling fish, vegetables and chicken, most of the food could be considered healthy. Frozen food is relatively affordable and quick to prepare, and consumption per person in Europe is less than in the US. This could lead to further growth of the category in Europe. On top of that, the company is operating in a mostly recession-resistant industry, but it faces tough competition from private label. While Nomad Foods also competes in the low-margin private label space, it needs to win with its branded goods in order to maintain margins and cash flow. The main risk with Nomad Foods is its high leverage, which I view as excessive. Its interest expenses are high compared to its free cash flow and subject to change, as most of its debt isn't at fixed rates.  Therefore, the share price tends to be volatile, as investors react more swiftly to minor changes. After the recent share price decline, I do believe Nomad Foods offers a good risk-reward ratio for investors who are comfortable with the risks mentioned. I bought some shares recently, but I maintain a very conservative position sizing. It's a speculative buy for me, rather than a core holding.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.2","shortVersion":"4.29.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2485550109"}