It's Just the Beginning for This High-Growth Market

By Berna Barshay

Wednesday, July 22, 2020
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► I’m usually a valuation-sensitive investor…

My first investing job out of business school was at Sanford C. Bernstein, a shop known for its value investing discipline.

At Bernstein, we focused in on the cheapest stocks based on expected future cash flows. Once we identified these targets, we would dig in and do weeks of due diligence, trying to separate the value traps (where the business would never recover) from the true bargains. We looked to buy companies that were cheap today based on tomorrow’s cash flows.

Over the years, I’ve gotten more flexible with my investment style. While I still think stocks should ultimately trade based on a relationship to future cash flows, I’m more comfortable with the process of imagining what future cash flows could be in the slightly more distant future – more than two or three years away. This is key when investing in growth stocks.

I’ve done much better in my career with shorting stocks where technological change is going to kill a company’s business models than I have been with buying technology disruptors.

Probably the biggest investment mistake I’ve made in the past 20 years is not owning e-commerce titan Amazon (AMZN), except for a brief period more than five years ago. I’ve owned other mega-cap tech winners like Google’s parent company Alphabet (GOOGL), iPhone maker Apple (AAPL), and software giant Microsoft (MSFT)… but they were all purchased in moments that they were out of favor and actually got cheap on an absolute or a relative basis. There weren’t many of those moments with Amazon.

I should have known better with Amazon and been less price-sensitive. And I’m trying to learn from my investing mistakes…

With the context of my bias toward value… my discomfort for stocks that trade at extremely high multiples of sales, cash flow, and earnings… and my mea culpa regarding Amazon, you might be surprised to hear that I’m bullish on shares of alternative-meat maker Beyond Meat (BYND).

► It’s hard to find high-growth markets at their early stage…

Investors who realized that e-commerce, streaming video, and electric cars were going to be big things and just closed their eyes, abandoned their near-term earnings models, and bought and held sector leaders Amazon, Netflix (NFLX), and Tesla (TSLA) have been massively rewarded.

Buying a growth sector doesn’t always work. Some sectors can prove to be large but also structurally unprofitable – I’m looking at you, Uber (UBER) and WeWork. It’s also possible that the early leader in a rapidly growing sector cedes leadership, as Myspace did in the social media world.

But if you have a clear path to profits and a market leader you believe in, sometimes you have to close your eyes and dream if the total addressable market (“TAM”) is big enough.

► Plant-based meat will likely a huge, highly profitable market…

And I think Beyond Meat, the early market leader, will be able to hold on to meaningful share in the market as it grows.

In terms of sizing the potential of the market, the global meat business at retail is $1.4 trillion, with $270 billion coming from the U.S. If you look at the non-dairy milk market (soy, nut, and oat milks), this currently accounts for 14% of total milk industry sales in the U.S. and continues to take share from traditional cow’s milk.

But plant-based meat currently makes up only around 1% of U.S. meat retail sales. If you believe that plant-based meat can grow to the share currently taken by plant-based dairy, that means $35 billion of retail category growth exists in the U.S. alone. That’s a $12 billion wholesale opportunity for sellers of plant-based meat.

And we can see signs that this share shift is already happening. Whether the motivation is improved health, reduced environmental impact, or ethical concerns, people are eating more plant-based meat. While sales of traditional meat have grown in the very low single digits or even declined slightly in recent years, sales of plant-based meats are growing in the high teens.

Yet this industry is in its early innings. In 2019, only 14% of U.S. households purchased plant-based meat, up from 13% in the year prior.

Looking more globally, the U.S. only accounts for around 20% of the global meat market. If the TAM in the U.S. – assuming similar penetration to plant-based milk – is $12 billion, it’s $60 billion for the entire world. I actually think it could be higher, as I think 14% is a floor for the market share that plant-based meat can take in the longer term.

► Many players are vested in the growth of the plant-based industry…

Besides pure-play plant-based companies like Beyond and its rival, Impossible Foods (which is rumored to be going public soon), many large public food companies have entries into the category… and are investing heavily in it.

