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Robert Abbott
Robert Abbott
Articles (609)  | Author's Website |

Middleby: Baking Up Capital Appreciation

It’s been said that the big winners of the California Gold Rush weren’t the miners who dug for gold, but the grocers and bankers and shoemakers who supplied the miners.

Can we say the same thing of the food industry, where we can invest in not the best restaurant chain, but rather one of the suppliers that puts food equipment in the kitchens of many chains?

One such supplier, The Middleby Corporation (NASDAQ:MIDD) came to our attention through its inclusion in the Buffett Munger screener at GuruFocus. Middleby came into existence more than a century and a quarter ago as a manufacturer of simple ovens. Since then, it’s come to have all kinds of roles, many of the sophisticated, in all kinds of kitchens, from high-end homes to discount burger palaces. It’s number 1 in pizza chains, convenience stores, deli/convenience stores, and several other food categories.

It finds a place on the Buffett Munger screener because of its consistently strong earnings, and because it is considered fairly valued using the PEG formula. The PEG formula as we’ll see, combines the familiar P/E ratio with average EBITDA growth over the past five years.

It’s a growth-focused company, through both organic and acquisition activities, paying no dividends and spending little on share buybacks. Here’s how that strategy has played out in the past 5 years (green line = share price, blue line = revenue, red line = earnings per share):

MIDD Price Revenue EPS

History

1888: Joseph Middleby and John Marshall found Middleby Marshall; they develop and patent the first moveable oven, the Model A.

1900-1915: The company develops the Model B (continuous bake oven) and Model C (first double oven).

1960: As the baking industry transitions from Mom & Pop shops to factories, it develops traveling tray ovens, and conveyor loading and unloading ovens.

1976: The privately held company is sold by descendants of the founders, and subsequently changes hands and names several times over the next decade.

1985: Incorporated as The Middleby Corporation.

1988: The company lists on the American Stock Exchange (AMEX).

1989: In a major acquisition it buys the Foodservice Equipment Group from Hussmann Corporation.

1990: Acquires a majority interest in a foodservice equipment manufacturer and distributor in the Philippines.

1997: Listed on the NASDAQ exchange.

2001: Acquires the commercial cooking business of Maytag Corporation.

2008: Buys TurboChef, previously a competitor in speed cooking pizza ovens.

2012: Named to America’s Best Small Companies list for the ninth consecutive year by Forbes Magazine

2013: Purchases Viking Range with the aim of increasing residential sales; this is one of 14 acquisitions within three years.

2014: Receives the 2013 Relationship Partner of the Year Award from Papa John’s International.

History based on information from the company website, FundingUniverse, and Wikipedia.

Middleby’s Business

The Middleby Corporation works through an operating subsidiary, Middleby Marshall Inc., which in turn has several subsidiaries. Within that context, the company has three divisions, or groups: Commercial Foodservice Equipment, Food Processing Equipment, and Residential Kitchen Equipment.

Commercial Foodservice Equipment:
This group has what it calls a ‘portfolio’ of cooking and warming equipment for use in a commercial kitchen or foodservice operation. Customers include quick-service restaurants, full-service restaurants, convenience stores, retail outlets, hotels and other institutions. The following illustration from the Jefferies Industrial Conference, 2014 Presentation shows some of Middleby’s major customers:

MIDD customers

Under 34 brands, this equipment include conveyor ovens, combi-ovens, convection ovens, baking ovens, proofing ovens, deck ovens, speed cooking ovens, hydrovection ovens, ranges, fryers, rethermalizers, steam cooking equipment, warming equipment, heated cabinets, charbroliers, ventless cooking systems, kitchen ventilation, induction cooking equipment, countertop cooking equipment, toasters, professional refrigerators, coldrooms, ice machines, freezers and beverage dispensing equipment.

Food Processing Equipment:
Provides processing solutions for precooked meat products (hot dogs, dinner sausages, poultry lunchmeats, etc.) and baked goods (such as muffins, cookies and bread). Customers include the following big names:

Middleby Food Processing customers

Products are sold under 12 brands, and include “...batch ovens, baking ovens, proofing ovens, conveyor ovens, continuous processing ovens, frying systems and automated thermal processing systems. The company also provides a comprehensive portfolio of complementary food preparation equipment such as grinders, slicers, emulsifiers, mixers, blenders, battering equipment, breading equipment, food presses, and forming equipment.”

Residential Kitchen Equipment:

This group manufactures, sells and distributes kitchen equipment for the residential market, including ranges, ovens, refrigerators, dishwashers, microwaves, cooktops and outdoor equipment.

