Beyond Meat’s stock surged on its first day as a public company. You could say it was BEYOND expectations. The stock surged 163% in the first day of trading. This was one of the strongest one day performances since the 2000 dot com bubble.
Is Beyond Meat’s Stock… Beyond Sensical?
Beyond Meat’s Valuation is currently is $4 billion based on market cap. Based on my calculation, the company is currently trading at 36.5x 2018 sales. For context, Google trades at 5.0x sales. Tesla is 2.4x sales. I would actually be interested to hear any stocks with higher price / sales multiples that are non-pharma related. Clearly, this is a high multiple.
As an aside, this is actually a poor outcome for the company, all things considered. They could have raised the same amount of money by issuing much less shares if the underwriters had priced it correctly at a higher price. That said, hindsight is 20/20.
But the companyIS growing quickly and has noted that it has been capacity constrained. Sales were up 170% in 2018 from 2017 (albeit, only $88MM in sales in 2018 so coming off of a low base). Based on the company’s disclosure, they estimate the total meat market to be $1.4 trillion in size. Clearly, they will not be able to capture the total market here or even come close. What they want investors to say is, “well, if they just get 5% of the market, thats $70BN!”
I don’t think that is going to happen. The product is good, but its not that good. There are also competitors (I’ve personally tried the Impossible Burger and I really like what they’ve done).
When assessing this company’s moat, and taking the ingredient list into consideration, it is hard for me to say over a long period of time no competitor can break in. The ingredient list looks pretty simple to me, so it really comes down to texture. Obviously not an easy task since veggies burgers have been around for at least 30 years, but players are emerging. Again, I’m not being paid by Impossible Burger but it is good stuff!
So is Beyond Meat Stock a Buy?
It seems almost impossible to justify a price to sales multiple like what BYND trades at. That is likely why the underwriters had so much trouble pricing it. But if you take a longer term view, it is actually interesting.
Lets walk through some assumptions:
I am going to assume the company grows 175% in 2019. This is decent deceleration from their Q1’19 pace. The company was able to triple its monthly capacity and its corresponding sales are expected to be up ~290%. Gross margins are also set to improve to ~25-26% of sales, from the 20% area during 2018.
Following 2019, I expect the company to double in 2020, 75% in 2021 (stark deceleration) and 45% in 2022. Once the company has capacity online, its relatively easy to ramp if demand is there and the incremental margins already appear quite strong. I am going to assume they have a 38% incremental gross margins in 2019, stepping up to 40% as they hit the high notes of 2021 and beyond. Long story short, as my snapshot below shows, I have the company reachin 12-13% EBITDA margins by 2022-2023.
The interesting thing is that the business, like most food companies, does not require much capital to grow. Therefore, I have the company FCF positive by 2023. That may not seem that great, but considering the growth, it isn’t too bad.
Unfortunately, as shown at the bottom of this snapshot, Beyond Meat’s stock valuation just is not there. It is just way too high. These are optimistic assumptions and by 2023 we’d still be sitting at 20x EBITDA. That seems too rich for my diet.
The total return for the S&P500 year-to-date in mid-April is 16.6%. Truly fantastic performance for any year. Clearly, its hard to see whether the gains will continue. The long-term rate of return for the S&P (including dividends) is 9.4% (based on data sourced from NYU). That means this year is clearly above average. Then again, in the past 91 years, how many years have had a higher return than 16.6%??
Well, that may piece of information actually be surprising to hear. There have been 39 other years when the total return on the S&P was higher than 16.6%. That’s about ~40% of the years from the available data!
Clearly, part of the reason for this recent surge was the sell-off in December, where stocks declined nearly 20% from peak-to-trough in just one quarter. The decline was quick and steep and the snap back has been quick and steep as well. We still haven’t recovered to those peaks yet, so a bullish investor could also say we could at least see a couple more points of total return this year from that.
All that said, I have to ask what the risk/reward is at these levels? Is there valuation support?
The consensus earnings estimate for the S&P in 2019 is $164/share. Let’s break that down compared to current trading levels and what that implies (i.e. is the market cheap on its face).
The long-term average P/E multiple is around 15.0x , so this would imply… no the market is not that cheap.
That said, Peter Lynch’s old rule of thumb for if the market was cheap was 20x minus the 10-yr treasury rate (a proxy for inflation). That would put us around 17x-18x. Therefore…the market still doesn’t look that cheap now.
But what if we look to 2020? The market is forward looking after all.
