Food companies are finding it harder and harder to hold on to pricing, and Mexico’s Gruma (OTCPK:GPAGF) (OTCPK:GMKKY) isn’t an exception. Good execution in the company’s new product development efforts are helping, but overall volumes and top-line performance have flattened out and the company is likely past most of the benefits of lower input costs. Even so, the results are relatively good in a consumer products sector that has seen more pressure in recent quarters.
Gruma shares are up about 10% in local currency since my last update and basically flat in U.S. currency. I don’t think Gruma shares are expensive, but I likewise don’t see a huge discount to fair value at this point. I do continue to think that this is a solid, more defensive, name for investors who want this kind of exposure, but I do worry that ongoing sluggishness in overall revenue growth and diminishing margin leverage from input cost relief could be a more challenging combination in the second half of the year.
Pretty Good Execution Against Moderate Expectations
I think analysts got ahead of the story of a more challenging environment for food producers earlier this year (less pricing power, more competition from private label, et al), and Gruma has been doing fairly well against that adjusted bar. For this recently-reported second quarter, revenue was about 2% better than expected, while EBITDA was 6% better than expected, marking the second quarter in a row of better than expected EBITDA performance.
Revenue was flat in U.S. dollars this quarter compared to the year-ago quarter and up less than 1% sequentially on volumes that declined slightly year over year and were basically flat sequentially.
Gross margin was impressively strong, though, climbing more than three points year over year (to 38.1%) and another 80bp quarter over quarter, as the company continues to benefit from lower input/raw material costs – corn prices were down about 15% year-over-year at the end of the second quarter, and while that’s a crude estimation of Gruma’s actual pricing experience, it does at least reflect on the raw material environment.
EBITDA rose 17% in U.S. dollars, with margin up 250bp year over year to 17.2%.
Healthy Products Driving Healthier Performance
The U.S. business makes up over half of Gruma’s revenue and about two-thirds of EBITDA, and performance here was mixed but basically positive.
Revenue declined 1% on a 1% decline in volume, but some of that was a byproduct of a deliberate client optimization strategy in its foodservice channel – basically winnowing out less profitable business where management didn’t see much prospect for materially better results over the long term. That drove a 2% decline in foodservice volume that couldn’t be completely offset by a 2% improvement in retail volumes.
In the retail business, Gruma continues to see some competition from private label, but overall volumes (as per Nielsen data) have held up better than most food service companies. Gruma has also continued to see good results from its product innovation efforts, with its “better for you” product lines growing 14% year over year in the quarter. While retailer shelf space is always limited, Gruma has had success introducing a range of new products (low carb/no carb, organic, non-corn grains) that have been well-received in the market and have helped offset the pressures on the more “run of the mill” product offerings where private label competition has been a little more intense.
Gross margin improved by 280bp to 43.4% (and another 70bp qoq), and EBITDA rose 9% year over year, with margin up close to two points (to 20.5%). I do expect relatively flat revenue performance for the rest of the year. The specialty product lines should continue to provide a welcome boost to revenue, but I see that being offset by really no pricing power and more pressure on volumes in the foodservice channel as restaurant traffic slows.
Margins Offset A Soft Top-Line In Mexico, Too
Gruma reported a 2% decline in revenue (in U.S. dollars) in the Mexican operations this quarter, with volume basically flat. Management blamed weather disruptions for some of the volume weakness, as well as “supplier diversification” from some of its customers, but I suspect that a somewhat softer consumer spending environment in Mexico is also having an impact. As a reminder, a lot of Gruma’s consumer business in Mexico is basically built around convenience (time and labor savings versus traditional tortillas), and that does make it somewhat price-sensitive.
The company still benefited from lower input costs, though, with gross margin up 260bp to 25.2% (up 90bp qoq) and EBITDA up 37%, with margin up 330bp (to 11.4%).
The Outlook
The worst I can really say about Gruma at this point is that I just don’t really see many tailwinds in place that will drive substantially better results over the next six months or so. As I said above, the company’s new product development efforts in the U.S. are performing well, but I don’t see much acceleration in the near term and there are still pressures on the base business from private label and weaker consumption/spending patterns. Likewise in Mexico, where I just don’t see much opportunity to raise prices or drive substantially higher volumes.
On a more positive note, management does still believe there’s more to gain from lower grain prices, and they’re going to start hedging in the second half of the year. That could produce a nice margin tailwind into 2025, and they did raise full-year EBITDA margin guidance by half a point (to 120bp yoy improvement).
My core expectations really haven’t changed much. I’m still looking for around 4% to 5% revenue growth over the next five years, helped by share growth in the U.S. (particularly with new product categories) and further share growth in Mexico. Long term, I think 4%-plus revenue growth remains a reasonable expectation.
On the margin side, I expect 2024 EBITDA margin to be around 17% (in line with management guidance) and improve slowly thereafter, with some possible additional upside in 2025 from lower input prices carrying over. Long term, I still expect modest improvement in free cash flow margin from an historical trend a bit below 6% to closer to 6.5%, driving respectable high single-digit FCF growth that should support additional capital returns (dividends and buybacks) to shareholders.
The Bottom Line
The only real “but” I see here is that the market seems to already anticipate this. Discounted cash flow suggests moderate undervaluation (in the neighborhood of 10%), and I get a similar result with EV/EBITDA, though I think it’s worth noting that these shares have traded at over 9x EBITDA in the past, and that multiple today would support quite a bit more upside (30%-plus).
I still like Gruma as a defensive name in the consumer products space, and I think management has been executing well on operational efficiency and product innovation efforts. Valuation and sluggish top-line growth are the main impediments right now, and neither of these may be deal-breakers for more patient long-term investors.
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