Middleby Singed By Margin Weakness

Commercial kitchens and food processors are eager to increase capacity and contain (if not reduce) costs, and automation is a key part of that process. That’s very good news for Middleby (NASDAQ:MIDD), but strong demand from restaurants and foodservice customers is being offset by intense cost pressure, as well as emerging weakness in the residential business.

The valuation wasn’t great, but I thought Middleby was setting up as a “buy the dip” opportunity back in early March. That was absolutely the wrong call, as the shares have remained weak ever since, dropping around 17% and underperforming the market. There aren’t many good comps anymore, as most of Middleby’s competitors are part of larger conglomerates, but neither Marel (OTCPK:MRRLF) or Rational (OTCPK:RATIY) have been all that strong of late either.

 

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Middleby Singed By Margin Weakness

Middleby Seeing Scorching Foodservice Demand

 

Middleby's (NASDAQ:MIDD) exceptional growth track record got even better in 2021, with the company generating exceptional organic growth through most of the year on both recovery and expansion demand, including national quick-service restaurants (or QSRs) adding more suburban locations and food companies (proteins, especially) turning to automation to address in-plant labor and safety challenges.

Middleby was another "like the business, don't like the valuation" stock for me a year ago, and although Middleby did indeed have a good run after my last update, rising from around $165 to a peak of over $201, the shares have since given almost all of that back in this broad market sell-off. While these shares are still not exactly conventionally cheap, I still like the company's leverage to growing adoption of labor- and space-saving automation, and I think the valuation is quite a bit more interesting now.

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Middleby Seeing Scorching Foodservice Demand

Middleby Has Rocketed Higher On A Much-Improved Foodservice Outlook

Never underestimate the upside potential for a proven growth story with strong fundamentals.

I’ve had my issues with Middleby’s (MIDD) valuation over the years, as well as the company’s reliance on M&A to fuel growth, but the reality is that we’re talking about a company that has generated almost 13% revenue growth over the past decade (from the not-so-tiny starting point of over $850 million) and consistently generates double-digit FCF margins – something not all that many industrials manage to do. On top of that, not only has the foodservice industry held up better than expected during the pandemic, the government has really stepped up in terms of financial support.

All of that has fueled a remarkable 270% trough-to-peak run in the shares. I can’t say that I see Middleby as undervalued now, but that hasn’t held back the shares in years past.

 

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Middleby Has Rocketed Higher On A Much-Improved Foodservice Outlook

Middleby's Premium Is Gone, But Longer-Term Demand Destruction Is A Real Concern

For some time now I’ve stayed away from Middleby (MIDD) because I thought the market gave too much of a growth premium to a stock where the underlying company really wasn’t a true growth story anymore. Relative performance has indeed been poor over the last three years or so, as the company has struggled to put together compelling growth and margin leverage despite restructuring initiatives and ongoing reinvestment in product development.

I no longer think that premium valuation is a problem here. In fact, the shares look undervalued if the company can manage long-term annualized free cash flow growth of just 3% (from 2019’s level). That should be an achievable/beatable target, but I don’t want to underplay the risk that Covid-19 will cause long-lasting demand destruction in its core market, nor that management will continue to make questionable strategic and capital allocation decisions.

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Middleby's Premium Is Gone, But Longer-Term Demand Destruction Is A Real Concern

Middleby Continuing To Struggle, But Margins Can Start Supporting Valuation

I've written many times before that one of the biggest risks in paying up for growth is that sooner or later the growth slows and those inflated multiples come back to earth. And so it is with Middleby (MIDD), where the company has seen a return to revenue contraction on an organic basis and ongoing execution challenges across the business. I thought multiples/valuation were too high back in May, and the shares have lost almost another 20% of their value, far worse than the performances of Welbilt (WBT), John Bean (JBT), Rational AG (OTC:RATIY), and Marel over that time period.

I'm not as negative on Middleby down at these levels. The company has a legitimately good commercial foodservice business and I see some options for mitigating the drag from the residential and food processing businesses. Margins are pretty decent and the company should generate solid cash flow over the next few years. I'd like to see a new strategic direction from the company focusing more on consolidating its strengths and improving margins/cash flow, but there is still a valuable core here. With a "mid-high" to low double-digit return potential from here, this is a name worth following.

