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LaCroix’s National Beverage – 100% Upside: New Castle Equity Research

LaCroix’s National Beverage (NASDAQ:FIZZ)   – Exponential Growth Equals 100% Upside by New Castle Equity Research – the author of this article has a long position in the stock

  • LaCroix growth is going exponential – and we believe the trend will have legs for three to five years or longer
  • LaCroix represents “organic” consumer demand and choice as reflected by social networks, making it extremely valuable to potential acquirers
  • The recent pullback creates a unique opportunity for National Beverage to shrink the float – while continuing its tradition of paying special dividends
  • We see +100% upside over a 18 to 36 month time horizon, and strong potential for faster gains if the company is acquired

LaCroix's National Beverage

We have been following the LaCroix brand since 2013.  Since that time, we have followed the company closely and invested in the common stock.  We have conducted countless channel checks, followed industry and segment sales estimates, cross checked against Nielson scanner data, interviewed dozens of Whole Foods and Target employees with regards to restocking rates, and conducted “boots on the ground” research via a network of investors scattered across the four corners of the United States.

Yet in spite of this long term, extreme diligence, it was the above, spontaneous testimonial that we began this article with that made us realize the true power of the LaCroix brand. The testimonial above was written by a friend with whom we have not spoken with in years.  Our family knows this person.  We know his life has been transformed for the better. He is healthier, happier, and feels more alive than ever before.  And the critical, relevant fact for this article – he publically credited LaCroix sparkling water for playing a role in his positive transformation.   LaCroix has become a personal and social marker that represents increased healthfulness, optimism, and success.  It is a powerful brand that has risen above the herd and created meaning in people’s lives.

The world has changed – “social” has smashed the old playbook

The social and consumer world we live in today is radically different from the world of just 10 or 15 years ago.  Not that long ago, major corporations such as the stagnant, transparently cynical Coke and Pepsi dictated consumer tastes with the authority of a Soviet Commissar– backed by monstrously sized marketing budgets that dominated the narrow media channels that existed at that time.

The “connected” world of social media has not only leveled the playing field, it has completely transformed it.  Today, individual consumer choice – organic choice – networked by the awesome power of constant social interaction and sharing, is the power that creates and magnifies great brands.  It is the “network effect” that created the dominance of Facebook, Tumblr, Snapchat, but applied to consumer products.

Today, authenticity and organic consumer choice represents the Holy Grail of consumer branding.  In the fast growing “sparkling water” segment, LaCroix has created a profound lead via its emotional connection with consumers.   While National Beverage supported and enhanced this relationship, the true power of the brand derives from its authentic appeal – consumers chose the brand in masse and made it a reflection of their values, and National Beverage listened, enhanced the message, and reflected it back.

The current investment opportunity

We believe that National Beverage has entered a growth phase that will last for at least the next five years, and quite possibly much longer – We see LaCroix as an emerging brand that will build on its lead to become one of the greatest consumer brands (Yes, global brands) of the 21st century – significantly expanding on its market leading position in one of the few growing beverage categories.  What Red Bull and Monster became to “Energy” drinks, LaCroix will become for the growing healthier alternative market, which is rapidly becoming the new mainstream.  We pick up our coverage at this time because we believe the stock has reached an opportunistic buy point – the current pullback in the stock’s price has created a buying opportunity with a margin of safety.

Media mentions of LaCroix are exploding

A Google search of LaCroix currently turns up the following:

LaCroix's National Beverage

We see media mentions as a key way to track if and how brands are resonating with consumers.  Perhaps the most significant article we have ever seen on the brand was an article published at Vox titled “Why LaCroix Sparkling Water is Suddenly Everywhere” published June 20, 2016, months before the exceptional Quarter 1, 2017 results were released.  Investors looking to understand the brand, its appeal, and the LaCroix phenomenon in general must read this full article.

Sector Growth Tailwind

We see the move to healthier beverages such as sparkling water as a long term macro tailwind for LaCroix and Shasta Sparkling.  Recent projections from Zenith International, (a premier market consultant to the food and beverage industry) forecast strong growth over the next five years.

LaCroix's National Beverage

We actually view the above projections as conservative, and for this reason.  What defines the sparkling sector will be growing over the coming years. The segment will capture an increasing number of former cola, soda pop, and even energy drink consumers, and it will transform into something that is still in the process of being defined.