Products are marketed under four brand names: Brigade®, Jade®, TurboChef® and Viking®.

Revenues
The following excerpt from MIDD’s 10-K for 2013 shows the revenue contributions of each of the segments:

Middleby revenue segments

This segment shows revenue by geography for The Middleby Corporation:

MIDD revenue geographically

We note that Commercial Foodservice accounts for more than half of the company’s revenue, and USA/Canada accounts for an even higher proportion of its geographic sources.

Competition
The company describes its industry as highly competitive and fragmented. It assesses its competitive advantages as, “...strong brand equity, exceptional product performance, short lead-times and timely delivery, competitive pricing and superior customer service support.”

Middleby lists its major competitors in Commercial Foodservices as Manitowoc Company, Inc. (NYSE:MTW); Vulcan-Hart and Hobart Corporation, subsidiaries of Illinois Tool Works Inc. (NYSE:ITW); Electrolux AB (ELUX.A); Groen, a subsidiary of Dover Corporation (NYSE:DOV); Rational AG (RAA); and the Ali Group.

For Food Processing, it lists competitors as AMF Bakery Systems, Convenience Food Systems, FMC Technologies (NYSE:FTI), Multivac, Marel (MARL), Formax, and Heat and Control.

In the Residential segment, competition generally is broad and intense. In the premium sector, however, there are fewer major competitors; they are Wolf and Subzero, subsidiaries of Sub-Zero Group, Inc.; Thermador (THEP), Bosch and Gaggenau, subsidiaries of Bosch Siemens; Dacor and Miele.

The company is based in Elgin, Illinois, listed on NASDAQ, and had 4,500 employees at the end of 2013.

Takeaways: The Middleby Corporation has a solid hold with many of the world’s major food companies, including both processors/manufacturers and retailers. Most of its revenue comes from the Commercial Foodservices segment, and from North America, geographically. It faces significant competition from a wide range of well established and well financed corporations.

Growth

First, let’s look at MIDD’s historical growth over the past 20 years (green for stock price, blue for net income, and red for Earnings Per Share):

Middleby Price revenue eps

Looking to the future, the company has plans to capitalize on issues faced by its customers (as listed in the Investor Day 2014 Presentation):

Commercial Foodservices Equipment:

  • Reducing labor costs - minimum wages going up in many jurisdictions
  • Energy and water use efficiency - both social and economic pressures
  • Waste management - converting waste food into fuel
  • Ventless technology - reducing emissions

Food Processing Equipment:

  • Food safety: improving worker safety and food quality safety

Residential Equipment:

Middleby residential kitchen

Takeaways: Middleby appears to be actively working to address trends in each of its three key markets, with new products that address the needs and opportunities of its clients. The company should be able to extend its revenue and net income lines upward in coming years.

Management

Chairman & Chief Executive Officer: Selim A. Bassoul, age 57, became CEO in 2000 and Chairman in 2004. He joined the company in 1996 as President of the Southbend division. Before joining Middleby, Bassoul worked for eight years in commercial food equipment for Premark, Inc.

Vice President & Chief Financial Officer: Timothy Fitzgerald has held these positions since 2003; previously Corporate Controller of the company and Middleby Marshall from 1998 to 2003.

Board of Directors: Made up of Chairman/CEO Bassoul and six independent directors; the directors have experience or expertise in academia, finance, publishing, banking, investment banking, food manufacturing and marketing, and private equity.

ISS Governance Quickscore: 4 (a score of 1 indicates lower governance risk, and a score of 10 indicates higher governance risk). MIDD receives red flags for Equity Risk Mitigation and Controversies, as well as two green stars for Use of Equity, and Other Issues.

Takeaways: Both senior officers have extensive experience in their respective corner offices, and CEO Bassoul at least is young enough to remain at the helm for several more years. The board, which receives a medium score from ISS, has a broad range of experience and expertise (executive and board profiles based on information from Morningstar.com and the company website).

Ownership

Gurus: Among the gurus followed by GuruFocus, eight have holdings in The Middleby Corporation: Joel Greenblatt (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio), Alan Fournier (Trades, Portfolio), Jim Simons (Trades, Portfolio), Ron Baron (Trades, Portfolio), Mario Gabelli (Trades, Portfolio), Columbia Wanger (Trades, Portfolio), and John Rogers (Trades, Portfolio). Ron Baron (Trades, Portfolio) owned 4,271,376 shares and Alan Fournier (Trades, Portfolio) owned 1,976,704 shares (as of September 30, 2014).

