Middleby‘s (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, do not 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.
Changes In Food Production And Service Play To Middleby’s Strengths
Middleby is sometimes criticized for its growth by acquisition strategy, but the reality is that management has historically done a pretty good job of buying attractive pieces and anticipating the needs of customers in the restaurant (foodservice) and food production markets. In particular, not only has Middleby rounded out its offerings to touch most areas of the commercial kitchen, it has built a technology portfolio that addresses where these markets are going.
Strong results in 2021 were driven in no small part by strong restaurant openings. While Middleby generally does a lot of replacement business in its commercial foodservice operations, new business was more than half of the order flow as regional and national QSR chains continue to add suburban locations. I expect that will slow some as Middleby fulfills those orders in 2022.
Beyond that, though, I still see a lot of growth drivers. Prepared food has proven to be a winning category for non-restaurants like supermarkets, and as these businesses look to expand their offerings, I see them moving towards “ghost kitchen” formats where production can be centralized, saving valuable in-store selling space. Even if these customers do not go with the ghost kitchen approach, Middleby is still a strong incumbent provider of the ovens, combi-ovens, fryers, and other hot-side equipment used to produce the food.
I likewise expect ongoing expansion of prepared food offerings at convenience stores, driving more demand for Middleby’s products. Most of the major C-store chains have announced plans to expand their in-store food offerings, and Middleby enjoys a strong position in this market.
Within the traditional restaurant space, I find it interesting to see the surge in new restaurant openings, but I still believe at least some chains will explore the ghost kitchen concept to serve and service delivery demand. I likewise expect restaurants to take even more serious looks at labor-saving automation in the kitchen as labor costs and availability continue to impact the sector.
I’ve talked about the opportunities in automation for the food / beverage end-market before, but more often in reference to traditional automation companies like Rockwell (DRESS). I do not expect Middleby to look to become a head-to-head rival there, but they have been stepping up their offerings of automation equipment, including forays into robotics.
The argument for increased automation in food production is pretty straightforward – while automated systems are expensive initially, they do not ask for raises, they do not call in sick, and they do not get hurt. With companies like Tyson (TSN) facing more demand than it can meet, I see increasingly automated production lines as a natural solution
Continuing To Build A Robust Residential Portfolio
I have more mixed feelings about Middleby’s efforts in residential, but that’s nothing new. Management’s track record here is more mixed, but I can not deny that the company has assembled a broad, deep portfolio of higher-end brands and offerings for mass-affluent / affluent customers.
Higher-end residential kitchen equipment is a market more driven by remodel / renovation than new construction, and I think the renovation wave seen during the pandemic has petered out. That does not mean there’s no growth potential here, but I think that potential is more on the order of what Middleby managed in this last quarter (up around 4%).
Middleby instituted price hikes in August and November, and another is coming in April; these moves should help offset margin pressure, but it may take a year or two for EBITDA margins to resume their march toward the mid-20% s. In the meantime, while I do think that the pace of new restaurant openings will slow, I still see retrofit opportunities in the commercial foodservice market, as well as growth in food production automation.
A big question I have with modeling now is whether 2021 results (and the strong backlog Middleby carried into this year) represents a pulling-forward of demand and whether these new store locations are going to come in place of more significant renovation spending. I’m still looking for around 5% long-term revenue growth from Middleby, but that pull-forward risk is worth monitoring. I do expect ongoing M&A, and I think investors should be encouraged by the discipline management shown with the Ali Group – Welbilt situation.
On the margin side, I expect input costs to have an ongoing impact in 2022 and 2023, but I still believe that the company will get back on the path to mid-teens FCF margins in 2023/24 and generate high-teens FCF margins over time, driving double-digit FCF growth.
Discounting those cash flows, Middleby looks priced for a high single-digit return, which is cheaper than it usually looks and my revenue estimates may prove too conservative, as this is a company with a 13.5% trailing revenue growth rate over the last decade ( boosted, of course, by M&A). Looking at prospective margins and returns, I think Middleby’s performance can support a 14x-15x forward EBITDA multiple, which drives a fair value close to $ 190.
The Bottom Line
Sentiment and further derating in industrials would seem to be the biggest risk for Middleby right now – I do expect demand to slow in commercial foodservice, but that’s already in my model, and margins should start expanding again in 2023. Although many industrials have gotten a lot cheaper, and Middleby still isn’t exceptionally cheap, this is a second chance at a quality growth name that does not often get all that cheap in the normal course of business.