Description

Vita Coco is the dominant brand in the packaged coconut water market. They have a 51% market share in the US and >70% in the UK. Their IPO in October 2021 was poorly timed because it was right at the time where Covid started disrupting every industry’s supply chain. It also didn’t help that the IPO was targeted at retail investors and that the 2021 mania in stocks of well-known consumer brands (BYND, OTLY, PTON) had just ended.

Since its founding in 2003, Vita Coco has been able to balance double-digit growth with decent profitability. While margins are currently pressured by supply chain issues, at scale Vita Coco should be able to do mid-to-high teens EBITDA margins and mid-teens Revenue growth. Due to its asset-lite business model, where there is only some capital tied up in inventory, almost all EBITDA minus tax converts into FCF. The business currently trades for 1x EV / sales. A conservative 15x earnings multiple would translate into a 2.1x sales multiple: 15 [P/E Multiple] * 18% [EBITDA Margin] * (1 – 21% [tax]). I think any CPG company would be willing to pay 3x sales for a high growth, dominant brand with 400-500m USD in sales as it would be instantly accretive and fit with any company’s ambitions to tilt their portfolio to high growth, healthy and sustainable categories. While I don’t consider OTLY a good comparison as it’s not profitable (although higher growth) and at a higher risk of being a fad, OTLY still trades at >3x sales despite their 80% correction. Even at 2022 guided earnings, which are heavily impacted by higher logistics costs, you pay a high teens multiple. I think COCO is cheap.

Contrary to what some might believe, I do not think coconut water is a consumer fad. I think it’s akin to drinking orange juice. It’s healthy, (almost) everybody loves sugar, it mixes well as a base for smoothies and it’s the perfect recovery drink for after a workout. The reason we didn’t drink it previously was because it wasn’t readily available in the stores.

While Vita Coco has a strong brand as indicated by their 51% US market share and 76% UK market share, I think their real competitive advantage stems from their supply chain. Vita Coco sources from small scale farmers in South East Asia or Brazil. Traditionally, coconut processing facilities treated the water as a waste product. Vita Coco as a first mover, figured out how to effectively process, package and ship the coconut water. They don’t own any processing or packaging factories but have long term contracts with farmers, often containing exclusivity clauses.

Coca Cola entered the industry in 2009 but sold their Zico brand in 2021 back to its founder during a portfolio rationalization. Apparently it’s not easy for a large company like Coca Cola to grow a business organically if that means dealing with lots of small coconut farmers in South East Asia. The fact that COCO sources from different parts of the world is also a huge benefit in this current period with supply chain disruptions as it gives them more options to optimize shipping routes.

Recent Trading

COCO sold off during Q4 on worries that supply chain problems would result in cost overruns. Those worries were confirmed in yesterday’s Q4 earnings release, which saw GP margins drop from 33% to 25%, with EBITDA close to break even. At scale, this business should be doing 35-38% GP margins, with ~100m USD in SG&A, or 15-18% EBITDA margins.

If earnings were weak, guidance might have been even weaker. Supply chain problems have not yet abated and 2022 EBITDA guidance was in line with 2021 EBITDA. COCO is taking several steps to mitigate this impact, but the most reassuring sign was that they have started raising prices and have found demand to be quite inelastic to price. This is in contrast to the previous quarter, where they still believed that higher logistical costs were just a temporary headwind and that raising prices would mean giving up market share. The recent price increases won’t fully show in their earnings until Q2. They also planned a second round of increases at the end of H1 2022.

It is everyone’s guess when supply chains will be back to old levels, or when the market will start pricing equities for this inevitable recovery. It will not be fixed overnight though, so I have no idea where this will bottom. I believe this provides a couple of quarters to build a position if you believe in the long term value of the business.

Bear arguments

There are a couple of things not to like about COCO. You can find data online by Euromonitor that shows that the coconut water has been in decline from 2015-2020. COCO opportunistically cites growth rates from 2012 – 2020 in their S-1. In calls I’ve had with them they assure me that growth has been steady over the years, without giving any exact data. Euromonitor data excludes several retail channels, including Costco. Since a lot of Vita Coco is sold through clubs / gyms, Costco is an important sales channel. Vita Coco has also grown quite rapidly outside the US. But most importantly, the growth of private label during this period was pressuring ASPs which reduced the market size as expressed in dollars. Growth in 2020/2021 has really picked up and revenues grew 10% in 2020 and 22% in 2021. The supply chain problems help Vita Coco gain market share, both from branded and private label. US market shares were 46% at the time of the IPO and 51% YTD 2022. I am waiting for the 10-k to have this confirmed, but the Vita Coco brand supposedly grew 65% YoY in the quarter as private label gets replaced by branded in times of shortages.

While I don’t know the exact details, COCO was struggling in 2019 when they were about to lose shelf space at some of their large retailers (Walgreens and Walmart). It was at this point that Martin Roper stepped in as co-CEO. Martin has had a long career as CEO of the Boston Beer company and brings some much needed experience to the management team.

Management also keeps talking about wanting to do small scale M&A in the healthy beverage market. They believe they have better distribution than some of the smaller brands. As I mentioned, their real competitive advantage is in sourcing coconut water. There are many giant beverage companies with much better distribution. While I don’t think they will waste large amounts of money on M&A, M&A would probably be a distraction. Examples of such deals in the past include Runa, Ever & Ever, and PWR Lift. As a consumer I have never come across those products and I’d be surprised if I ever will.

IPO dynamics

COCO IPO’d to give their 2 largest shareholders: Reignwood and Verlinvest, an opportunity to exit. Reignwood is COCO’s Chinese distributor. They bought a 25% stake in COCO back in 2014 for a valuation of 665m USD. Coconut water never took off in China. Given that Reignwood is Chinese and that I have a tendency to jump to conclusions, I’m assuming they are desperate for cash and were willing to exit at an 853m USD valuation 8 years later. The lockup expires in April and could see continued selling from VerlInvest and Reignwood. The 2 founders Michael Kirban and Ira Liran have been buying shares at prices 12-20% above today’s share price. They did so in December, meaning they were already well aware of all the challenges they were facing.

The free float is tiny. The IPO was only 11m shares, but if you assume the top 20 shareholder are steady hands, there are only 3m shares freely traded, which might explain the high volatility.

In conclusion, I think if COCO had IPO’d 1 year earlier, the market might have been more forgiving about their cost overruns and retail would have paid an insane revenue multiple on this business. Fortunately, COCO has always managed to run their business profitably, and once supply chains normalize, the absurdly low valuation should become apparent.

Catalyst

Supply chain normalization (H2 2022 event?)

Continued market growth, market share gains and better pricing until supply chains have normalized.