Adding ACI as a Best Idea Short
We are adding Albertsons to our Best Idea Shortlist. Our concerns are sales declines, gross margin contraction, and lower returns on capital. Albertsons has now anniversaries the two largest stockpiling weeks ahead of the pandemic shutdown (as seen in the following chart), but the comparisons will remain difficult. Based on the vaccine rollout and the cautiousness that many vaccinated continue to exhibit, the difficult comparisons will last for more than one year.
Gross margins will have several headwinds this year from lower SSS, slower turns in produce (higher shrink), and higher promotions. Accelerating food inflation is a concern, especially as the competitive environment will become more intense this year. During the pandemic, grocers were challenged by out of stocks in many categories, leading to promotions.
Online grocery shopping and the investments to support the business are margin and return dilutive. Yesterday, Albertsons announced a partnership with Google. The collaboration will integrate Google Search and Maps, facilitate Google Pay, and infuse Google Cloud AI technologies. Google’s technology is a vast improvement over Albertsons’, but it also highlights the competitive disadvantage versus Amazon. Amazon is still years from a full rollout of Fresh stores, but the growing risk can not be ignored. Albertsons’ history of poor free cash flow generation will be difficult to ignore in a non-pandemic year.
Investor sentiment has changed dramatically in March for Albertsons. Lockup shares have not been a headwind to date, but with more of a market multiple (11x consensus EPS and 7x EBITDA for a grocer), they are more likely to be this year. Albertsons does not have store growth or a likely acquirer, which also limits its multiple. Pension liabilities are not top of mind currently but become a concern in market downturns. We see a downside of 25% this year.
Removing Sprouts from long bias (SFM)
We are removing Sprouts Farmers Market from our long bias list. Despite a significant shift in at-home food consumption, the company’s SSS increased 4.2% and 3.7% in Q3 and Q4, respectively. Consumers' shopping behavior during the pandemic has increasingly adopted online food shopping and in-store trip consolidation. Both changes in behavior are a competitive disadvantage for Sprouts compared to conventional grocers and big-box food retailers.
We have several concerns for the stock performance from current levels, including Sprouts’ ability to recoup traffic lost during the pandemic, increased competitive intensity with less home meal consumption, and the risk of losing customer occasions without produce promotions. The company is embarking on an acceleration in CapEx spend for new produce distribution centers and 20 new stores which will depress returns as profits decline against difficult comparisons. Management is rolling out a smaller store prototype that can match the existing stores’ sales. The lower cost footprint and higher productivity are expected to enable double-digit store growth. The new prototype and pricing change have not been proven out yet.
At 15x 2021 consensus EPS estimates and 10.5x EV/EBITDA, management must prove its new store model to see the multiple expand from current levels. Our EPS estimates are now below consensus expectations for 2021 and 2022, driven by lower SSS and gross margins. Our updated position monitor is as follows:
Oatly’s China expansion begins (STKL)
Yeo Hiap Seng, a Singapore-based company, has entered into a JV with Oatly. Commonly known as Yeo’s, it is a leader in the region’s soy milk sector. As part of the JV, both companies will produce 60M liters of Oatly’s enzyme-treated oat milk at Yeo’s manufacturing site (in comparison, the new U.K. plant is expected to produce 300M liters initially). Production will begin in the second half of the year to supply China and the rest of Asia. The oats will be supplied from Sweden. Yeo boasts that it was the first in the world to package Asian drinks in Tetra Brik aseptic cartons. That gives Oatly a skilled manufacturing partner in a new market while encountering challenges amidst a significant expansion in the U.S. and U.K.
Oatly has been looking to enter the Asian market because of the size of the market and because part of its mission is to improve the environment by reducing dairy milk production. The Asian market brings different challenges to Oatly because dairy milk is a relatively new product category. According to Yeo’s, 40x more people are lactose intolerant in Asia compared to Europe. Consumers in Asia are more accustomed to dairy milk alternatives, so the marketing of “Wow no cow” does not have the same messaging in Western countries.
Oatly is expected to IPO in the coming months. Oatly has tremendous growth potential ahead of it, but its manufacturing capacity challenges it. The company is adeptly setting up its growth and expansion plans on three continents ahead of the IPO. We are excited about the IPO, but the rumored valuation is ~$10B. SunOpta is the best way to invest in the secular growth of plant-based milk.
