Looking For Value In The Great Beyond (Meat)

May 6, 2019 3oliver

Beyond Meat (BYND) is the latest and greatest IPO to hit the market in 2019. I became interested in this company very recently, having been intrigued by what I considered to be the very low $1.6 billion dollar price tag, at $25. However, as of opening day’s close at $65.75, a market cap of about $4.2 billion, there is certainly less value remaining in shares at this price point. My goal here will be to assess whether there is still any potential for value in shares at this new price point to achieve superior returns over the long run, and then to question if those returns justify the extraordinary risk inherent with a fledgling company that is clearly many years from achieving profitability.

Historical Trends Look Great, But Unsustainable

Firstly, it cannot be denied that Beyond Meat is posting absolutely incredible sales growth. In 2018, the firm posted ~$88 million in sales, up from ~$16 and $33 million from each of the two years prior. This amounts to a growth rate over 100%, which is, in fact, accelerating. However, triple-digit sales growth is clearly not a sustainable practice, so I’d like to try and identify the drivers of this growth, to come to some more reasonable long-term estimates.

Source: BYND S-1

Further, among this incredible growth the company has seen so far with respect to sales, they have also been able to grow gross margins significantly, from -39% in 2016, all the way up to 20% in 2018. With margins growing over time, at the same time as sales are growing exponentially, the cumulative effect has an incredible impact on gross profits. As with revenues, this trend cannot be extrapolated indefinitely into the future, so it will be my goal to identify a terminal limit for gross margins.

Source: BYND S-1

So far, the historical data looks really great. Perhaps most encouraging, is how the company has managed to already grow margins to a level that suggests, by reducing operating costs, net profitability may already be possible. Through growing the business and achieving economies of scale, it is already possible to see how 2018’s 20% gross margin figure may translate well into future profitability.

Identifying Growth Drivers

For anyone who follows my work, you will know that I tend to look for numbers-based arguments. There are certainly many qualitative reasons that will allow Beyond Meat to achieve strong growth, and I would recommend reading up on other authors’ work to garner a better understanding. My analysis, rather, starts from a position of already believing in the company, and attempts to quantify what it is capable of, in order to generate both reasonable expectations, and a fair value based on those expectations.

In the company’s S-1, I have noticed a very clear pattern tying SG&A expenses to COGS growth. Because COGS is representative, if not perfectly proportional, to the volume of sales, I think this is a great place to begin with identifying how quickly the company is able to sell more product. At this stage of the game, simply moving more product, getting it on more shelves, in front of more customers, is paramount. So, instead of judging the sales team based on revenues, I think it’s useful to evaluate them based on how much product they get moved. As a note, my 2019 estimates are a simple annualization of the Q1 guidance contained in the company’s S-1.

	2016	2017	2018	2019 est.
COGS	22.494M	35.772M	70.36M	116.00M
COGS Growth	N/A	13.278M	34.588M	45.64M
SG&A	12.672M	17.143M	34.461M	55.00M
Efficiency	N/A	77.5%	100.4%	83%

Source: BYND S-1

As we can see from the chart, SG&A lines up quite nicely with COGS growth – rather than COGS themselves. So while the ratio of sales to SG&A is increasing, which others have pointed out, and is a nice metric to see, because it implies increasing efficiency, comparing SG&A to the growth of COGS allows a framework to understand how and why that efficiency is increasing. Essentially, I think it is best to understand SG&A expenses as building customer relationships and brand equity – both of which are worth more than just an individual sale. So it seems plausible that this relationship, of COGS growth aligning with SG&A expenses, is likely to hold up moving forward. Moving forward, SG&A expenses will be the number to watch out for – bigger is better – as well as the efficiency that the company achieves on those expenses.

Next, it’s important to look to see where margins seem likely to peak out at. I like to look at margins, in this context, in a bit of an unorthodox way, preferring to calculate the markup. Instead of calculating what percentage of revenues is profit, I like to understand how much profit is being generated on top of cost. Because gross margins can never be greater than 100%, and markup increases exponentially as costs approach 0% of revenues, I think watching markup is a better way to identify where margins will ultimately peak out at. Again, this next chart simply annualizes the Q1 guide found in the S-1, so these numbers are likely below the year’s midpoint, but I think it’s useful to be on the conservative side here.

Source: BYND S-1

Noticeably, the change in markup has come down, going into 2019. Again, this may be impaired by comparing just the first quarter of expected performance, which, for a growing company with growing margins, may be lower than the midpoint of the year. Still, I’d like to stay on the conservative side here. So it appears as though markup may be reaching a terminal level in the 40% area, and maybe optimistically reaching 50%. I’ll be using 45%, going forward. This would have gross margins in the 29-33% range. Given that a large portion of operating expenses are, in truth, investments into growth, it should be possible to significantly scale back SG&A to achieve profitability, even using current metrics. However, given current market price, there’s clearly no way to translate a few million dollars of gross profits into a worthwhile investment, at the cost of several billion dollars.

The last driver I want to look at, is how much acceleration we should expect moving forward. While it would be really wild to be expecting to accelerate from 100% growth rates, I’m looking for an acceleration of dollar value growth, rather than percentage growth. This is something that, ideally, should be able to continue accelerating until the company reaches a semblance of maturity – but in doing so, percentage growth rates will likely slip over time, as larger dollar figures stack up less favorably against the whole. With SG&A expenses linked to product sales, I think it’s prudent to estimate how much these will grow, moving forward.

