Opinion: Invest in Vital Farms’ IPO
Context
Vital Farms, Inc. is a Texas-based brand of pasture-raised eggs and butter. They are one of the top sellers of pasture-raised eggs, butter and ghee in US retail. Pasture-raised eggs are defined as eggs which come from hens with access to 108 sq. of pasture per bird. Vital Farms’ eggs are a very premium, niche offering for consumers who are very health, environment and socially conscious. They source their eggs from family farmers whom have pastures in the most ideal conditions part the country (The Pasture Belt). Vital Farms has seen rapid growth in their business and their sector, approx. 32% CAGR.
Vital Farms (VITL) has filed for a $125M IPO on NASDAQ offering 5M new shares at a price range between $15 and $17 per share. Existing shareholders are also offering 2.8M secondary shares. VITL currently has $43M in private investments from venture capital and private equity firms. The company’s scalable business model, growth outlook, increased overall demand for naturally-made food products and reasonable recession-resistance makes them one to watch out for once they complete their IPO. In my opinion, VITL could be a long-buy.
Qualitative Analysis
Industry
VITL has created a strong position in an everlasting sector. They sell shell-eggs, butter and ghee, with shell-eggs their largest offering. These are staples in consumer diets, so there will always be a demand for VITL’s products. In addition to being in the ever-lasting egg market, VITL have essentially created a niche market for themselves with pasture-raised products as a premium brand within in the natural/organic-food market, which is growing at approx. 20% CAGR, by “raising the standards”. With increasing GDP Per Capita, growing millennial population and other megatrends, organic-food products have been in high demand (evident from Amazon’s purchase of WholeFoods) because of the health and society benefits. The pasture-raised retail egg market specifically has had a CAGR of approx. 32%, where VITL has a 76% market share. This megatrend shift towards healthier, more premium, versions of staple food products show that there is a huge growth opportunity for VITL, especially given their scalable business model.
Business Model
VITL partners with local family farmers (currently 200+ farmers) and enters into buy-sell contracts, where in the farmers are responsible for all the CAPEX and Working Capital needs to source the eggs and VITL is contractually obliged to buy all their stock at a floating rate. VITL then moves it to their Egg Central Station (distribution center), where the shell eggs are washed, graded and packed, using third-party companies. Lastly, the team advertises their products under the VITL brand and sells to household and retail buyers, such as WholeFoods or Kroger.
I believe VITLs’ capital-light and premium brand-focused business model is something which is quite scalable and simple. This model allows VITL to operate in a relatively capital-light strategy. They outsource most parts of their business, such as production, logistics and farmer inspections, creating more free-cash-flow, which can increase shareholder value and returns in the forms of dividends or share-repurchases. In addition, by basing their brand around organic, healthy and sustainable food products, VITL has been able to tap into the megatrend we see in the Food & Beverages industry.
VITL’s flexibility to use cash for advertising has also created a strong brand loyalty for their products. According to VITL’s S-1 Prospectus, their brand has a 32% loyalty rate, wherein these consumers indicated they would rather not buy eggs, if VITL’s products are not available. This strong brand loyalty creates high seller power for VITL, as their consumer’s demand may be relatively inelastic, thus they can receive high margins. Their high seller power and brand loyalty is evident from VITL being a favorite for WholeFoods. To further supplement VITL’s stellar reputation as a healthy, premium brand of eggs, they are also a Certified Public-Benefit Corporation and Certified Humane (animal treatment), which gives the brand further credibility in their mission and keeps consumer willingness-to-pay high for their premium products and acts as a barrier-to-entry for new entrants, because these certifications are not easy to achieve and maintain.
Risks
VITL’s strong product outlook and business model are important, yes, but investors need to consider the risks associated with this IPO. COVID-19 has caused a lot of investors to be very bullish on high growth stocks, especially in the tech-sector, which may not yield as high returns as expected. We have seen from recent high-growth IPOs, such as WeWork, Uber and Lyft, that growth alone may not be a good enough indicator of the value of a stock. It is arguable that a ‘growth stock bubble’ may be forming, as NASDAQ has rallied compared to the S&P 500 and Dow. Therefore, investors need to be wary of VITL’s high-growth outlook, and also take a look at the stock from a fundamental perspective before joining the supposed herd of growth stock investors.
Additionally, VITL’s core differentiator is its relationships with the 200+ family farmers. In order to keep the company profitable and scale up, VITL will need to maintain these relationships because any disruptions can cause significant issues in their pasture-raised egg supply-chain. VITL is also very dependent on one product, their shell eggs, and any change in consumer preferences or buying powers (recessionary periods can affect premium priced products) can adversely affect the demand for their highest-selling product- it is interesting to note that VITL managed to perform well throughout the COVID-19 economic downturn. Is their brand strong enough to remain recession resistant? Maybe, for some consumers.
VITL also faces high competition from several private-label brands such as Kirkland’s, who have a much larger financial flexibility and better economies of scale and scope advantages- perhaps a successful IPO will help mitigate some of this risk. Lastly, because VITL outsources a lot of their operations such as the farming and inspection, they may have less control over the quality of their eggs. It is imperative that once VITL scales up, they do not lose their quality-control, otherwise they lose their competitive advantage.
