Description

Investment Thesis & Valuation:

MGP Ingredients (MGPI) is a turn-around story in the early stages of substantial growth in EBITDA and free cash flow (FCF) due to lower corn prices, higher ethanol prices, and normalized SG&A.  Of note, MGPI screens poorly: it looks expensive on a trailing basis (13X on 11.4M EBITDA). LTM operating performance was negatively impacted by high corn costs and 7M of non-recurring SG&A related to a proxy contest.  We believe MGPI should generate over 35M of EBITDA and over $1.20 in FCF on average annually from 2014-2015.  On a 7X EBITDA multiple and 14X FCF multiple, our price target is $14-18 over the next 12-18 months, implying 60-120% upside to the current stock price.   In addition, MGPI offers further leverage to the secular growth and strong fundamentals in the specialty/craft “food-grade, brown alcohol” sector that could further improve investor perceptions. 

Key Considerations:

MPGI processes corn, rye and barley into food grade alcohol (ethanol) which is approximately 80% of the company’s revenues as well as protein and starch food ingredients (which accounts for approximately the remaining 20% of the company’s revenues).

• Leverage to Corn & Ethanol Prices:
  • Management estimates Corn at $4 to $5 per bushel would improve Distillery segment %GM by 5-10% versus 2013.  At sub-$4 Corn recently, even if we conservatively use 5% GM improvement on 260M of LTM Distillery revenue, this improves EBITDA by 13M (10% on 260M = 26M).  
  • 83M Gallons of Ethanol Hidden Value at Pekin, IL (Illinois Corn Processing; 30% JV with Seacor): MGPI includes their 30% equity earnings within Corporate.  Average Ethanol plant margins in IL were ~$0.35 / gallon in 2013 versus YTD of ~$1.00 / gallon (assuming 55 cents / gallon total cash conversion costs).  In addition, if we assume a normalized Dried Distiller’s Grain price given recent weakness, we could deduct $0.15 / gallon from the $0.65 incremental Y/Y per gallon improvement.  Therefore, $0.50 x 83M gallons x 30% = 12M EBITDA benefit Y/Y.            

• 7M Non-Recurring Corporate Expenses: MGPI does not “adjust” for 7M of non-recurring SG&A in their “Adjusted EBITDA”.  These expenses were related to a proxy contest (which has since been settled) and severance.  Typically companies will adjust for these expenses in earnings releases, but MGPI does not provide these reconciliations and highlights them only in the 10K. 

• Price Target Multiples of 7X EBITDA and 14X FCF:  MGPI is currently a mix of both Food ingredient and Industrial customers, so the company would fall somewhere between commodity processing (Corn/Wheat into end products) of 6X and Food ingredient for human consumption of 8-9X.  Also, the 14X FCF is fully-taxed, but MGPI still has 37M and 99M of Federal and State NOLs as of 12/31/13, respectively.  Assuming 35% of pre-tax earnings is shielded for at least another 3 years this 10M could contribute another 30M in cash (or $1.70 / share).

• “Brown Goods” Secular Growth Cycle: specialty craft breweries and distilleries are undergoing a multi-year growth cycle at the expense of larger brands.  The craft segment is under-served because the Distillery supply chain is dominated by larger companies (Diageo, for example) who are not interested in serving smaller customers who may only need 5 to 10 barrels per order.  MGPI is in a unique competitive position to capture additional market share alongside the industry’s growth and replace low-margin Vinegar and volatile Vodka or Ethanol margins with stable “Brown Goods” demand. 

• Brand-New CEO eliminates leadership overhang:  Just today MPGI announced that Gus Griffin is joining the company as CEO and President.  Griffin served in a number of operating and marketing positions at Brown-Forman over the course of 20+ years at the company.  He then worked for a wine company as EVP of Marketing.  We have not had the opportunity to speak with Mr. Griffin but he is stepping into a situation that will help maximize his chance of success.   This development comes on the tail of a refresh of the Board of Directors in May.  2013 featured a proxy fight settlement that concluded with the termination of the prior CEO.

Disclosure

We make no claims, promises or guarantees about the accuracy, completeness or adequacy of the contents of this document and expressly disclaim liability for errors and omissions in the document.  We have no obligation to update this document.  We may change our position at any time without posting an update.  The views expressed here are merely the opinion of the author.  Readers should do their own research.

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