Grocery chains are also eager to see the category grow, as innovation drives growth and foot traffic, and they aren’t getting innovation or growth from traditional meat. Since plant-based products currently price at a slight premium to traditional meat, grocers aren’t losing overall sales when volume shifts from traditional to plant-based… and I suspect they make more money as they move from selling unbranded products to branded ones.

Fast-food restaurants have even joined in. Dunkin’ Brands (DNKN) introduced a breakfast sandwich featuring Beyond Sausage last year, and it drove traffic from a younger customer base – something chains are always looking for.

Offering a substantial and satisfying plant-based option is key for fast-food restaurants looking to eliminate the “veto vote,” which is losing the business of a group because one group member refuses to eat there. It’s why McDonald’s (MCD) added salads to its menu years ago.

But unlike salads at McDonald’s, chains believe that plant-based food can be a real driver of new business – both here in the U.S. and across the globe. For example, Restaurant Brands International’s (RBI) Burger King introduced the Impossible Burger and Starbucks (SBUX) teamed up with Beyond to offer plant-based offerings in China.

The introduction of plant-based options from Beyond and Impossible at fast-food joints is great news for both companies and the plant-based category as a whole. Not only do fast food outlets provide free, location-based advertising for the brands and the category, but they also offer consumers low-risk opportunities to try the products. Instead of committing to spend $9.99 on a package of Beyond burgers at the grocery store, a curious consumer can spend half that to try one that someone else has cooked for them.

One fast-food collaboration to keep an eye on is the ongoing and recently expanded roll out of Beyond Fried Chicken with Yum Brands’ (YUM) KFC. While many eaters would agree Beyond has successfully imitated the flavor and texture profile of ground beef and sausages, the company has yet to conquer chicken… If executed successfully, this would only broaden Beyond’s reach and TAM.

BYND is admittedly an expensive stock…

I ignored all the noise last year when the company went public – partly because I was more focused on European stocks at the time, but mostly because I thought its valuation was ridiculous. I also generally hate battleground stocks… Don’t look for me to offer an opinion on Tesla.

Even down almost 50% from its highs last summer, BYND shares still trade at incredibly high multiples. They’re currently valued at an enterprise value (“EV”) to sales ratio of 11 times and an EV to earnings before interest, taxes, depreciation, and amortization (“EBITDA”) ratio of 108 times, both using 2021 estimates. On a price-to-earnings basis, BYND shares trade at an eye-popping 215 times 2021 estimates.

I’m willing to take a chance at these levels with money earmarked for more speculative, high-risk/high-reward investments because I believe in the giant TAM, as well as the fact that Beyond will be profitable and maintain share in the segment.

Unlike some recent large TAM initial public offerings (“IPOs”), Beyond has already proven it can turn a profit. The company was profitable for half of 2019 and in the first quarter of 2020, despite being a young business with low sales compared to its long-term potential total.

Beyond had $355 million in sales over the last 12 months. During that time, its product margin was 36%. This gross margin is high versus traditional meat companies… Hormel Foods (HRL) runs at around 20% gross margin, and Tyson Foods’ (TSN) gross margin is around 12%.

High margins leave more for Beyond to spend on sales, marketing, and research and development (R&D)…

These operating costs should leverage over time – meaning that they should grow slower than sales – thus allowing Beyond to grow its operating margins substantially from the current level of around 3%. It’s possible that margins at Beyond could reach 10% or more several years from now.

In terms of competition, Beyond can be successful even if it only captures 5% to 10% of the plant-based meat market in the long term. Unlike some of the offerings from more diversified food companies, Beyond and Impossible products taste good. With a healthy investment in R&D, these two companies should maintain their current leadership positioning.

As far as the competition with Impossible, this is a huge potential market… and there’s room for both companies.

The fact Wall Street doesn’t love it gives me some comfort with the high valuation…

Usually, expensive stocks with huge growth – Beyond is expected to grow sales around 55% this year and next – also have huge support from sell-side analysts at Wall Street Banks. Surprisingly, only three out of 21 analysts covering BYND shares rate the stock a “buy.” (Nine are at “hold” and nine are at “sell.”)

