Is The Middleby Corporation Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Middleby (NASDAQ: MIDD  ) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Middleby's story, and we'll be grading the quality of that story in several ways:

  • Growth: are profits, margins, and free cash flow all increasing?
  • Valuation: is share price growing in line with earnings per share?
  • Opportunities: is return on equity increasing while debt to equity declines?
  • Dividends: are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Middleby's key statistics:

MIDD Total Return Price Chart

MIDD Total Return Price data by YCharts

Passing Criteria

Three-Year* Change 

Grade

Revenue growth > 30%

98.9%

Pass

Improving profit margin

5.5%

Pass

Free cash flow growth > Net income growth

20.4% vs. 109.9%

Fail

Improving EPS

104.6%

Pass

Stock growth (+ 15%) < EPS growth

170.4% vs. 104.6%

Fail

Source: YCharts. * Period begins at end of Q1 2011.

MIDD Return on Equity (TTM) Chart

MIDD Return on Equity (TTM) data by YCharts

Passing Criteria

Three-Year* Change

Grade

Improving return on equity

8.1%

Pass

Declining debt to equity

39.3%

Fail

Source: YCharts. * Period begins at end of Q1 2011.

How we got here and where we're going
Middleby puts together a respectable performance by earning four out of seven passing grades, but its fundamentals fall somewhat short of the strength its share price growth might indicate. While Middleby has done a good job improving its bottom line at a faster pace than its revenue, both metrics fall short of the company's soaring share price -- and while lagging free cash flow hasn't fallen too far behind net income yet, it could become concerning if the gap continues to widen. How can Middleby -- which is our CEO's greatest investment -- boost its free cash flow and its net income to pull closer to an elusive perfect score? Let's dig deeper to find out.

Middleby hasn't had a very good year since its late-February pop on strong fourth-quarter results. In fact, shares have given up nearly all of the gains they booked to that point, as February's report has thus far been Middleby's high-water mark. The worst came after first-quarter earnings disappointed Wall Street on the bottom line in May, but Middleby has since recovered as investors choose to look to the future.

Or are they looking to the "kitchen of the future," which is Middleby's current organic-growth initiative? This efficiency-boosting system has gained a foothold in virtually all of Brinker International's (NYSE: EAT  ) 1500-plus Chili's locations, and should become the core product in Middleby's lineup within the next two years as it's rolled out to other restaurants. The impact on Brinker's bottom line, while subtle, is apparent -- after a peak and decline in its earnings  in 2011, Brinker has enjoyed years of steady bottom-line growth, with trailing 12-month net income up 17% since early 2012 despite a modest 2% improvement in trailing 12-month revenue.

Middleby's current woes stem largely from weaker-than-expected margins, which have been blamed on its spate of recent acquisitions, which have expanded sales but have cost Middleby time and money to integrate. However, Middleby has proven adept at acquisitions over the years, as it's bought out 33 companies since 2005, but has not suffered any drop in margins despite quadrupling sales during that time frame. While it wasn't up to Wall Street's standards in the latest quarter, Middleby's profit margin has actually expanded over the past few years, as we've already seen.

Going forward, Middleby will almost certainly benefit from increased competition in the fast-casual and casual segments of the restaurant industry, and from the growing international presence of many major American franchises, most of which happen to be key Middleby customers. Yum! Brands (NYSE: YUM  ) has been a long-term purchaser of Middleby ovens, and a year ago the company's Chinese subsidiary awarded Middleby its first-ever "Bridge Builder Award" for its role in Yum!'s rapid Chinese expansion. Middleby continues to develop new products as well, with those introduced in the past four years now comprising roughly 20% of revenue.

Putting the pieces together
Today, Middleby has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

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