Thesis summary
At about 18 times trailing 12-month earnings and 12 times trailing 12-month earnings before interest, taxes, depreciation and amortization, National Beverage Corp. (FIZZ, Financial), best known for its flavored sparkling water La Croix, is not a deep-discount stock, nor one trading with a remarkable margin of safety. However, the selloff following the company's bizarre third-quarter report, highlighting slowing sales, maybe a bit overdone as La Croix has become well entrenched in the rapidly growing flavored sparkling water segment of the beverage industry.
If short-term headwinds are managed properly, mainly a lawsuit regarding La Croix's use of natural flavors, we believe they should not affect the long-term growth story. The stock actually trades at a discount to competitors in the beverage space despite being better concentrated in higher-growth market segments. Owning National Beverage Corp. undoubtedly comes with risk, most notably centered around management execution, but in our view, the potential upside makes it worth a closer look.
Company overview and history
National Beverage Corp. has an unusual background and is an interesting read - the company was created by Nick Caporella in 1985 when he purchased the "Shasta" brand in an attempt to fend off a takeover attempt for a publicly traded telecom company he owned. The company was spun-off in 1991, with Caporella owning 77% of shares outstanding, as he turned his full attention to the newly independent enterprise. Out of the gates, National Beverage's stock price tanked as the ownership structure shunned institutional investors, a phenomenon that still exists with the stock (only 24.24% of shares outstanding are owned by institutions today).
Caporella exerts an enormous amount of control over the company, yet it's unclear how involved he remains with the day-to-day decisions. Traditionally, the Street has viewed Caporella's presence as a major roadblock to the company being acquired by a beverage giant like Coca-Cola (KO, Financial) or PepsiCo (PEP, Financial). National Beverage does not host public earnings calls or answer analyst questions.
The silver lining is Caporella's incentives are clearly aligned with shareholders; today, he still owns 74% of National Beverage, representing a majority of his net worth. He is also 82; his role with the company may gradually reduce as he ages and, with it, some of the barriers that have kept intuitional investors out.
Today, the company has products across multiple verticals - soft drinks (Shasta, Ritz), juices (Everfresh), energy drinks (Rip-It) and flavored sparkling water, with La Croix being the company's crown jewel. The company doesn't break out individual sales numbers by segment line or product, but estimates have La Croix making up 40% to 55% of revenue and an even greater portion of earnings due to the higher margins - it is, after all, just carbonated water with subtle natural flavors.
Right place, right time
La Croix exploded onto the scene for National Beverage in 2015, driving 57.66% top-line growth ($645.83 million to $1.01 billion) and nearly tripling earnings ($49.31 million to $151.16 million) over the past three years. After years of a ho-hum product lineup, it seems National Beverage hit the market sweet spot with its La Croix product. Flavored sparkling water is a unique, expanding subsector because it panders to two major overlapping consumer markets; it gives consumers the flavor, carbonation and kick they look for out of soda while remaining a healthy alternative to sodas (calories) and diet sodas (artificial ingredients). La Croix is all natural, has zero calories, and no additives.
The American sparkling water sector is expanding rapidly; third-party research company Mintel projects sparkling water sales in the U.S. rose 118% from 2013 to 2018 and expects the market to continue to grow at a 9.8% compound annual rate through 2023. Nelsen data shows Canadians spend, on average, 21% more per household on sparkling water than in the U.S., suggesting the American market has more room to grow as the health-conscious trends continue to upend traditional food and beverage preferences.
Source: Mintel Research
The past couple years have shown us that consumer staples, such as Coca-Cola, Pepsi, Kraft Heinz (KHC, Financial) and Campbell's Soup (CPB, Financial), do not have as much staying power as they did during Warren Buffett (Trades, Portfolio)'s heyday. Consumer demands, particularly driven by millennials, are shifting toward healthier products with natural or organic ingredients.
Natural Beverage never invested much in terms of marketing to fuel La Croix's sudden and unexpected growth; instead, a big reason for the beverage's surge in popularity among millennials has been through a combination of brand design and the product's social media presence. Most value investors tend to not focus on marketing, but I think it's an underrated aspect of the company worth mentioning. Even after the lawsuit, La Croix is still expanding its Instagram following by an average of 2,610 a month. For comparison, Pepsi's Bubly social media following has grown at half that rate, despite financing an advertising campaign centered around Michael Buble that debuted with a 30-second Super Bowl ad.
So why is it down?
National Beverage Corp. reported declining revenue growth for the second consecutive quarter last week in an eccentrically named report, '"We Just Love Our La Croix' Consumers Chant" (The opening line from Caporella read: "We are truly sorry for the results above. Negligence nor mismanagement nor woeful acts of God were the reason - much of this was the result of injustice!"), in large part due to a lawsuit regarding the origin of its "natural essence" flavors levied against them in early October.