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Middleby Continuing To Struggle, But Margins Can Start Supporting Valuation

Middleby Doing Better On A Core Basis, And Valuation Reflects That

With much-improved performance in the residential business and decent growth in commercial foodservice, Middleby (MIDD) has come back into investors’ good graces, with the shares up better than 25% over the past year. I liked Middleby better when the restructuring efforts were still in process and recovery in the business (and sentiment/perception) was still up for debate, and now I find the valuation more demanding for a company that I believe is too large to significantly outgrow its markets on an organic basis.

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Middleby Doing Better On A Core Basis, And Valuation Reflects That

Can Middleby Follow Through After Beating Low Expectations?

You never really can tell just what Wall Street will decide to focus on when it comes to a company undergoing a turbulent transition period. In the case of Middleby (MIDD) and its second quarter earnings, it seems as though the Street was happy to look past weaker-than-expected EBITDA (a 6% miss on already-lowered expectations) and gross margin and focus on a small revenue beat and a generally more constructive tone from management.

I had some interest in Middleby earlier this year as it slid toward $100, and I wouldn’t call today’s valuation unreasonable, although it is trading for more than I’d care to pay on both a DCF and EV/EBTIDA basis. If Middleby can maintain, or improve upon, the best results seen in the Commercial Foodservice and Residential businesses in years, I expect these shares to trade higher, but the weaker margins are a concern, and I’m not completely sold that the organic growth issues are fixed.

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Can Middleby Follow Through After Beating Low Expectations?

Middleby's Recent Run Of Disappointments May Mark A Transition

With the shares down 20% over the last year, 10% over the last two years, and EPS misses in three of the last four quarters, there are clearly still some issues with Middleby (MIDD). This growth-by-M&A foodservice equipment vendor has long been a somewhat controversial name, but free cash flow margins have been eroding and so too as organic growth in its core Commercial Foodservice business.

If you invest long enough, you start to see patterns, and Middleby seems fit the pattern of a company that once consistently outgrew its end-markets, expanded its margins, and enjoyed robust valuation multiples as a reliable growth stock, but is now transitioning to a new phase of its cycle. These transitions are usually chaotic and are marked by revenue and margin volatility, as well as weaker valuations as the growth crowd moves on to greener pastures and new investors enter the mix.

I don't really know whether that is truly what's going on with Middleby, but the company is definitely losing the benefit of the doubt with Wall Street, and I believe revenue growth is likely to normalize into the mid-single-digits in the coming years. The valuation is getting more interesting, but the shares are likely to remain volatile until the company shows it can settle back into a new growth groove.

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Middleby's Recent Run Of Disappointments May Mark A Transition

Familiar Concerns Dogging Middleby

Even though value-oriented investors tend to approach the investment process with more patience than growth or momentum investors, timing still matters. Had I been writing this article on Middleby (MIDD) just three weeks ago, I’d probably have concluded that the shares offered a rare chance to pick up a proven (if controversial) grower at a reasonable valuation. With the third quarter results in the books, though, the shares have shot up more than 15%.

Although Middleby isn’t back at peak multiples, I’m more cautious on the shares with that recent run. There are still growth issues here, and I’m not fully convinced that the Commercial Foodservice and Residential businesses are in the clear. There are still ample growth opportunities for Middleby, but Welbilt (WBT) seems to be performing better than it has in recent years and it’s tough to make the cash flow numbers work unless you’re willing to accept what I believe is a relatively low required rate of return given the risks in the business model.

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Familiar Concerns Dogging Middleby

Illinois Tool Works Finding It Harder To Clear A Rising Bar

The great post-election melt-up has continued, but the pace seems to be slowing and expectations have risen to a level that many companies are finding more challenging to satisfy. Illinois Tool Works (ITW) has seen its share price rise about 3% since my last update, lagging the S&P 500 only slightly, and keeping pace with most of its large peers (Honeywell (HON), Stanley Black & Decker (SWK), and 3M (MMM)) apart from Dover (DOV).

As I see it, the story on Illinois Tool Works remains more or less the same. The company is unquestionably a high-quality industry conglomerate, but it's not heavily leveraged to recovering markets like oil/gas and important end-markets like autos are slowing. A very strong operator already, I think Illinois Tool Works will be hard-pressed to drive substantial additional restructuring benefits, but management isn't going to stop trying. In a “gotta buy something” market, I suppose Illinois Tool Works isn't the worst idea, but it's hard for me to like the share price outside of a relative value approach.

