MGP Ingredients Inc (MGPI): Whiskey, Management, And Margins Drive Upside

Apis has conducted a deep dive on the ongoing turnaround at MGP Ingredients (ticker: MGPI). We believe the company is deeply undervalued and hope that our research highlights the potential at MGP, the significant scale and quality of its assets, and the strong pedigree and vision of the management team. While we do not offer a price target, we believe MGP Ingredients will be a long-term compounder for the patient value investor and hope our research serves as a helpful road map to valuing the company.

Introduction

If you are a whiskey aficionado, you will undoubtedly have heard of Lawrenceburg, Indiana. If not, head to your nearest spirits shop and start looking on the back of some whiskey bottles for the word “Lawrenceburg” – you’ll have better luck if you look in the section for whiskey ryes. Still need some help? Ask for Diageo’s Bulleit Bourbon Rye and look on the back of the bottle. If you find whiskeys or ryes produced in Lawrenceburg, chances are you are drinking something distilled by MGP Ingredients.

MGP, founded by Cloud Cray who is proudly survived by the Cray Family, is the largest distiller you have probably never heard of, and for good reason – the company white labels its product to some of the largest brands globally and smaller craft brands as well. Based on company estimates, MGP Ingredients produces 8% of the 18.5M American whiskey cases out there and, of that, 70% of American rye whiskeys (a sub-segment of 500K cases). MGP is also the largest distiller of the 6.3M cases of gin in the US, with an estimated 65% share.

Executive Summary

Today, there is an opportunity to invest in the management turnaround of America’s largest white-label distiller which has brought in new management, commands significant market share, and maintains meaningful barriers to entry. Margins will expand in coming years, driven by mix shift towards premium alcohol and ingredients products, and additional upside exists if the company is able to successfully launch its own, branded whiskey. Finally, the company benefits from secular tailwinds in favor of whiskey – rye whiskey in particular – and higher-quality protein, fiber, and starch products. Price Target? We believe MGP Ingredients is a long-term compounder for the patient value investor. In lieu of a price target, we hope our research helps highlight the potential earnings power and margin leverage of MGP. We estimate that if just 10% of current production were allocated to MGP-branded products, net income could increase approximately $35M, or to roughly 2.5x our forecasted 2015 earnings. And this is still before acknowledging upside for the vast majority of the remaining business and significant, additional capacity that we estimate MGP Ingredients has on hand. Additionally, strong earnings growth combined with modest rerating towards its branded alcohol peer group offers substantial upside.

MGP Ingredients Inc (MGPI): Whiskey, Management, And Margins Drive Upside

Why The Opportunity Exists

MGP Ingredients has largely been under the radar as they sell white-label supplies of alcohols. Additionally, no sell-side coverage is available, and the recent proxy fight (since concluded) gives investors pause. In fact, the proxy fight was a positive catalyst for the company as poor former management obscured MGP’s high-quality business. Finally, the significant value of “barreled distillate” (discussed below) is hidden as this asset is booked at cost and realizes market value years later.

Investment Case

  1. New, High-Quality Management: historically, MGP Ingredients has been managed by family and insiders rather than professional management. After a proxy fight that erupted in mid-2013, Karen Seaberg, granddaughter of founder Cloud Cray dramatically revamped management and the Board. Gus Griffin, who was brought in by Karen to lead MGP as President and CEO, served 24 years with Brown-Forman. There, he ultimately became Senior Vice President and Global Managing Director in charge of the company’s flagship Jack Daniel’s business. The senior management team is further bolstered by MGP’s new CFO, Tom Pigott who hails from Kraft and Nestle as well as a crop of new Vice-Presidents with significant functional expertise. The Board now also boasts backgrounds from Diamond Foods, Anchor Brewers and Distillers, among others. Senior members of MGP Ingredients continue to purchase MGP stock, in spite of the continued run-up in price.
  2. Margin Uplift from Mix Shift and Branded Product: MGP’s gross margins have increased from single-digits to mid- to high-teens. This improvement will continue as the company shifts production towards higher-margin distillates and away from commodity products; MGP produces the following products, from lowest to highest margin: new white spirit distillate, new brown spirit distillate, aged brown spirits, branded brown spirits. As MGP Ingredients moves towards aged brown spirits and its own branded product, gross margins will dramatically increase. Branded players in the space (most notably, Brown-Forman), command gross margins between 50-70%. We believe Gus Griffin, MGP’s new CEO and former manager of the Jack Daniel’s brand, will drive this change.
  3. Existing Business Growth with Significant Market Share and Sustainable Barriers: based on company estimates, MGP produces 8% of the 18.5M American whiskey cases out there and, of that, 70% of American rye whiskeys (a sub-segment of 500K cases, or approximately 3% of American whiskey, growing at 45%, 5 Year CAGR). MGP is also the largest distiller of the 6.3M cases of gin in the US, with an estimated 65% share. Barriers for this business include scale, human capital, and MGP’s strong reputation for quality (all discussed below).
  4. Earnings Growth and Multiple Expansion: today, the market perceives MGP Ingredients as a commodity-sensitive company rather than a whiskey and branded product company. This is evidence by MGP’s valuation which is near ADM – an agricultural and commodity products giant. We believe this is unjustified given the company’s current rate of growth and future prospects. While we don’t expect MGP to achieve Brown-Forman-like valuation overnight, we do believe the company deserves multiples somewhere in between.
  5. Secular Tailwinds in Favor of Whiskey: macro trends in whiskey are favorable as the spirits category takes share from wine and beer, and whiskey increases share within the spirits category.

Catalysts

MGP-Driven

  • Raise corporate turnaround target of “4X = 5Y” – or increasing adjusted operating income by 4x over 5 years.
  • Management guidance on quarterly margin expectations, or longer-term targets.
  • Additional insider buying.
  • Branded product launches under the liquor business.
  • Continued ramp of warehousing capacity and “Barreled Distillate” – or MGP-owned and aging distillate.
  • Longer-term, additional buybacks or dividends given a relatively debt-free balance sheet.

Discovery and Environmental

  • Sell-side initiations on the MGP Ingredients story. Liquidity should increase as well.
  • Continued macro growth in whiskey as a category, and rye and craft whiskey as sub-categories.

Risks

Commodity Business Risk