Institutions: Pension funds, mutual funds and other institutional investors own almost 88% of the company, according to nasdaq.com:

MIDD institutional ownership

Short interests: Very low at just over 1%, well down from the high hit during the financial crisis:

MIDD short interests

Insiders: GuruFocus puts insider ownership at 3%; according to Yahoo! Finance, the biggest holdings among insiders belong to CEO Bassoul, with 181,968 shares and CFO Timothy Fitzgerald with 66,397 shares (as of March 15, 2014).

Takeaways: With solid holdings by gurus, institutions, and insiders, as well as small holdings by the shorts, this stock enjoys significant confidence among investors. It also means, of course, that the stock is unlikely to make any dramatic gains (or losses).

MIDD by the Numbers

Middleby key statistics

Takeaways: With the share count going up (some minor exceptions have occurred in the past 12 months) and no dividends, this company focuses on growth. It also has used its financial strength to post an excellent ROE (fiscal 2013 is a reasonably typical year).

Financial Strength

The Middleby Corporation enjoys 8/10 GuruFocus ratings for both Financial Strength and Profitability & Growth.

MIDD financial strength

The company’s stock does draw red icons for its Cash to Debt ratio, both compared to its industry and to its own history. Looking at the 10-Year Financials, we see it has indeed grown dramatically in the past few years, after previously hitting almost zero. But, for context, we’ll chart long-term debt (green line) along with total equity (blue line) and total assets (red line):

MIDD long term debt

Here’s how it compares to its peers in Global Diversified Industrials:

MIDD - GuruFocus

The ratio (currently .07) and comparison with peers might concern some investors. Taking the analysis a step further, let’s have a look at the company’s free cash flow:

Middleby free cash flow

As we can see, cash flow has risen quickly and consistently since 2005. It’s currently leveled out a bit, but still looks promising.

The GuruFocus automated system issues one Severe Warning Sign, but that sign can be disregarded. The warning indicates a problem with the Sloan Ratio; that ratio refers to the amount of earnings made up of accruals, or non-cash items (in other words, not normal business income). When the Sloan Ratio is between -25% and +25%, accruals are not considered a problem; when outside those boundaries, investors are urged to be cautious about the quality of earnings.

Middleby had a Sloan ratio of 26% at the end of fiscal 2013 (December 31), putting it just into the warning area. However, for the trailing twelve months ending on September 30, 2014, the ratio had fallen to 7%, putting it well within the safe parameters. At the same time, it’s worth noting MIDD’s Sloan Ratio has bounced up and down, but generally stayed within the safe boundaries.

Takeaways: MIDD’s long-term debt has grown. But, at the same time, it has also grown its assets, equity, and cash flow. As we’ll see in the following section, it appears to have used that funding well. It does get one GuruFocus severe warning, but the condition that caused that signal has since rectified itself.

Valuation

The Middleby Corporation appears in the Buffett Munger screener because its PEPG or PEG number puts it under valued or fair valued territory.

The PEPG / PEG ratio comes from what might be called an enhancement to the familiar P/E ratio; Price divided by Earnings. As we know, using the P/E comes with several caveats, such as knowing the ranges of different industries. For example, we expect the P/E of tech growth stocks to be much higher than sectors such as utilities or banks.

The PEG ratio, originally developed by Peter Lynch, allows us to get a bit closer to comparing apples with apples. By dividing the P/E ratio with average EBITDA or earnings growth (GuruFocus uses 5 years), we get a number that can be extended across industries and remain comparable.

The Buffett Munger screener does that arithmetic for us; as of December 30, 2014 the PEG ratio for Middleby was 1.35. In the GuruFocus system, a PEG ratio between 1.0 and 2.0 ranks as fair valued; stocks with a PEG ratio below 1.0 are considered under valued, while those above 2.0 are considered over valued. So, as of this date, MIDD ranks as fair valued.

The other major qualification for achieving Buffett Munger status is the predictability of earnings or EBITDA. After all, it would be misleading to take an average of these metrics when they fluctuate wildly; we would have much more confidence our expectations of future earnings, and the PEG ratio, when earnings grow consistently. The following chart illustrates how smoothly EBITDA per share has risen:

MIDD EBITDA

MIDD earns a 4-Star rating at GuruFocus (top rank is 5-Star). Backtesting by GuruFocus has found that the higher the star rating, the higher the returns that might be expected in the next 10 years, and the higher the rating, the lower the likelihood the stock will lose money.

The company does not pay a dividend, and it generally has issued more shares than it retired through buybacks. However, the growth of outstanding shares has been slight, suggesting it may involve stock options rather than new financing.