What is interesting to me is that EPS estimate is $184 vs. $163 for 2019. That means Wall Street is expecting a pretty strong rebound in earnings growth, roughly 12.9%. That seems pretty lofty, but if they’re correct, that helps explain why the multiple for 2019 is so high.
But even if it is right, the upside for the next 2 years seems pretty capped. Wall Street also has a tendency to reduce estimates, right up until the quarter, which allows for more “beats”.
I could of course be wrong though. And I probably am. There are more than a couple ways I could be wrong, but for me it means pulling back a bit on my risk.
To be clear and candid though, I would never recommend selling on this. There is a great blog post by Wealth of Common Sense blogger, Ben Carlson, that helps reinforce that point. In that, he highlights the story of Bob, the markets worst timer (essentially he only invests at the peaks). I won’t spoil it for you, but everyone should go read it here. The story has had a long-term impact on me.
JP Morgan also publishes a slide on missing the market’s best days and the cost of being out of the market vs. sitting idle. Look at the difference of just missing he best 20 days of the market out of 20 years! That is missing 0.27% of the total days (20 / 7,301). And note how close together the best and worst returns were (in the box callout).
My takeaway from that is: even if you can call the top, being able to call the exact bottom would be even harder.
CorePoint had a nice run from my recent write-up in January, up 12.5%. Q4’18 earnings beat expectations too, reporting comparable RevPAR growth of 9.9% and adj. EBITDA was $30MM, 13% higher than street expectations.
However, the stock was taken to the woodshed on Friday (March 22) when the company’s outlook disappointed.
The company’s outlook called for $173MM to $184MM of EBITDA compared to $199MM by consensus (though only one analyst covers the stock, so hard to say there is much of a consensus). Like many others have announced, CPLG is cost inflation in its operating costs (e.g. payroll).
In addition, the company’s hurricane-impacted hotels would not be adding as much EBITDA as originally expected. The company previously said it lost $20MM of EBITDA from the hurricanes on these assets. Instead of getting the full EBITDA back, mgmt expects just $10MM of EBITDA. It also expects $7MM from re-positioned hotel portfolio, but expects pressure in its oil-related market (company’s largest state exposure is Texas).
This is clearly disappointing, but not sure its worth the 26% drop on Friday. Like anything, it is likely a mix of factors. Part of this could be spin dynamics. In other words, people decided to blow out of CPLG now because they didn’t want to hold the stub piece long-term anyway. Another piece is likely due to the recession fears that were re-ignited on Friday that led to the S&P being down 1.9% in one day (the worst day so far for 2019). Hotels do not do particularly well in downturns.
Silver Lining -> Strategic Opportunities
There were several silver linings that management highlighted on the call, overshadowed by the market’s focus on the 2019 EBITDA outlook.
First, there are several strategic priorities for 2019:
Improve Operating Performance
Clearly, the company is facing cost headwinds. Therefore, its strategic priority is to identify underperforming hotels that have revenue and cost synergies available
Benefit from Wyndham Relationship
CPLG transfers onto Wyndham’s platform in April 2019 and full integration will be complete in 1H’19.
There are clearly cross-selling opportunities and increased distribution for their hotels.
I continue to think it is underappreciated that La Quinta had 15MM loyalty members, but Wyndham had 55MM in 2017. Those Wyndham loyalty members will now be able to book La Quinta’s in 2019.
Divest Non-core Hotels
CPLG sold 2 hotels in Q4 for $4MM. Mgmt noted these hotels were operating at significantly depressed margins.
More importantly, the company has identified 76 other non-core hotels that are operating at a hotel adj. EBITDA margin of 8%, well-below the 26% average of the core portfolio. In addition, RevPAR is 40% below the core average.
I have written about the first two points in my previous post, but I want to focus on the last point because divesting these hotels could be extremely accretive to the equity. Recall, the SEC document here cites $2.4BN of hotel value compared to $1.6BN of EV. To me, if the company can sell these hotels at higher prices than what the market has ascribed to them (currently a 33% discount to the 2018 appraisal), that will be a solid catalyst for the equity.
When reviewing the portfolio as a whole, and what constitutes “non-core” it becomes more clear why it makes sense to divest these assets. The company will lose $138MM of sales, but very little EBITDA in the grand scheme.
What I think is the most compelling case for upside on the equity is what the 2 under-performing hotels were sold for. Very low EBITDA margin, these hotels were sold for $4.5MM. As Sam Zell has said, investing in real estate many times comes down to replacement value. Perhaps what this sale represented.