The average stock has more than 50% of sell-side analysts recommending it. For BYND, it’s just 14%. That means the stock isn’t overhyped and that plenty of analysts who are negative now can later upgrade the shares to “buy.”

It’s hard to say exactly what BYND shares could be worth in a few years…

But if 10% of the $1.4 trillion market for meat goes to plant-based, that’s a $140 billion market at retail and $50 billion at wholesale. If Beyond can capture just 10% of the market, that’s $5 billion in sales. At a 10% operating margin, that would be after-tax profits of around $400 million, only about 20 times the current market cap.

If this scenario actually came to fruition, the stock is going a lot higher.

And I could make a case that the margin will be greater than 10% and that the market share will be higher than 10%… which would make the stock cheaper today on the dream scenario.

This dream scenario is probably 10 or more years away, but we should have visibility within a few years if this dream can be a reality.

This is a speculative idea, and the stock could very well go down before ultimately going up. High valuations can lead to extra volatility, and the second-quarter earnings report next month could be rocky, with so many restaurants serving Beyond closed for much of the spring.

But if you can take a long-term view with some “fun money” that you can invest in riskier ideas, BYND shares merit a speculation.

Today in the mailbag, one more investing mistake and reactions to yesterday’s NYT recommendation

If you have tried Beyond Meat or Impossible Foods’ plant-based meat products, what did you think? Did you try them at a restaurant or purchase them at a grocery store? Are you interested in eating more plant-based foods? Send your thoughts to [email protected].

► “Hi Berna, I’m a subscriber to several paid investment newsletters. One recommendation that I bought dropped about 30% within six months, so I doubled my investment. Later that same day, a sell alert was issued by that newsletter writer. I stupidly ignored that advice. I still own that dog today. It’s virtually worthless. If I sold it today; my return would barely cover the $6.95 brokerage fee. It’s not worth selling now.

“It was a really stupid mistake. I could have gone to the newsletter’s website, found their latest advice, and sold my holding for a 30% loss, instead of having a 200% loss on paper. In addition, I could have put that money into something else. Live and learn is very apt.” – Edward B.

► “The NYT has become leftist and appeals to them [leftists] but will IMO lose readership after the election. Other outlets that are moderate or conservative or liberal will take over.” – Paul H.

► “The NYT offered me an online subscription earlier this year for $4 a month. I tried to read it, but was so disturbed by the slant of nearly every article that I cancelled my ‘almost free’ subscription. Currently the only print media I read is the Wall Street Journal. Regarding Trump, I find many WSJ stories quite slanted as well. I do enjoy their editorial pages as they usually report both sides of an issue, usually in competing articles, and I find the letters to the editor engaging. I do like their limited sports page and find Jason Gay particularly clever even when he writes about cycling or something else in which I have very little interest. Very clever writer.

“Most social media is very slanted left or right, so I read very little of it. In fact, the less I engage in news, the happier I seem to be! I learned that a few years ago on a very relaxing trip to Antarctica where I consumed no news at all for two weeks, was the better for it, and didn’t miss it a bit!! I do enjoy a couple of newsletters for different reasons: Yours for sure, for financial insight, and I like anything Peter Diamandis shares as the good news he offers about progress in so many areas gives me hope for the future of the world, if we don’t destroy it first.” – Jan P.

Berna comment: Jan, you’re not the first person to tell me they’re happier when they don’t consume any news!

Regards,

Berna Barshay
July 22, 2020

Whitney Tilson

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About Whitney Tilson

Prior to creating Empire Financial Research, Whitney Tilson founded and ran Kase Capital Management, which managed three value-oriented hedge funds and two mutual funds. Starting out of his bedroom with only $1 million, Tilson grew assets under management to nearly $200 million.

Tilson graduated magna cum laude from Harvard College with a bachelor’s degree in government in 1989. After college, he helped Wendy Kopp launch Teach for America and then spent two years as a consultant at the Boston Consulting Group. He earned his MBA from Harvard Business School in 1994, where he graduated in the top 5% of his class and was named a Baker Scholar.

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