Source: BYND S-1

As we can see from this last chart, SG&A growth isn’t, or at least hasn’t, grown at a steady percentage rate. Using 2018’s value as a baseline, however, it seems plausible for the dollar growth to increase roughly 5% plus $3 million per year. As dollar growth becomes a smaller percentage of the whole, the year-over-year growth rate will moderate towards a more reasonable level, even as dollar growth continues accelerating.

Finally, I want to take a peek at tangible capital investments, and how many products the company is able to produce out of a given investment into facilities. While building more facilities is a capital expenditure, rather than an operating cost, bundling these factories in with the SG&A costs that I’m looking at as an investment makes sense. In 2017, the company had $14 million in plant, property, and equipment on the balance sheet, and spent $34.8 million on costs of goods sold. In 2018, they had ~$30.5 million in PP&E, and spent $70.4 million on costs of goods sold. Efficiency seems to be slipping a little bit, with 248% of PP&E produced in 2017, and only 231% in 2018. Still, this is pretty similar, and I expect greater economies of scale moving forward, so looking forward, I expect the company’s production facilities to process 250% their value in products per year.

Looking Beyond

By understanding what is driving growth, rather than simply extrapolating growth rates and hoping for the best, I think it’s now possible to plug it all in together to reach an approximate expectation for the company’s growth story, in numbers. Once the numbers reach a level that could be considered “mature”, with low growth, it is then possible to value that mature company, and discount backwards, to identify a fair value for today. Additionally, we can evaluate our expectations for cash burn over the next several years, and question if any dilutive events may be necessary in the future. The optimal solution for current shareholders would thus be to buy at a minimal price now, have shares appreciate to excessively-high prices, do an equity raise, and then have shares come down again by the time the company reaches profitability and can begin rewarding shareholders directly with buybacks and dividends. Of course, my own philosophy would preclude me from owning the stock if I viewed it as excessively priced. On the plus side, I detail why it is acceptable (if not ideal) for companies to issue equity, even when the equity is very undervalued, so long as they’ve got a superior alternative investment in mind with the cash, in my previous strategy article “The Three Rs Of Great Capital Allocation”.

To begin, let’s go back to SG&A. Starting with a $55m in SG&A estimate for 2019, and growing by 20.5 million +3 million +5% per year, this is the growth curve on expenses over the next ten to twenty years.

Source: Author

With an average 87% efficiency of conversion from SG&A expenses into more product sold, and a markup of 45%, this next pair of charts show the amount of facilities needed to produce all of the necessary product, as well as the total sales and gross profits.

Source: Author

Finally, this last set of charts shows, over ten to twenty years, operating profits, contrasted with cash charges for investments. I’ve split R&D out of operating expenses here, because I view it as an investment into the future, same as any other investment might be. For a number, I’ve used 5% of sales, which is lower than present, but probably more than is likely in the future, as a food company. However, the company may have good reasons to spend significantly more than the industry on R&D, having such high-tech products. This also shows cumulative cash carried on the balance sheet, assuming reinvestment into 3% bonds. This would likely provide more benefit elsewhere, but I’ve noticed that many tech companies like to hoard cash, and I’d rather assume the norm to be conservative here. It will serve as a dollar-for-dollar value add on top of my enterprise valuation. To make the charts a bit easier to read, I’ve divided revenue and accumulated cash by 10, to put them more in line with the rest of the values.

Source: BYND S-1

Some key values from this last chart include 10-year estimates on free cash flow at $266M, and 20-year at $2220M. Also of note, net cash on the balance sheet never drops below about $250M, indicating that following this general outline, there will not be a need for an equity raise. At the end of 10 years, accumulated cash reaches $1071M, and all the way up to almost $14 billion by the end of twenty years.

Valuation and Conclusion

Naturally, with any long-term horizon estimate such as this, there’s a ton of places to be wrong. As such, this article and my analysis form merely a rough framework of expectations, and a valuation target in line with those expectations. For fellow investors that believe in the mission and successful execution of strategy of Beyond Meat, and that don’t think I’ve made too many outlandish assumptions about the future, this valuation should prove useful.

Based on my FCFTR methodology, I value BYND at 50 times 2028 free cash flow, plus cash, discounted 15% per year to roughly $3.6 billion. With BYND’s Friday close at $66.79, a market cap of $4.2 billion, I see the company as approximately 20% overvalued, against a 15%/yr annual return expectation. Using my 20-year numbers, I value BYND at 25 times 2038 free cash flow, plus cash, again discounted 15% per year, to $4.33 billion. With a longer time horizon, BYND seems fairly valued against a 15%/yr return expectation.

Unfortunately, with the gigantic surge on the IPO, I can no longer see exceptional value in BYND. Ideally, for such a young growth company, I would want to be paid very well for taking the risk to invest. The goal would is to be able to purchase at a significant discount to even a 15% annual return expectation. This would allow selling at or near fair value for considerable short-term returns, and taking risk off of the table for the long term, or greater outperformance for a long term hold. Unfortunately, the market has beaten me to it, after having opening on the market at almost a 100% markup to the originally-cheap IPO price. However, with the immense volatility inherent with IPOs, I think there’s a reasonable chance of a fall back down to earth, where opportunity may present itself. As such, I will be looking to write $50 puts (a market cap of $3.15B), with the potential for writing more at lower strikes. Once options become available, this should present a compelling income opportunity, with the downside constituting a long position in a high-risk/high-reward stock, at a price that seems more than fair.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BYND over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.