Anyway, I don’t think it would be appropriate to think that these 2 sales are data points we can anchor on, but let’s run through some scenarios. First, let’s sale they get the same price/sales multiple.
Translating that into what happens to the valuation of the company:
This math roughly lines up with what is presented in the chart above provided by the company. And what this means is that if you think the company can get $230MM for these assets, the core portfolio is trading for ~8.0x and a 12% cap rate!
Indeed, no matter how you cut it, the PF valuation is very attractive.
So let’s say you think the portfolio should be 8.0% cap rate (a discount to the valuation given in the CMBS report). This points to a $21.6 price target. And this doesn’t bake in any growth for the next 2 years, it simply excludes the non-core portfolio.
No surprises here, when volatility reared its head throughout 2018, the “safety” classes outperformed risk. That should make intuitive sense, especially when considering the S&P500s 18.7% return in 2017 (and 21.4% when including dividends).
But as we all should know, it pays in the longer term to have some diversification. If anything, I prefer to have some asset classes that zig while everything else zaggs. For example, in 2018 the S&P was down ~5% for 2018 when including dividends.
But looked at what happened right when volatility hit (as a reminder, 2018 was not a good year for bonds up until that point… the 10 year treasury yield had moved up to 3.25% in October). Long-term treasury bonds nearly erased their losses and the aggregate bond index eked out a small gain. Purchasing power maintained.
As I shared in my post on Ray Dalio’s All Weather portfolio, I like to see what worked in the last recession as it may provide an indication of what worked then and what will work in the next recession. Obviously, history does not repeat itself, but there is a pattern here: good times – risk stocks outperform. Bad times: people fly to quality. The important thing is being the right sport before everyone else does.
So lets look at what would have preserved purchasing power the best in the last cycle. I want to see what did well in 2008.
The blue line is a 60/40 portfolio of stocks and the Barclay’s Agg index (bonds)
The red is a selection of assets that performed the best with minimum volatility (more on this below)
The yellow line is simply the S&P500
Surprisingly, this is the breakdown of what constitutes the red line may not be intuitive. It is made up of:
26% long term treasuries
8% high-yield bonds
The treasuries clearly helped perform then, both from a flight to quality in the Great Recession as well a compression in interest rates. As you can imagine, this would have allowed you to sell some outperforming asset classes (i.e. treasuries) and buy underperforming assets (stocks).
The same is true for 2018. Having some exposure to bonds would have given you the privilege and opportunity to buy stocks!
I was taken aback today when I saw that 3-month LIBOR is now sitting at 2.6%. As a reminder, LIBOR is the rate that other banks will lend funds to each other on a short-term basis. It is often used a benchmark interest rate for other loans, for example corporate loans will typically be set at LIBOR + some spread. For a long time coming out of the crisis, LIBOR didn’t matter that much for these loans since there was a floor set at 1%. As such, and L+200 loan would be 1% (the floor) plus 2.0%, to equal 3% yield. Now however, that loan would yield 4.6% due to move up in LIBOR. It has moved up as the Fed has raised short-term rates which in turn impacts other rates of similar maturities.
If we look at the 10 yr rate today however, obviously a much longer-term bond/rate than 3-month LIBOR, we can see the yield is still just ~3.2%. What this tells us right off the back is that the spread between long-term bonds and short-term bonds is very narrow. Said another way, the term structure of interest rates, or the “yield curve” must be very flat.
In a healthy market, the yield curve will typically slope upwards and to the right as investors demand higher rates of interest for longer-term investments.
However, when the yield curve flattens people often wonder whether this will extend to an “inverted yield curve”, when short-term rates actually will exceed long-term rates. This is often viewed as a harbinger of a recession. The reason it’s a recession predictor is that every recession since 1970 has been preceded by an inverted curve. In addition, a rise in short-term rates pulls back on the capital available on the “fringes” of the economy (e.g. entrepreneurs). At the same time, expected deflationary pressures in the long-term may push long-term rates down. The combination of these factors results in an inverted yield curve and is easy to see why this would indicate a looming recession. (Note, though, this is a small sample size of predictors and there is no perfect predictor out there!)