LaCroix and National Beverage are perfectly positioned for this sea change.   Not because they invented the trend, but because they have wholeheartedly embraced it, and from the top down.  CEO Nick Caporella stated in the 2016 annual report:

“These last few years have witnessed a broad, startlingly chaotic transformation in our society, our planet, our lives and our Company… We, National Beverage, are perfectly ready and more – our assets, our brands and our philosophy are a fit with helping to make America healthier. Momentum will increase as exponential growth magnifies, initiated by the replacement of unhealthy choices with healthier options. Retailers will devote space to healthier products and a dynamic period will occur just like the beginning of the soda pop days. That’s what we anticipate.”

Growing awareness of heath crisis

The obesity and diabetes epidemic have proven beyond a shadow of a doubt that the world needs “old school” soda pop about as much as kids need to be smoking unfiltered cigarettes while swigging malt liquor.  Here are a few sobering facts.  In 2010 alone, 73,000 Americans over 20 had lower limb amputations as a result of diabetes.    Just one sugary beverage a day is proven to significantly increase the risk of type two diabetes.   With Soda taxes coming and a tremendous need to reduce skyrocketing medical costs, we hypothesize that “soda pop” and sparkling will ultimately merge into something new.   A perfect example of this synthesis is found in the new Sparkling Shasta – an emerging product that defies conventional categorization.

LaCroix's National Beverage

Channel checks indicate that Sparkling Shasta is just now leaving the early market testing phase.

LaCroix's National Beverage

If Sparkling Shasta gains traction via distribution and consumer acceptance, we believe that it could potentially become a second LaCroix, which would create a second “grand slam” for National Beverage shareholders.

Premium varieties and line extensions

Here is a thought experiment:  Could “sparkling” capture energy beverage drinkers?  We see it as inevitable and already in progress.  Replace the artificial ingredients, sugar, and deceptive “crank” formulas found in today’s energy drinks with sparkling water that is fortified with natural, scientifically validated functional ingredients, first and foremost (the true magic ingredient) caffeine.    It is the same “modernization program” that National Beverage has pursued with its Sparkling Shasta, but applied to the energy beverage market instead of soda pop and cola.   Why not?

National Beverage’s stellar Q1 2017

Vince Martin covered National Beverages sensational Q1 very well in this article.  We link to it, because we hate to be redundant and we view Vince’s work on the Quarter one results very highly.   While we don’t expect margins to expand each quarter, we do anticipate consistently higher margins as sparkling climbs further above 50% of National Beverage’s sales.

Credit Suisse initiates coverage

We see the recent initiation of coverage by Credit Suisse as a tremendous positive for the stock for a few reasons.  First, investors can’t afford to be naive.  Certainly, there is a “Chinese wall” between research and investment banking, as there should be.  Yet, there is still (always has been, always will be) an institutional imperative for firms to cover stocks that might need investment banking services in the near future.  Read any research report and you will find a disclaimer at the end that states something like, “We seek to do business with the companies that we cover via research.”

As such, coverage, to us, suggests that major firms are viewing National Beverage as increasingly ripe as an acquisition target.  The Credit Suisse analyst set a price target of $55, or $68 in a takeover situation.   We view both of these price levels as representing floor values, not price targets.

Potential Acquirer is unlikely to be big cola

Our read is that Coke and Pepsi are unlikely to be potential acquirers.  They appear firmly committed to their “buggy whip” brands that we view as utterly meaningless to consumers.

We see the most likely suitor as a European (such as Nestle) or Japanese (such as Asahi) global corporation that is still committed to authentic innovation.   Our last idea on this front will surprise many people.  We think that 3G, the legendary private equity firm, could take an interest in National Beverage.  We believe that LaCroix would slide right into the Anheuser-Busch InBev distribution network and create a new, complementary profit center.

Our estimates and financial model

We see LaCroix as a brand on the cusp of standing upon a much larger stage, similar to the position of Monster Beverage in 2005 or 2006.

LaCroix's National Beverage

Note that in 2006, Monster Beverage sales were right around $700M, not that far from National Beverage’s full year 2016 sales.  For those who don’t know, Monster Beverage’s fiscal year 2015 sales were 2.7B.

We believe that expanded single-serve distribution could radically increase LaCroix’s margin profile, particularly for the Curate variety.   We see global appeal and distribution potential in the coming years.   CEO Caporella included the following graphic in this year’s annual report:

LaCroix's National Beverage

Notice that the lever which triggers further momentum and “indeterminable” growth is labeled “distribution”.  We view this graphic as a ready clue that expanded distribution deals are on the horizon or at a minimum viewed as a key strategic objective.

