Middleby Has A Bright Future (NASDAQ:MIDD)

Hispanolistic

The Middleby Corporation (NASDAQ:MIDD) continues to deliver excellent results quarter after quarter. Profit margins remain very high despite ongoing inflationary headwinds, and sales appear to be stabilizing at a high level compared to pre-covid levels boosted by an aggressive M&A strategy. Despite this, expectations of a slowdown in sales as a result of customers' destocking and losing purchasing power among consumers due to high inflation rates are beginning to lower expectations among investors, who remain cautious. To this, we must add rising interest expenses and growing concerns of a potential recession due to recent interest rate hikes at a time when the company holds $2.73 billion in long-term debt. Despite the fact that the rest of the segments are showing relatively fast growth rates, sales from the residential market are beginning to show signs of significant weakening.

Still, the company continues to generate vast amounts of cash quarter after quarter, and the debt is highly manageable thanks to very high inventories of $1.12 billion. In addition, excess cash generation should allow the management to continue performing acquisitions and/or share buybacks, whereby investors should be rewarded with an ever-growing position over the years. If we add to this that the P/S ratio is currently 32.38% lower than the average of the last 10 years and 53.85% below the highest peak of this period, we are in front of what I consider to be a good opportunity for long-term investors since the upside potential is very high in the long run.

The Middleby Corporation is a leading designer, manufacturer, marketer, distributor, and service provider of a wide line of foodservice equipment, food preparation, cooking, baking, chilling and packaging equipment for food processing operations, as well as premium kitchen equipment including ranges, ovens, refrigerators, ventilation, dishwashers and outdoor cooking equipment. The company was founded in 1888 and its market cap currently stands at $7.54 billion, employing over 10,000 workers worldwide.

The Middleby Corporation logo (Middleby.com)

The company operates under three main business segments: the Commercial Foodservice Equipment Group, the Food Processing Equipment Group, and the Residential Kitchen Equipment Group. Under the Commercial Foodservice Equipment Group segment, which provided 60% of the company's net sales in 2022, the company owns 72 brands that manufacture foodservice equipment for cooking, warming, holding, refrigeration, freezing, and beverage application. Under the Food Processing Equipment Group segment, which provided 14% of the company's net sales in 2022, the company owns 26 brands that manufacture processing solutions for customers producing protein products, such as bacon, salami, hot dogs, dinner sausages, poultry and lunchmeats, and bakery products, such as muffins, cookies, crackers, pies, bread, and buns. And under the Residential Kitchen Equipment Group segment, which provided 26% of the company's net sales in 2022, the company manufactures kitchen equipment for the residential market.

Currently, shares are trading at $143.98, which represents a 28.40% decline from all-time highs of $201.34 on February 9, 2022. This drop has been caused by various factors that have led investors to lower their expectations for the short and medium term, such as a mild decline in EBITDA margins due to inflationary pressures, a stabilization of sales and slight sales growth expectations due to weaker demand in residential markets and high customer inventory, growing concerns of a potential recession due to recent interest rate hikes, and rising interest expenses due to increased debt as the company recently performed acquisitions to expand operations.

Middleby is a major acquirer that has boosted its sales at a rapid pace in recent years thanks to an aggressive M&A strategy.

In December 2021, the company acquired Masterbuilt Holdings, a leader in outdoor residential cooking products with annual revenues of ~$250 million, and Char-Griller, a U.S. leader in residential outdoor charcoal and gas cooking products with annual revenues of $150 million. Later, in June 2022, the company acquired Proxaut, a leading Italian manufacturer of Auto Guided Vehicles for the food industry and industrial processing companies with annual revenues of $15 million, and during the same month, the company also acquired Icetro, a global manufacturer of ice, soft serve, and slush machines for commercial foodservice businesses with annual revenues of $40 million.

A month later, in July 2022, the company acquired Colussi Ermes, a leading Italian manufacturer of automated washing solutions for the food processing industry with annual revenues of around $50 million. During the same month, the company also acquired CP Packaging, a U.S. manufacturer of advanced high-speed vacuum packaging equipment with annual sales of around $15 million. And in November 2022, the company acquired Escher Mixers, a manufacturer of highly-engineered spiral and planetary mixers for the industrial baking industry with annual revenues of $15 million.

More recently, in December 2022, the company acquired Marco Beverage Systems, an Irish manufacturer of innovative and energy-efficient beverage dispensing solutions with annual revenues of $30 million. And the latest acquisition took place in January 2023 when the company acquired Flavor Burst, an innovative technology used in a variety of flavored beverage and soft serve products with annual revenues of $5 million.

The continuous acquisition of companies has allowed Middleby to grow its sales at a high rate, and I would expect more acquisitions in the foreseeable future as further borrowing capacity is still high at $2.3 billion. Nevertheless, the company has increased its debt significantly to $2.7 billion, so it will eventually have to start deleveraging its balance sheet.

Thanks to its aggressive M&A strategy, the company has managed to grow its net sales over the years at a very fast pace. Despite the fact that the coronavirus pandemic caused a reduction in sales of 15.08% in 2020, net sales kept reaching new heights in 2021 boosted by acquisitions as net sales increased by 29.35%, and they increased again by a further 24.06% in 2023.