Ray Dalio wrote in “Principles for Navigating Big Debt Crises” that,
“Typically, in the early stages of the top, the rise in short rates narrows or eliminates the spread with long rates, lessening the incentive to lend relative to the incentive to hold cash. As a result of the yield curve being flat or inverted… people are incentivized to move to cash just before the bubble pops, slowing credit growth…”
A look at prior 10-2 year spreads:
I decided to look at other instances when the spread between the 10 and 2 year were this tight and what the right investment decision at the time would be. Below are four different instances when the spread between the 10 year and 2 year yield were as tight as it is now and what unfolded few years or months. Note, I start each the 10 and the 2 year yield at 100 and mark the change in yield over time (since price data isn’t available) which is charted on the left-hand side. The right-hand side and in gray is the spread between these two rates (the “10-2 spread”), essentially showing the data another way.
What may or may not be surprising is that in most cases, the yield on the 2 year tightens more than the 10 year by a dramatic amount in percentage terms. Why that may not be surprising is that the Fed uses short-term interest rates to dictate monetary policy and historically, that has had a less pronounced impact on long-term rates.
Since yields move in an inverse relationship to prices, this points to price appreciation for bonds in each of the cases.
This may not be a great predictor since you can imagine the spread widening as long-term rates gap wide and short-term rates move less, such as a long-term change in the inflation assumptions. However, given demographics and a technology changes resulting in long-term deflationary pressures, this currently seems unlikely to be the case to me.
Should we be adding long-term bonds or short-term bonds to our exposures:
Does it make sense to buy short term bonds today, which are yielding ~2.98% or the 10 year, which is yield 3.24%? At first, I would clearly say buying a 2 year bond makes a lot of sense. However, we must remember that interest rate risk cuts both ways.
Let’s run through some scenarios by comparing the purchase of a 2 year bond and re-investing the proceeds after 2 years into another 2 year bond. We will compare this to holding a 10 year bond for a total of 4 years.
First, I’ll go through what I personally think is most likely to happen. We undoubtedly are later in the business cycle and when we inevitably enter a recession, I think the fed will once again lower short-term rates to help the economy with a softer landing and to spur investment. I have written a bunch of posts on why I think lower for longer is here to stay, even though that is not a popular opinion (mentioned here and here and here).
As such, I show the 2 year rate moving to ~1.80% and the 10 year moving to 2.92%. I base these numbers off of the typical tightening we saw in prior cycle in the charts above. E.g. the 2 year yield comes in by about 40% and the 10 year much less (I assume about 10%, which is not as much as it has, but am being conservative). The result may surprise you.
The 2 year actually under-performs the initial coupon rate on an IRR basis given you must re-invest in a lower yielding security at maturity. On the flip side, the 10 year appreciates in value as rates move lower and you can sell it for a nice profit, for an IRR above the initial coupon rate.
I know what some of you are already thinking… OK that is great, but I think rates are going up, not down! Well for that scenario, we could look back to 1994 when the Fed abruptly raised rates.
I didn’t show this one before given the spread between the 10-2 was high and tightened over time (opposite than today). Recall in 1994, there was a great “Bond Massacre”, as Alan Greenspan who was the Fed Chair at the time, decided to let air out of the system to prevent an overheating of the economy (that really only had been out of a recession for a couple years).
Let’s look at the numbers if that were to occur. I assume the 2-yr rate moves higher to 4.47%, nearly 150bps higher than today and also 1.5x the current level and assume that the 10 year has a 80bps spread to the 2 year, which implies a 5.27% yield.
In this case, it is obviously advantageous to invest in the two year bond and roll over into a higher yielding bond for the next two years. However, it is also interesting to see that you don’t witness a negative IRR on the 10 year bond (and obviously if held to maturity, you still capture the 3.2% that you locked in a purchase).
To back this up, I used portfolio visualizer to show the results of either buying $10k of 10 year treasuries (Portfolio 1) or $10k of short-term securities in 1993 (Portfolio 2) and holding through 1995. The 10 year dips below on performance for a bit, and then returns to outperforming.
Rates moving like this is an unlikely scenario for me to bank on for a few reasons. One, it is hard for me to see an abrupt change in the long-term inflation assumption, which will cap long term rates. For example, if the “real yield” i.e. the yield in excess of long-term inflation is 1.7% today (3.2% less 1.5% inflation assumption) then the inflation figure would have to move up to ~3.6% for the 10 year to be priced at 5.3%, keeping the real yield figure flat. Second, it would then be tough to see how a sharp rise in short-term rates doesn’t cause a significant tightening on the economy.
Bottom line: I hope this is helpful analysis for those making long-term asset allocation decision. For me, interest rates could likely move up further, but it doesn’t mean that we should be significantly underweight long-term, high quality securities at this point in the cycle. Especially when it appears to be contrarian to do so…