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Illinois Tool Works Finding It Harder To Clear A Rising Bar

Rational AG Has Significant Growth Potential, But The Market Knows It

Companies with returns on invested capital consistently above 30%, strong market share, and the potential to continue generating double-digit growth are hardly a dime-a-dozen, and I believe Rational AG (OTC:RTLLF) (RAAG.DE) has had uncommonly good results in no small part by maintaining a narrow focus on the foodservice equipment industry. More specifically, Rational AG pioneered the combi-oven concept and continues to focus its energies around a very limited product line-up built around saving space, labor, and operating costs in the commercial kitchen.

There a lot of very important "buts" to consider. First, Rational's ADRs have virtually no liquidity, so investors will have to look overseas (and even there its low share count doesn't lead to a lot of turnover). Second, insiders control the company. Third, the valuation is quite high as investors have rewarded the shares with a generous multiple as revenue has notably accelerated. Still, there is a large market opportunity waiting for Rational outside of Europe, management has shown it can run this business very well, and Rational would be an attractive target if or when those insider owners decided to sell.

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Rational AG Has Significant Growth Potential, But The Market Knows It

Growth Reacceleration Has Rebuilt Middleby's Multiple

When I last wrote about Middleby (NASDAQ:MIDD), I thought that a mix of concerns about growth had created a pretty rare opportunity to pick these shares up at a reasonable valuation. Since then, organic growth has improved and the shares are up around 40%. While I do think there is ample room for Middleby to improve its residential business, opportunity to improve is not the same thing as capability. I'm also a little more concerned about the company's potential growth leverage from M&A if/when interest rates start moving higher.

The valuation on Middleby shares has returned to its more normal level of overvalued in my eyes. Although the company is likely only at 10% share (or less) of its addressable market and its debt level isn't that high relative to EBITDA and/or free cash flow, roll-up stories usually reach a point of diminishing returns and the underlying market growth rate isn't that high. Middleby will likely eventually need to centralize its operations more than it has and I'd like to see the company pursue service-oriented business. Nevertheless, this is a stock I'd keep on a watch list with an eye toward taking advantage of future pullbacks.

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Growth Reacceleration Has Rebuilt Middleby's Multiple

Without Major Improvements, Manitowoc Foodservice Looks A Little Overcooked

I can appreciate scarcity value, and I can appreciate the appeal of a company that enjoys strong share in a large, fragmented market and has only recently returned to sounder operating and management policies. Even so, it's hard for me to get comfortable with the valuation on Manitowoc Foodservice (NYSE:MFS). While I definitely think its "right-sizing" and margin improvement efforts will pay off, I think the company's business mix and the underlying growth potential of the foodservice industry are limiting factors.

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Without Major Improvements, Manitowoc Foodservice Looks A Little Overcooked

Seeking Alpha: Diworsification Messing Up Middleby's Growth

Among the many nuggets to be found in Peter Lynch's books, the concept of "diworsification" is one of my favorites. The term refers to companies that eventually expand or acquire beyond their core competencies and end up ruining their business in the process. With Middleby's (NASDAQ:MIDD) struggles in its Viking business leading to real pressure on growth and margins, it's fair to ask whether this company's foray into residential cooking equipment is destroying the value created by the strong commercial operations.

These shares have lost about a quarter of their value since I last wrote about them, as a slowdown in food processing sales and the mess in the residential business has led to disappointing quarters (including organic revenue contraction in the second quarter), downward revisions, and a re-examination of whether these shares still merit such a robust premium. I've cut back my growth expectations, but I believe Middleby is still well-placed to take advantage of growing demand for labor-saving automation in commercial kitchens. There's elevated risk right now, and I'd be nervous about buying ahead of fourth quarter earnings, but there's still above-average growth potential in the core business.

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Diworsification Messing Up Middleby's Growth

Seeking Alpha: Illinois Tool Works Is A Growth Story Now

Before hardcore Illinois Tool Works (NYSE:ITW) investors light the torches and sharpen the pitchforks, I'll explain the title right away; my view on this industrial conglomerate is that the biggest swing factor in the company's stock market performance in the next one to three years is going to be the amount of organic revenue growth that it can generate. ITW has done a good job of boosting margins through streamlining, and management is quite willing to divest commoditized businesses, but its projections call for the company to perform on a level that has historically been out of reach.