Convenience Stores: Tremendous growth potential within the domestic market

These quotes were taken from a recent article in “Convenience Store Decisions”

“Earlier this year, John Archer noticed the display for LaCroix sparkling water in his local grocery store kept growing in size and prominence. He wondered what would happen if he elevated the brand’s real estate in his convenience store.”

and

“I (Archer) was able to convince a vendor to put a display of 12-packs (of LaCroix) up front in my store, and it’s unbelievable how fast that sells now,’” he said. ‘We also sell single cans, and you can’t believe how much we sell of that.

(Emphasis mine)

While Archer had success moving 12-packs to the front of the store, we believe the “c-store” opportunity lies in the increased single-serve distribution via this channel.  Such a move would be great for America’s health, convenience store owner’s profits – and yes, National Beverage’s shareholders.

Our bull case

Our bull case model sees full year top line growth of 20% in 2017, with Sparkling revenue up around 40% (currently estimated at just over 50% of sales revenue).  We see full year EBIT margins of around 17%, and 2017 EPS of around $1.98 per share, a 50% increase.  Three years forward (FY 2019), we anticipate continued growth, with EPS around $4.00 per share.  Applying a 25 multiple leads to a three year forward price of around $100 per share.

In our view, the best upside case will be seen in a potential takeover scenario.  It will either pull this value forward (even if at a lower takeout price, as the IRR will almost certainly higher) or it will take place at an even higher value further down the road.

Simplified framework – LaCroix brand + residual

On October 3rd, Reuters reported speculation that Bai Brands LLC (Beverage Company with $120 M FY 2015 sales and a historically rapid growth rate) might be for sale at around a $2B price tag.  We believe that given LaCroix’s extremely valuable consumer-driven growth in a strategically critical market segment, it should trade at between 7 and 10 times trailing sales – at least equal to Bai or the Vitamin Water acquisition, as we consider it to be a much better brand.

If we estimate run-rate LaCroix sales at $375M, this would indicate a value for LaCroix of between 2.625B and $3.75B, vs. National Beverage’s current market cap of just over $2B.  If we take the mid-point of this range and add cash of around $145M and value the remaining company at $300M, we get to just under $3.75B, vs. today’s $2B market cap – in other words nearly 100% upside.

Capital Allocation

As investors, we will be monitoring a few key items with regards to National Beverage’s capital structure.

First, we firmly believe that the absolute first priority must be investment in the LaCroix and (If it catches wind) Shasta Sparkling brands.  National Beverage is not simply the slow growing “special dividend” value stock that it was a few years ago.  We believe that in order to reach the next level of valuation and revenue growth, National Beverage must continually raise the bar with regards to both marketing and distribution.   This will be necessary if LaCroix is to fulfill the “Red Bull” or “Monster” type potential that we anticipate.

Second, we believe that the recent short seller’s “research report” was (ironically!) very opportunistically timed from the perspective of National Beverage’s long-term shareholders.  National Beverage’s cash balance has climbed quite high – above the level where the company has historically issued a significant special dividend.

The company is “locked and loaded” for a serious capital return.  By the end of calendar year 2016, the company should have over $250M in liquidity (cash plus credit line).   At this point in time, we see a tremendous opportunity to mix the company’s historical use of special dividends with a share buyback implemented at a scale that would significantly shrink the already small float.   Of course, this is assuming that the shares stay cheap relative to growth and brand prospects.  If the Stock gets back above the $58 level (what we see as a reasonable floor) it would make less sense.

About that “short report”

We viewed it as an artful smear based upon unsubstantiated accusations.  The most serious accusations were made by an individual attempting to score $4M off of a billionaire.   In our view, the most significant part of National Beverage’s response can be seen here:

LaCroix's National Beverage

To us and others who we have spoken with, it appears the accusations resulted from a failed extortion scheme.  Nothing about it makes sense from the perspective of logic, incentives, or what we know of the company and its CEO.  The rest was a mix of minor trivia (not material to LaCroix’s present value) and clear cut logical fallacies (such as guilt by tenuous association).  All artfully framed in the worst possible light.  Once again, we felt that Vince did a good job with his coverage (see here).   Orange Peal Investments also did a nice job with their article.

Final thought:  Is LaCroix the new National Beverage?

When we read the 2016 annual report, conduct channel checks, and read “fan comments” on Facebook, Twitter, and Instagram, we see something radically new.  National Beverage has moved beyond what it was, and become something more.   Just as Hansen Natural changed its name to Monster Beverage, we believe that National Beverage should consider becoming “LaCroix” as symbolic of the health-focused company that it is today.

Regardless, we see 100% upside over an 18 to 36 month time horizon – which could be accelerated if the company ends up being acquired.