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

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.

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

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.
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.
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).
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.
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

Historically, MGP Ingredients has operated in a commodity-like business with little pricing power. As such, there exists the risk that MGP continues operating in this difficult business. However, we believe new management is driving MGP towards high-margin products and premiumization of lower-margin products. Additionally, we believe there are substantial barriers to entry for these higher-margin products (e.g. whiskey).

Ownership Structure

Karen and the Cray family own just under 30% of the common stock and, alongside the Kansas University Endowment Association, the vast majority of Preferred Shares. In short, the company is still very much family-controlled. However, since Karen installed professional management, the family has been generally hands-off. Current management also confirms minimal family involvement in the day-to-day operations of MGP Ingredients. Both the family and management are aligned on the vision for MGP.

Execution Risk Around Branding and Barreled Distillate

As the company has historically been a white label supplier, there is no assurance its venture into branded product will be successful as branded product involves significant investment in SG&A talent and skillsets in distribution and marketing. However, we give management the benefit of the doubt given their backgrounds and access to differentiated market intelligence. Additionally, there will be increasing opportunities to offer a niche product given the excitement around craft and the broader taste preferences of younger and more sophisticated consumers.
“Barreled Distillate” is MGP Ingredients-owned, booked at cost, and will be held under MGP ownership for the aging process. In theory, this stock of aging whiskey will be used for MGP-branded product. Should a branding effort fail, “barreled distillate” would be left on MGP’s balance sheet. However, MGP Ingredients would still be able to wholesale this distillate for 3x cost (by company estimates) – still implying dramatically higher margins, or 60%+, compared to non-aged distillate. In lieu of wholesaling this aged distillate, MGP could alternatively hold on to this inventory for a longer period, allowing for additional premium on a longer-aged product.

American White Oak Supply, Distilling Talent, Raw Materials

American White Oak barrels (20-30% of the all-in cost of a barrel) remain in relatively short supply across the industry. However, at this point, the shortage is primarily being felt by craft players, as documented by Fred Minnick: http://bit.ly/1Rf7OtT. Even if barrel prices continued to rise, however, MGP has several levers to pull to continue ramping gross margins. We believe the company will weather the current price hike on barrels and that the shortage will be alleviated in the coming seasons. (See below for data on historical stave log prices.)
Loss of distilling talent is a key risk for the company. However, the team is keenly aware of this risk and is incenting retention through compensation, by instilling culture, and mapping out a clear career path for younger members of the team.
Raw material costs may dramatically increase. However, we believe Tom Pigott (MGP’s new CFO) is a seasoned manager and will hedge these costs in a smart, measured way. Additionally, as the company churns away from commodity products and its historical ethanol production, we expect gross margins to be less impacted by commodity prices.

Working Capital

With an increasing amount of capital tied up into the business, working capital issues may arise. However, since new management arrived, around $5M per quarter has been spent on working capital while the sum or net income and depreciation addback has been approximately $9M per quarter. The company generates healthy, positive operating cash which will continue to ramp in coming years. The company is not significantly levered and has ready access to $34M of additional borrowing capacity.

Corporate Restructuring

New, High-Quality Management Emerged from Proxy Fight

In mid-2013, a proxy fight erupted in Atchison, Kansas, the home of MGP Ingredients. Tim Newkirk (then CEO) and John Spiers (then Chairman), sought to take control of the Board, disqualify the Cray Family and its Trust, and sell the family business. Karen Seaberg, granddaughter of founder Cloud Cray, with the support of MGP employees, the unions, and Atchison and Lawrenceburg residents, fought back and won.

In mid-2014, after the tumult, MGP Ingredients completely reshuffled the Board, and brought in new management, including Gus Griffin who today leads MGP as President and CEO. Gus Griffin is central to this turnaround story; prior to MGP, Gus served 24 years with Brown-Forman, where he ultimately became Senior Vice President and Global Managing Director in charge of the company’s flagship Jack Daniel’s business. His brand assignments also included Old Forester Bourbon, Southern Comfort Liqueur, Southern Comfort Cocktails, Jack Daniel’s Beer and Early Times Kentucky Whiskey. Longerterm, Gus’ experience abroad will provide support for MGP’s international growth. Gus is an industry veteran with a skillset of building “businesses, teams, and brands.”

In addition to Gus, Tom Pigott, MGP’s new CFO, brings a wealth of experience from Kraft and Nestle. Most recently, Tom served as VP of Finance for the Meal Solutions division at Kraft. The senior team is further supported by the additions of Michael Buttshaw (who is “coming home” to lead Ingredients), the promotion of Steve Glaser to VP of Production and Engineering, Dr. Ody Maningat (former MGP), and Bruce Gubser. Meanwhile, the Board brings a strong matrix of functional and industry expertise especially with the additions of David Colo (COO, EVP, Diamond Foods) and Anthony Foglio (Chairman of Anchor Brewers and Distillers, the distributor of MGP Ingredients’ Metze’s Select). Skip and Karen, members of the Cray Family remain on the Board but have entrusted the company to the new, professional management team. While there were no settlements or agreements barring further litigation, the proxy issues of 2013 have largely been resolved and members of the team are aligned. MGP and all of the employees are now focused on “Building Our Legacy”.

In spite of the recent run-up in price, senior members of the MGP Ingredients team continue to purchase stock (green markers represent purchases, red markers represent sales) – 17 of the top 40 holders of common shares are insiders. Gus and Tom both purchased stock in advance of joining the company.