Quantitative Analysis
VITL is a fast-growing company in a fast-growing sector. Their company is growing at 32% CAGR and the niche industry is expected to grow at 33% CAGR, these will fuel the strong financial outlook of the company over the next few years.
Financials
The IPO is offering approx. 5M primary shares at a price of $16 per share, and the shares outstanding after the IPO is expected to be approx. 39M, giving VITL a market capitalization of almost $630M. VITL is very less levered, with only $10M long-term debt outstanding as of Q1 2020. This should give investors’ confidence as the company will have cash flow to return to shareholders or invest into growing the business, rather than service a large debt balance.
VITL currently has very slim margins, with EBITDA margins as low as 3%. The main reason for this is because of a high proportion of Costs of Good Sold. This is because the company is still relatively small, compared to its large-scale competitors such as Costco’s Kirkland’s, thus they cannot achieve the economies of scale or scope needed for higher margins. Yet, the company still remains profitable. One of the main use of proceeds from this IPO is to achieve better economies of scale and scope through more financial flexibility from the capital markets. I predicted the future margins for VITL, and they showed significant improvements. Since the business is still relatively small, even a 5% increase in the Gross Margin can have an adverse effect on the cash flows generated by VITL. Investors should also take into account that VITL is focusing on its triple bottom-line and Research and Development, which keeps margins low in the short-run, but may have a positive impact on the long-run. According to Continental Search, one of VITL’s subsidiaries, Ovabrite, with the help of an Israeli technology company, is coming up with an ethical solution to reduce, and eventually eradicate the culling (slaughtering) of male chicks (as they are not cost-effective). The approx. value of wasted eggs from male and infertile chicks is $440 million a year, with up to 7 billion chicks killed each year. VITL, by investing in R&D, is introducing a new technology, TeraEgg. This technology will identify the gender and fertility of chicks during the embryo development process, so they can capture the value which is being wasted currently. Though this is a huge investment into the triple-bottom-line and reducing value-lost right now, VITL could see the positive effects in its margins in the long-run.
Valuation
For my valuation analysis of VITL, I only used the Discounted Cash Flow (DCF) method. Other methods, such as the Comparable Multiple Analysis, was not used as VITL does not have appropriate comparable companies; they are either companies with a diversified product range (Kirkland’s) or private corporations with undisclosed financials.
For my 5-year projection of cash flows, I assumed a revenue growth rate of 32% for the first two years, and 30% for the next three years. VITL’s 2020 Q1 results remained strong, with approx. 35% increase in revenues from Q12019, therefore I did not show declining growth because of COVID-19. In addition, as their product offering is a staple, though expensive, COVID-19 is less likely to have a negative impact on the demand for eggs, especially since most consumers are still taking precautions and cooking at home. For the rest of my projections, I used the Percent-Of-Sales Method, only reducing the COGS proportion year-on-year as scaling up should improve VITL’s economies of scale. CAPEX of $15M for the first three years was taken from VITL’s IPO Prospectus, as they plan on spending this amount in capital investments to grow their business. For my Terminal Value calculation, I used an exit EBITDA Multiple of 12x, as I believed this is an appropriate multiple given the nature of VITL’s business. Using this DCF analysis, I believe VITL should have an Enterprise Value of $664M, which is approx. $17 per share. Their IPO valuation ranges between $16 and $17 per share, so I believe this to be a pretty fair valuation.
Risks
The major financial risk associated with VITL’s stock is if it cannot maintain its growth. The prospectus has also highlighted this issue, and the company states it cannot assure past-performance like growth. I ran a sensitivity analysis to see how a decreased growth rate would affect the value of the company. Instead of an approx. 30% growth rate of the revenue for VITL, I applied a 15% growth rate for my DCF calculation. This resulted in an Enterprise Value of approx. $340 million and share price of $8, which is around half the current valuation of VITL at a growth rate which is relatively still quite high. Investors would need to closely monitor VITL’s performance over the next few quarters to get a sense of whether their high growth is attainable or not.
Conclusion
In my opinion, I believe Vital Farms should be a buy, or one to look out for as the company IPOs hopefully later this month. It is a fast-growing business in a fast-growing sector. VITL’s product offering is servicing some megatrends in the Food and Beverages Industry and one that should last for a while, given their main product is eggs. In addition, I believe their fundamentals of a capital-light and premium-brand orientated business-model will help investors earn some strong returns over the long-run. The IPO is fairly priced, according to my analysis, so it really comes down to the demand for VITL’s stock.
However, the stiff competition in this industry VITL will face from large players like Costco’s Kirkland’s, small product portfolio and changing consumer preferences could have an impact on the performance of VITL’s stock. Investors should also closely monitor VITL’s growth, as this is one of the main factors driving its value-creation. Investors should also dig deeper into the filings of VITL once the company is public and obligated to report earnings in detail.
Nonetheless, I believe VITL is a stock to buy for the long-run as it is trying to disrupt a very old industry, so it will be interesting how much of a difference the company can make.
My analysis was done studying the SEC filings of Vital Farms, Inc, reports on general market trends and financial news. If you’d like to see my excel workbook, or have any further questions, please feel free to reach out to me, especially if you have any positive or constructive feedback.
Written by,
Abhishek Khetan
BU 2020 Graduate
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