The Middleby Corporation net sales (Seeking Alpha)

Still, net sales are stabilizing as they increased by just 1.28% year over year during the first quarter of 2023 due to the fact that the company's residential segment is currently impacted by retail customers' destocking and consumer lower purchasing power, which caused a 32% decline in revenues in the segment compared to the prior year. Nevertheless, revenues in the Commercial Food segment increased by 11.5% organically compared to the same quarter of 2022, and by 24% in the Food Service segment.

The company keeps launching products in order to maintain its leadership position in the industry and capitalize on new trends. In this regard, the company is currently testing its new launch, FryBot, in leading restaurant brands. FryBot is a fully automated dispenser and frier which can be a great step towards the automation of fast food chains. In this sense, net sales are expected to increase by 4.47% in 2023, and by a further 4.28% in 2024. Still, these forecasts do not take into consideration new potential acquisitions. Using 2022 as a reference, 71% of net sales are generated in the United States and Canada, whereas 19% are generated in Europe and the Middle East, 7% in Asia, and 3% in Latin America, which means the company enjoys some geographical diversification.

The recent share price decline coupled with increased sales caused a sharp drop in the P/S ratio to 1.938, which means the company currently generates net sales of $0.52 for each dollar held in shares by investors, annually.

This ratio is 32.38% lower than the average of the past decade and represents a 53.85% decline from decade-highs of 4.199, which shows growing pessimism among investors as they are placing much less value on the company's sales due to relatively low growth expectations and potential headwinds in the short to medium term. But despite this, the company remains highly profitable, suggesting that it will be able to continue generating high cash from operations year after year with which to deleverage its balance sheet and/or continue to make acquisitions to keep growing.

The company's leading position in the industry and the high added value of its products are reflected in its high profit margins. Trailing twelve months' gross profit margin currently stands at 36.95%, whereas the EBITDA margin is at 20.05%, which means the company is highly profitable. In addition, these profit margins have remained very stable over time, with which the company has a very small cyclical component.

During the first quarter of 2023, the company reported a gross profit margin of 37.50% and an EBITDA margin of 19.49%, which means the company remains highly profitable despite current inflationary headwinds. Cash from operations has been relatively weak in 2022 as the company has raised inventories, but nevertheless, adjusted EBITDA increased by 6% year over year during the quarter, which is still enabling very high cash from operations despite rising inventories.

In this regard, trailing twelve months' cash from operations is very high at $439.9 million, and capital expenditures have tripled since 2019 to over $80 million as the company is currently investing heavily in capacity expansion and process automation within its operations in order to drive profitability. As for the first quarter of 2023, the company generated cash from operations of $92 million as inventories increased by $38.7 million and accounts receivable by $27.8 million while accounts payable increased by just $10.6 million. Thanks to this, the company's debt does not pose a significant risk as the company can easily cover both capital expenditures and interest expenses with cash from operations. Furthermore, high inventories should allow for even higher cash from operations in the short and medium term.

Over the years, Middleby has built up a huge debt pile, which today stands at 2.73 billion, in order to acquire other businesses and grow. Also, cash and equivalents are very low at $157 million.

As a consequence of rising debt, interest expenses skyrocketed over the years, and the company reported interest expenses of $29.46 million in the past quarter, which means trailing twelve months' interest expenses should soon reach almost $120 million per year, which is significantly lower than current trailing twelve months' cash from operations of $440 million. Furthermore, the company still has $2.3 billion of borrowing capacity, which means it could continue to borrow more cash in order to keep acquiring companies as cash from operations is still significantly higher than current interest expenses and capital expenditures.

Also, despite the company having little cash and equivalents on its balance sheet, inventories have risen significantly since 2021 to $1.12 billion, and therefore, cash from operations is expected to be strong in the foreseeable future as the company can convert these inventories into cash.

It is for these two reasons (high cash from operations compared to interest expenses, and high inventories) that I consider that the current debt level is highly manageable and that the company could continue borrowing more cash in order to keep making further acquisitions. In addition, excess cash generated should allow the company to continue performing share buybacks in order to reward shareholders.

The company began to reduce the total number of outstanding shares through share repurchases in late 2017, and shares outstanding declined by 7.11% since then. These share buybacks continue in force as the company repurchased $48 million worth of shares during the first quarter of 2023.

This means that each share represents a growing portion of the company as there are fewer shares remaining as time passes. Furthermore, the company's business model characterized by very high profit margins and strong cash generation capacity should allow share buybacks to become a tradition as the company is reaching a large enough size to be considered a very mature company. Despite this, interest expenses will continue to limit the pace of buybacks until the debt load is significantly reduced.

Overall, I think Middleby's risk profile is very low thanks to very high profit margins and huge inventories that should allow for high cash from operations in the short and medium term, with which the current debt load is highly manageable. Even so, there are certain risks that I would like to highlight, especially for the short and medium term.

Overall, Middleby's operations continue to be as bright as usual. The company continues to generate vast amounts of cash from operations despite ongoing inflationary headwinds, and inventories have increased significantly to $1.12 billion, so its current level of debt should not pose a problem. In this sense, the company could continue to expand through more acquisitions in the short and medium term as it still has ample borrowing capacity.

This is why I consider that the current fall in the share price due to rising interest expenses, a mild decline in EBITDA margins, and growing concerns of a potential recession represents a good opportunity for long-term investors as the company is highly prepared to face a significant downturn due to a strong balance sheet and a high profitability profile. Furthermore, excess cash generation suggests that the company should continue to reward shareholders over the years, whether through further share buybacks, acquisitions, or even a potential dividend.

This article was written by

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