This Whiskey Stock Has Gained 423% in 3 Years. Is It a Buy?

Alongside the rise of craft breweries in the last decade, there's been a quieter, slower rise in craft distilleries. Rather than brewing beers, these local and regional upstarts produce spirits such as gin, rum, and whiskey. Product mix isn't the only difference. Distilleries also have slightly more logistical hurdles to contend with than do breweries. There's additional equipment needed, and in order to capture the most premium tier of the market, companies need to age product in warehouses for years, which requires a large footprint without any immediate payoff.

That's where MGP Ingredients (MGPI -1.45%) comes in. The company has become a distiller-for-hire for premium brands and craft brands alike. It handles the upstream part of the industry's logistics -- brewing, distilling, and aging -- so customers can focus on branding and distribution. It's proven to be a lucrative niche: The whiskey stock is up 423% in the last three years and over 1,000% in the last decade.

That said, there's some concern that the stock has yet to earn its ever-increasing valuation. So although it continues to deliver both top- and bottom-line growth, some have cautioned stock gains could be more difficult to come by in the near future. Is MGP Ingredients a buy?

Image source: Getty Images.

By the numbers

MGP Ingredients turned in a slightly disappointing performance in the first quarter of 2018 compared to the prior-year period. The company's revenue grew just 0.9% year over year, while net income increased 2.9% -- and all due to a lower tax bill. Operating income cratered.

It's still a comfortably profitable business capable of turning nearly 12% of sales into operating income, but the most recent quarter delivered slower growth relative to what investors have come to expect from the business in recent years. 

Data source: First-quarter 2018 press release.

The choppy quarter didn't sway management to alter its full-year 2018 guidance. MGP Ingredients still expects to deliver operating income growth of 10% to 15% compared to last year, when the business put up $41.9 million in operating profit. Sales are expected to grow by high single digits year over year.

But Wall Street wasn't quite so quick to dismiss the Q1 report, and reacted by sending shares down by double digits the day results were announced. That's easy to understand considering the premium valuation MGP Ingredients has been granted over the years. The diversified business -- only half of total revenue comes from premium beverage alcohol, with industrial alcohol, starches, proteins, and warehouse services comprising the remainder -- has been given the benefit of the doubt when it comes to executing on the long-term strategy to prioritize high-value beverage alcohol sales. Can it execute?

Image source: Getty Images.

About that valuation

The ingredients part of the business will remain a core source of value creation. After all, selling specialty starches and proteins left over from the production of alcohols is low-hanging fruit. While that won't change, MGP Ingredients is in the process of shifting some of its production capacity (and therefore sales) from industrial alcohol to premium beverage alcohol, especially aged whiskey. 

The move is expected to provide a boost to margins and make profits more predictable in the future, as evidenced by management's preliminary guidance for full-year 2019 operating income growth of 15% to 20%. An acceleration in profit growth rates will be needed for MGP Ingredients stock to earn its lofty valuation.

Consider that although the business has delivered consistent profit growth in the last decade, the stock's valuation has grown even faster. A little over five years ago, the whiskey stock traded at 0.25 times sales and 0.6 times book value. Today, MGP Ingredients stock trades at 4.2 times sales and 8.6 times book value with a nearly $1.5 billion market cap. It also trades at an expensive 33 times forward earnings, according to statistics provided by Yahoo! Finance. 

MGPI data by YCharts.

The company is hoping to cash in on a few powerful trends in the market. For instance, MGP Ingredients is increasing the investment in its own brands, in addition to providing distilling services for external customers. Then there's the $67 million worth of premium aged whiskey sitting in the company's warehouses, which should begin making a more significant impact in 2019 (thus the expectation for accelerated operating profit growth). Since the aged whiskey is valued "at cost" when discussed by management, investors should expect the market value to be considerably higher.

Here's the thing. Even if operating income grows at a 20% clip in 2019, the business would need to maintain that rate for several years to earn its valuation, let alone merit an even higher one. Consider that if the business achieves the high end of projected operating income growth this year and then delivers 20% growth in each of the next two years, total net income would reach around $55 million in 2020. That's impressive, but with approximately 17 million shares outstanding, it works out to $3.24 in earnings per share. Even with that level of profitability, shares would trade at a still-expensive 27 times forward earnings -- and that's if the stock price stays put. 

The stock has proven me wrong in the past by continuing to trek higher, but at some point the premium valuation is likely to catch up to MGP Ingredients. Simply put, it seems Wall Street is getting a little carried away with this whiskey stock.