Just outside Chicago sits the headquarters of Middleby (NASDAQ:MIDD), a lesser-known manufacturer of food preparation equipment. It's been on an acquisition spree this year, acquiring four businesses since February. But this news isn't so much a game-changer as the game-plan for Middleby. Every year it makes a handful of acquisitions to add to its now nearly 100 brand portfolio.
Organic growth -- growth from existing products and services -- is scarce in the food equipment business. Illinois Tool Works (NYSE:ITW) which might be Middleby's biggest competitor, operates in seven distinct business segments. One segment is food equipment manufacturing like Middleby. In its third quarter, ITW reported 1% organic equipment growth. This is similar to Middleby's second quarter, with organic sales only up 2.3%.
At that pace, organic sales won't make Middleby a market-beating investment. Let's take a look at whether acquisitions turn the company into a market-beater.
Staying on top of trends
Consumer tastes fluctuate and companies need to adapt. Take beer for example. Overall beer sales have plateaued, but the craft beer segment is growing substantially. Data from the Brewers Association shows that this segment is growing over 10% annually, and has more than doubled since 2014.
Noting this trend, Middleby acquired Ss Brewtech in June. Ss Brewtech supplies onsite brewing equipment for home-brewers and microbreweries -- a big piece of the craft beer puzzle. The company is small with only $20 million in annual sales, but Middleby believes it can leverage its existing customer network to grow the Ss Brewtech brand.
During the past year, Middleby has shared in earnings calls that it wants to diversify into other growing trends, including pet food and bacon. Pet food as a whole isn't growing much, but natural and organic pet food is. That segment of pet food is expected to grow at an annualized rate of 9% between now and 2023.Bacon is only expected to grow at a 4% annualized rate through 2024, but it's still another area Middleby believes could prove profitable in the near future. I'm inclined to agree since I don't think you can go wrong with bacon.
So Middleby tries to acquire manufacturers aligned with consumer trends, but it also wants to develop state-of-the-art products. Its recently revamped products include touchscreens, equipment diagnostics and analytics. Thought to be under the umbrella of the Internet of Things, these devices connect to the cloud, so Middleby's customers can perform tasks like schedule equipment maintenance and even distribute new recipes.
In April Middleby acquired Powerhouse Dynamics to further develop its IoT platform. Normally it allows businesses to continue operating independently, but in this case it consolidated its platform with that from Powerhouse Dynamics. In Q2, management pointed out an intriguing aspect of this acquisition when it revealed that Powerhouse Dynamics has "the largest installed base of cloud-based solutions in the restaurant industry." So not only does this acquisition improve Middleby's technology, it also gives the company access to a huge new customer base.
With acquisitions, one of Middleby's goals is to improve the acquired business's profit margins. A prime example of this comes from its largest acquisition ever. Last year the company acquired Taylor, a frozen beverage and automatic griddle brand, for $1 billion. At the time it had annual revenue around $315 million and EBITDA of $65 million -- a 19% margin. Middleby stated its goal was to bring Taylor's EBITDA margin up to 25% in 2019. While not terribly specific on how, (instead using vague terms like "integration efforts" and "initiatives") Middleby has achieved its goal of 25% margins for Taylor. Now the goal is to bring Taylor's margin up to 30%, which is the goal Middleby holds for the its entire company.
To be clear, Middleby isn't hitting its overall 30% EBITDA margin goal right now. The most recent quarter yielded $178 million in EBITDA -- a 23% margin. Management has stated that this situation is only temporary and resulted from heavy spending in technology improvements in its equipment.
That little 7% discrepancy between the EBITDA goal and reality is a $50 million quarterly difference. Considering Middleby's market cap is under $7 billion, $200 million additional annual EBITDA is a substantial increase.
It'll be challenging for Middleby to resume beating the market (as it did earlier this decade) with acquisitions alone. The consumer trends it's identified for acquisitions have modest growth prospects at best. Organic sales need to increase; Middleby noted in Q2 that some large chain restaurants were delaying purchases into 2020, giving hope that organic sales could improve next year. But the most pressing issue is improving EBTIDA margins toward the 30% goal. I'm optimistic this is achievable in time, considering that full-year 2019 results are trending toward a year-over-year EBITDA margin increase for the first time since 2016.