Takeaways: Middleby comes in as a fairly valued company; it has consistently increased its earnings for a number of years, giving us confidence it will continue doing the same in the future. It pays no dividend and the number of shares outstanding has remained relatively steady.

Opportunities & Risks

In North American and European markets, Middleby can use its research and development base to address the pressing need among its customers for greater productivity. That means working with customers to find solutions to rising labor, water, and energy (among other) costs.

In Asia and Latin America, it has rapidly growing markets, thanks to the newly emerging middle class populations. In those regions, the demand for more and better food drives the growth of in-home and out-of-home kitchen equipment.

From another perspective, the company can call on its experience in acquisitions to help maintain its growth. That allows it to both deepen its lineup, and to add complementary new lines.

MIDD has established sales, marketing, and distribution channels. That includes both independent dealers and distributors, as well in-house staff who can work with large national chains that want to directly with the manufacturer.

The company has a diverse line of products and brand names, allowing more flexibility when allocating capital and looking for new opportunities.

Risks
With almost $1.5 billion in sales in 2013, Middleby is a big company. But, in many segments it competes with even bigger companies for a share of markets; that includes both specialty firms and conglomerates.

As it taps into the outstanding growth in international markets, and particularly emerging markets, it increases its exposure to currency risk, as well as country risks (nationalization, punitive regulations, etc).

In recent years, it has taken on a material amount of long-term debt. If interest rates begin shooting up, Middleby may experience pain in several areas, not least of which might be its growth plans.

Both food service companies and consumers respond to economic conditions; slowing or declining economic conditions see them going to restaurants less frequently and remodeling their kitchens less often.

When research and development become important factors in any industry, players in that industry face the risk of disruptive technologies. While Middleby seeks to be a disrupter (Investor Day 2014 Presentation) rather than a victim of disruptions, there’s no guarantee that will always be the case.

For more on opportunities and risks, see the 10-K Report for 2013.

Outlook

Considering the opportunities and risks together, Middleby should be able to deliver strong top and bottom line results in the next few years at least.

More specifically, analysts covered by Yahoo! Finance expect earnings per share for 2014 to come in at $3.41, up from $2.71 in fiscal 2013, a 28.1% increase.

And, they expect EPS for 2015 to grow again, to $4.03 (based on a range of $3.70 to $4.30). That represents an 18.2% increase over $3.41.

Conclusion

In its 10-K for 2013, the company clearly states its intention to retain future earnings for growth and development; it has no plans to pay dividends in the foreseeable future.

That means The Middleby Company is only for investors seeking capital appreciation. Income is off the table. Yet, with EPS growth of 27.60% over the past few years, and more of the same expected, this company should not need dividends to attract interest.

With a reputation for high, predictable earnings and a fair valuation, it should be a consideration for all patient investors.

About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995 and in 2010 added options -- mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate-level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the "unseen revolution."

Visit Robert Abbott's Website


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Comments

Thomas Macpherson
Thomas Macpherson premium member - 4 years ago

Another great article Robert. We like Middleby but just never got the price point we were comfortable with against our current holdings (meaning we'd have to sell something to pick it up). Thanks again for posting. Best. - Tom

batbeer2
Batbeer2 premium member - 4 years ago

Nice work. Thanks for bringing this interesting company to my attention!

During your research did you notice any significant customer concentration?

Is it possible that most of the growth has come from an agreement with Subway or maybe Starbucks?

I'll be looking into it myself, thanks again.

Robert Abbott
Robert Abbott premium member - 4 years ago

Thanks for a good question, Batbeer2. I've checked the 10-K for 2013 (the 2014 version is still about a month in the future). In the 10-K, the company reports that its Commercial Foodservice group has "...several large multi-national restaurant chains, which account for a meaningful portion of the company's business, although no single customer accounts for more than 10% of net sales." and similarly for the Food Processing group, "Customers include several large international food processing companies, which account for a significant portion of the revenues of this business segment, although none of which is greater than 10% of net sales." It does not provide similar information for the Residential Kitchens group, but I'm guessing that would be a relatively diffused business in any case. Bottom line appears to be that Middleby has enough big customers that they 'cancel' each other out as dominating customers.

Robert Abbott
Robert Abbott premium member - 4 years ago

Hello Tmacpherson1966 - I agree that with your position - Middleby is fairly valued, thus it's not likely to be a compelling replacement for you. Just an additional note: I'm not sure if you use any technical analysis, but overall MIDD sticks fairly close to the 50 day simple moving average; perhaps a dip below the 50 SMA (currently $93.94) might make that case stronger.

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