Based on wide-ranging reports from Pop Science, Live Science and 538, the lawsuit does actually seem to have little merit. Nothing about the way La Croix flavors its waters is unsafe or out of the ordinary, but Caporella's response to the controversy has been questionable at best, as he blamed short sellers in another rambling release.
The lawsuit resulted in various retailers removing La Croix from their inventory, which took a sizable chunk out of the company's second-half 2018 sales and resulted in a big earnings miss to end the year. The good news is the lawsuit seemed to have a bigger effect on availability than demand - various proxies indicate the brand's following on various social media platforms continues to grow strongly, where they have double the followers of the next most visible sparkling water brand. And anecdotally, I haven't heard or seen anything that suggests popular consumer sentiment regarding the drink has changed drastically in the face of the lawsuit.
There was further potential good news on this front last week. National Beverage released a report that Joy Bauer, a registered dietician and the health and nutrition expert on the "Today" show, has partnered with the company to be "the national dietician representing La Croix." I am not entirely sure what this role will entail, but any news signaling there will be a fresh face outside of Caporella's defending the company against libel is good news. Hopefully, this is the first sign of National Beverage working with its channels to regain confidence and to ultimately restock La Croix.
If management is able to convince retailers there is nothing unsafe about La Croix's natural flavors and is able to reasonably restore consumer confidence, we believe this could be a short-term hiccup and a rare buying opportunity for a company with an otherwise great growth story and intangibles.
Another major risk to the bull case is increased competition; as mentioned earlier, Pepsi has invested heavily in its new Bubly brand. Amazon (AMZN, Financial) is offering a lower-priced flavored sparkling water product through the 365 Whole Foods brand. Pepsi recently purchased SodaStream, an at-home water carbonator, and Nestle (XSWX: NESN) recently launched Ice Mountain sparkling water.
Source: Statista
Overall, La Croix is navigating in an increasingly competitive sector with low barriers to entry, which is why we are paying particular attention to the intangibles surrounding the brand and story.
Valuation and outlook
Many value investors may not feel great about paying 18 times earnings for any company, much less one that has serious question marks, but when compared to the rest of the beverage industry, the stock is actually pretty cheap.
National Beverage Corp. may not be as big or powerful as the other heavyweights in the beverage industry, but its size should give the business much more space to grow. It's also worth mentioning the company has a tremendously healthy balance sheet, with no long-term debt.
The following is a rough model outlining what a potential bull case scenario for National Beverage Corp. may look like. The assumptions include:
- Non-La Croix sales growth remains flat.
- The American sparkling water market continues to expand at a CAGR of roughly 9%.
- La Croix is able to put its public relations issues behind it and resumes taking modest market share as the category continues to expand.
- Due to the improved earnings mix from La Croix making up a bigger part of sales, National Beverage is able to eventually produce standard net margins for the industry, around 20%
- Due to increased investor confidence in the business, the stock begins trading closer to the larger industry's median earnings multiple of 20.
That is obviously a lot of assumptions, but if investors are truly bullish on the stock, they likely think many of these are cautious. After all, while La Croix was ascending, it was growing volume at a 40% annual clip. At the very least, investors should not blindly assume that numbers three and four will happen and should monitor the Nielsen data closely to make sure the story holds up rather than waiting to hear about it in the quarterly report. If interested in the stock but still wary, I'd also suggest monitoring the sales data - it might be too late to act at a reasonable price, but it would be nice to get confirmation of the La Croix sales turnaround before investing.
A potential Peter Lynch stock
The more work we did on this stock, the more we felt the National Beverage Corp. bull-case centers around the Peter Lynch style of investing. In his investing classic, "One Up on Wall Street," Lynch urged investors to "stalk potential ten-baggers" (a stock that grows 10 times after you purchase) by carefully looking out for products that are quickly catching consumer demand. If these products are somewhat off the radar of "The Street", all the better.
We first became interested in the stock when noticing that every single office seemed to stock the popular flavored sparkling water, and we couldn't help but notice the sudden surge of popularity.
The price of National Beverage Corp kept us away at the time, but when the selloff caused $FIZZ to trade closer to its Peter Lynch median earnings line, we became bullish on the stock's outlook.
Source: GuruFocus Peter Lynch Earnings Line
Other attributes Lynch mentioned that I noticed are consistent with National Beverage Corp. are low institutional ownership, light analyst coverage, a niche product that consumers continuously buy and insiders are investing (Joe Caporella, president and the son of Nick, purchased an additional 6,000 shares on March 14).
The stock is cheaper today than it has been in a while but undoubtedly comes with more risk than it did before the lawsuit. Until recently, La Croix was rapidly taking market share in a segment experiencing remarkable category growth. If National Beverage Corp. can put the lawsuit behind it and regain just a fraction of the momentum the brand had shown prior, its current price could represent a rare, reasonable entry price for an otherwise excellent growth story.
Disclaimer: The author owns a long position in National Beverage Corp. This is not financial advice.
