I’m a buyer on the sell-off after the disappointing FQ3 results. This is far from a broken growth stock. The concerns are transitory. Longer-term EPS power between $7-8 remains, getting us to a $160 stock. Lamb Weston has had a volatile three years following a shutdown of the restaurant industry, with two short harvests followed by a bumper harvest. This does not reflect a change in the company’s intermediate margins or competitive positioning. EBITDA margins in the quarter were the highest in our model. Lamb Weston has never been cheaper, and the challenges are not nearly as large as some in the past. The ERP issues will be in the rearview, so trends will improve sequentially. The focus will shift to QSR industry trends, which, over time, should be positive.
FQ3 Details
Lamb Weston reported an FQ3 EPS of $1.20, short of consensus expectations of $1.45. Organic sales decreased 12%, with volumes down 16% and price/mix up 4%. The ERP transition had a larger impact than management anticipated. “The transition had a greater impact on shipments of higher-margin mixed-product loads.” The impact was estimated to hit sales by $135M or 8% ($123M N.A. & $12M International). The impact to EBITDA was estimated to be $95M ($55M lower order fulfillment & $40M incremental expenses. By segment: N.A. $83M, Int’l $5M, Corporate $7M) and net income by $72M. Management believes the impact is confined to FQ3, and fulfillment has been restored. The company also took a $25M charge for the write-off of excess raw potatoes with lower demand forecasted.
The Two Concerns
There were two negative developments that were known but not quantified during FQ3: 1) ERP issues leading to missed sales and 2) the slowdown in the QSR sector, which was highlighted by McDonald’s weakening trends.
- ERP was a known headwind for the Q, but it was worse than management expected. Importantly, it was contained in the Q. Its impact was included in previous guidance, but in Q3, it had a -$.37 impact.
- McDonald's foreshadowed the slowdown in QSR sales. Volumes declined 17% in FQ3. Half was due to the ERP issue. ~LSD% is due to exiting low-margin contracts, which were known and in the projections, and another LSD% is the industry slowdown. The company wrote down potatoes further (reflecting lower demand), which was a -$.13 impact.
Adding back the one-time costs in the quarter (including reversing lower incentive compensation), EBITDA was ~$430M. Although it is a beat that no one cares about, EBITDA margins would be 30%. It's not something one would expect with the price-to-sales valuation at its lowest levels since going public.
The Outlook
Management lowered guidance for sales and EPS due to the ERP impact and “soft near-term restaurant traffic trends.” EPS is now expected to be between $5.50-5.65 from $5.70-6.15. Revenue is now expected to be between $6.54-6.6B from $6.8-7.0B. The company previously had Fx losses of $.01 in the first half of the year, which increased to $.20 in the first three quarters. The outlook for restaurant industry sales is the go-forward challenge. Management believes they have appropriately guided. Production is recalibrating to demand trends. Q4 sales are expected to be flat to up 3% driven by price and offset by a MSD% decline in volumes. There are reasons to expect that guidance to be conservative. All that pricing in QSRs in recent years has finally impacted demand, which will be met with restaurants' readjustments. Lamb Weston is a Best Idea Long.
