Position Monitor (COST)
We are raising Costco Wholesale (COST) higher on our long list. Our decision reflects a greater appreciation of the earnings visibility derived from the membership fees and the likelihood of an increase in 2023. The sales comparisons are more difficult, but growth in units and traffic continues to look achievable in an environment that will be increasingly difficult to have either.
We are moving AppHarvest (APPH) and Kalera (KAL) to the bottom of our short list. The market capitalization of both companies has been decimated. Financing has been plentiful for the sector and that is part of the problem. There is too much capital investment in the start-ups without meaningful barriers to entry. AppHarvest borrowed $30M from produce distributor Mastronardi to construct its latest 15-acre salad greens farm that opened at the end of October.
Price lever pulled (MNST)
Monster Beverage reported Q3 EPS of $.60 vs. consensus expectations of $.59. Revenue growth of 15.2% (+20.2% ex-Fx) was slightly below expectations. Monster regained market share leadership in the energy drink category in the U.S. In October, Monster’s sales grew 11.8% compared to +6.2% for Red Bull, +8.1% for Rockstar, -2.2% for 5-Hour, and -27.3% for Bang.
Gross margins improved sequentially, but still contracted 460bps. The 420bps sequential improvement was mostly driven by price increases in the final month of the quarter – 6% in the U.S. Monster continues to incur additional costs due to supply chain inefficiencies for air freight, distribution, warehousing, and other logistical costs. The company will continue to deplete its higher cost cans over the next few quarters, but in Q3 the company utilized lower cost, domestic cans. Of the $84.2M in higher COGS nearly half or $40.1M was due to higher ingredient and input costs, $24.4M was due to increased freight rates and fuel, $11.5M was due to increased aluminum can costs, and $8.2M was due to mix. Operating expenses as a percentage of sales deleveraged 120bps.
The board authorized added $500M to its share repurchase authorization. Monster’s price increases are accelerating, market share gains are benefiting from competitive disruptions for Bang, and sales are outperforming Red Bull and Rockstar. Margins have inflected with price increases and are set to continue to improve sequentially. Monster Beverage is a growth story to own for the long term, with near-term COGS pressure presenting the buying opportunity.
More sauce (LANC)
Lancaster Colony reported FQ1 EPS of $1.36 vs. consensus expectations of $1.11. Sales grew 8.5%, above consensus expectations of 7.5%. Management estimates that $25M of sales were shifted into FQ4 due to the ERP implementation. Foodservice sales grew 20.3% with pounds shipped declining by 7%. The pull-forward had a 6% impact. Restaurant industry transactions decreased by low to mid-single digits during the quarter according to NPD Crest data. Dressings and sauces grew by 21% and frozen breads grew by 18%. Retail sales were flat, lapping 16% growth last year and negatively impacted by a 7% shift of sales into FQ4. Dressings, sauces, and croutons grew 0.6%. Frozen breads decreased by 2.5%. Dressings, dips, and other increased by 1.2%.
Gross margins contracted 30bps YOY, improving sequentially from a 330bps contraction. Raw materials and freight were still higher YOY. From a comparison perspective, Q1 was favorable relative to the remainder of the year, but the rest of the year will have other tailwinds including the new capacity, supply chain initiatives, and more matching with price increases. SG&A expenses decreased by $2.1M. EBIT margins expanded by 10bps. Foodservice margins expanded 640bps while Retail margins contracted 230bps.
Management believes they have the inflation they see in the future offset in their pricing plans. With the margins inflecting sooner than the consensus expected, estimates will be going higher. With new capacity coming online revenue visibility has also improved. Lancaster Colony is on our Best Idea long list.
Going to court (STZ)
U.S. District Judge Lewis Kaplan said Constellation Brands must face a lawsuit from AB InBev over whether Corona Hard Seltzer violates its licensing agreement. AB InBev sued Constellation Brands because it believes the agreement allows the latter to sell only beer and not seltzer under the Grupo Modelo brand names. The companies are disputing more than hard seltzer, there are other suits over additional “beyond beer” offerings like Modelo Reserva. AB InBev is not concerned about the offerings diluting the brand or causing confusion, it’s about sharing revenue. We expect a settlement before the case goes to court.
