The shares of this frozen potato provider have recovered somewhat since the pandemic started, but are still trading at a low valuation.
Lamb Weston Holdings, Inc. (LW)
From The Turnaround Letter
Lamb Weston is the largest producer of frozen potato products in North America and the second largest in the world. Selling French fries to fast-food restaurants (McDonald’s is a 10% customer) is a major part of its business. While the United States produces 80% of its revenues, it has 27 processing facilities around the world that serve fast-food and full-service restaurants and other customers in 100 countries.
Based in Eagle, Idaho, Lamb Weston was founded in 1950 by F. Gilbert Lamb in Weston, Oregon. The company gained a reputation for valuable innovations, including inventing the Water Knife Gun in the early 1960s that became the industry standard for slicing potatoes. Lamb Weston expanded through organic growth and acquisitions in Asia and Europe. In late 2016, the company regained its independence with its spin-off from Conagra Brands.
Lamb Weston shares remain 32% below their highs on concerns over how deeply its profits will decline due to widespread Covid-19-related restaurant closures. Investors also worry about a slow re-opening pace and whether uneasy consumers and capacity-reducing social distancing protocols will initially and possibly permanently impair the return of normal restaurant traffic unless a vaccine or effective treatment for Covid-19 is found. Concerns also include recent in-creases in input and fixed costs, virus-related supply chain issues and general agricultural risks associated with sourcing potatoes.
Lamb Weston shares offer investors an opportunity to invest at an attractive price in one of the largest companies in a stable, high-margin secular-growth industry.
French fries remain a dining-out staple; there is hardly a menu item that is more universally popular. While near-term demand will clearly be weak, long-term global demand will likely rebound and resume its steady 3% growth rate.
Near-term demand won’t completely collapse, either. About 65% of all fries are purchased at fast-food restaurants, and about two-thirds of those are bought via drive-through windows, carry-out or delivery, which continue to remain open for business. States (and countries) are beginning to re-open their economies, providing some clarity to what we see as a normalizing of restaurant traffic by the end of 2020. Recent results from China, where sales quickly rebounded to 70% of normal, provide some encouragement. Also, Lamb Weston will capture some of the (temporary) surge in retail French fry demand.
Lamb Weston has a cost-advantaged position (given its high-quality potato sourcing and large-scale and efficient production facilities) and a high 42% market share in a concentrated industry. The North American potato industry is dominated by Lamb Weston and three other large, family-owned companies, somewhat limiting the risk of aggressive competition.
Last year, the company produced healthy profits (22.0% EBITDA margin) and surplus free cash flow (nearly $200 million) even after funding an elevated capital spending program and its dividend. In a prolonged recession, we estimate that the company would still have break-even or positive surplus free cash flow.
Lamb Weston’s balance sheet is sturdy, and its liquidity is plentiful. Quarter-end debt of $2.3 billion was only 2.6x last year’s $853 million in EBITDA. The company raised cash by drawing $495 million draw from its credit lines after quarter-end, and even in the unlikely event that it goes through all that cash, its leverage would still be manageable. And, the nearest maturity other than the line of credit is a modest $280 million due in November 2021, providing time for an eventual recovery.
With Lamb Weston’s overall business and financial strength, its shares look quite appetizing for long-term investors. We recommend the PURCHASE of shares of Lamb Weston Holdings (LW) shares with an $85 price target.
George Putnam III, The Turnaround Letter, turnaroundletter.com, 617-573-9550, May 2020