I do believe we're in the middle of a promising buy-the-dip opportunity for a number of industrials, but I can't make the numbers work for Illinois Tool Works today. I believe management can generate mid-teens FCF margins on a sustained basis (a marked improvement over the past 10 years), but I just don't see enough organic revenue growth to drive an exciting fair value today.

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Illinois Tool Works Is A Growth Story Now

Seeking Alpha: Middleby Demands A Stiff Price For Growth

Investors will almost always pay up for growth. If you don't understand that, you'll never understand the trading in Middleby (NASDAQ:MIDD) shares, nor large swaths of the market. This doesn't mean that investors are always rational about what they'll pay for growth (if you remember the tech bubble, you know what I mean), and there are plenty of flame-out stories of stocks that carried steep multiples for five or more years, only to double back down to reality. But the bottom line is that growth draws investors like moths to flames.

I still like this company quite a bit, and I believe there are still significant growth/expansion opportunities in commercial foodservice (especially on the cold side), food processing, and residential (on the cold side and outdoor cooking). That said, while I don't think the valuation is crazy and I do think that the company can continue to double the growth of the underlying market, there's just not much breathing room left in the valuation from my perspective.

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Middleby Demands A Stiff Price For Growth

Seeking Alpha: Growth Still The Heart Of Middleby's Story

For an investor who sees himself as more value-oriented than growth-oriented, Middleby (NASDAQ:MIDD) is always challenging and frustrating. Built largely through acquisitions, the company has nevertheless posted revenue growth in the vicinity of 20% a year (annualized) over the past decade, with a doubling of FCF margins supporting even better FCF growth. What's more, it arguably doesn't get enough credit for growing and improving those assets it acquires.

Middleby remains a stretch from a DCF valuation perspective, or at least unless you're willing to assume double-digit revenue growth and FCF productivity well above the norms of the industry. That said, the price isn't so unreasonable from an EV/EBITDA standpoint, and the company is working on commercializing several concepts with significant revenue and margin potential.

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Growth Still The Heart Of Middleby's Story

Seeking Alpha: Middleby Continues To Defy Gravity

It says something about Middleby's (MIDD) valuation that a 20% pullback from its recent 52-week high still has the shares trading at around 15 times forward EBITDA. Then again, this is a company that continues to post organic revenue growth and profit growth well in excess of its industry peers while still looking at a large, mostly unpenetrated global market. While I can't really get all that comfortable with the valuation here, the operational story continues to be one of continued performance.

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Middleby Continues To Defy Gravity

Seeking Alpha: A Slower Recovery Threatens Manitowoc's Ambitious Multiple

Investors have been waiting for the boom/bust crane cycle to fuel another upswing in Manitowoc's (MTW) results, but the actual recovery in construction and infrastructure activity has proven slower and less stable than hoped. Management remains confident that the outlook for 2014 hasn't changed all that much, but investors clearly voted with their feet as the weak first quarter results sent the shares down 10% on Friday. Even after the decline, Manitowoc isn't all that cheap but it does remain a leveraged play on that recovery in construction and construction equipment spending.

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A Slower Recovery Threatens Manitowoc's Ambitious Multiple

Seeking Alpha: Can Manitowoc Live Up To More Bullish Crane Expectations?

Amidst the still-shaky non-residential construction recovery, investors have cast strong votes in favor of incoming prosperity for Manitowoc (MTW). This crane and foodservice company is certainly among those to benefit if construction equipment orders improve, and such improvement is likely more "when" than "if", but the volatility of that "when" could still make for some interesting times in the stock.

Speaking of the stock, I think an investor's time horizon and dedication to intrinsic value are both pretty relevant here. Unless you think Manitowoc can transform itself into one of the best-run, most-profitable heavy equipment companies over the next decade, discounted cash flow just doesn't suggest much value here. On the other hand, if you believe that a recovery in construction demand will fuel double-digit EBITDA growth over the next three to five years and that that growth merits a double-digit multiple to 2014's EBITDA, there's still upside left in these shares.

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Can Manitowoc Live Up To More Bullish Crane Expectations?