Stock in food equipment company Middleby Corporation (MIDD 5.11%) is in line with the S&P 500 index so far this year -- it's recorded a 5.1% increase as of this writing. However, this is definitely not a case of a company simply tracking the market.In reality, it's been a volatile year, with the stock trading at $100 in March, and then some 28% lower, at $72, in August, only to increase 21% to the price of around $85 as of this writing. Why has the stock been so volatile this year?
Future earnings
As the following chart demonstrates, Middleby's current valuation has little to do with its current earnings -- it's the market's view on its future earnings that counts. While Dover Corp. and Illinois Tool Works aren't the perfect companies to use as a comparison -- they're more mature and low-growth, although they do have segments that compete with Middleby -- the valuation discrepancy seems to reflect the premium that the market is pricing in for Middleby's growth.
Enterprise value, or EV, is used as a valuation method instead of earnings before interest, taxes, depreciation and amortization, or EBITDA. This is because EV -- market cap plus debt -- factors in debt considerations. This is worth doing because Middleby has built up debt by making acquisitions over the last decade.
MIDD EV to EBITDA (TTM) data by YCharts.
If Middleby's valuation is based on its potential for future earnings growth -- analysts have 16% and 20% inked in for EPS growth in 2014 and 2015, respectively -- then Fools need to look at the drivers of that growth, and then form a Foolish view on whether Middleby will fail/hit/exceed expectations.
How Middleby can generate growth
Essentially, there are three main, and somewhat related, growth drivers for the company. To understand their relevance, here's a chart of the share of segmental sales in 2013.
Source: Middleby presentations.
The three drivers are focused on the commercial food service and residential kitchen segments.
- Successful rollout of its "kitchen of the future" to restaurant chains.
- Execution of its plan to generate margin improvements following its purchase of Viking (residential kitchen segment) distributors and restructuring of its dealer network.
- Growth in sales with its new products at Viking.
Most of the excitement around the company centers on the "kitchen of the future," and Middleby has a number of restaurants in trials at the moment. Simply put, Middleby argues that its kitchen model is more productive than its rivals', and will generate cost efficiencies for restaurants.
The opportunity is to convert the trials already in place into rollouts in the coming year. The gist of CEO Selim Bassoul's update on the matter on the second-quarter conference call is that smaller chains -- 20- to 50-store outlets -- are installing the kitchens, with "close to 300 'kitchen of the future'[s] [installed] in the past few quarters."
However, the larger chains have been "slower than ... expected" because of the large capital commitments necessary to roll out the kitchens in 1,000-plus store outlets. Indeed, Bassoul noted that the decision by Chili's owner Brinker to install the kitchens imposed a $50 million capital expense structure on the restaurant owner. To put this figure in context, analyst forecasts are for Middleby to generate $1.64 billion in sales in 2014, so there is significant upside to Middleby's revenue just by converting a few trials into rollouts.
Executing distribution and dealer network plans
The second two points are interconnected. Earlier in the year, Middleby bought two of its major Viking distributors. Then, in the second quarter, it reorganized its relationships with its dealers. According to Bassoul, the plan is to focus on dealers who will make an "exclusive display for us."
In discussing developments, Bassoul outlined that its dealer numbers had been reduced to 1,000 from 1,500, with 250 dealers having made a "commitment to us." Furthermore, he believes that the total number of dealers would "go down to close to 700 as we go into 2015."
The good news is that the plan appears to be working on track, with CFO Tim Fitzgerald confirming that the company remained on target to exit the year with 20% EBITDA margins for Viking. This was a welcome update because, as Fools already know, Middleby saw some margin reduction in the first quarter as a consequence of the dealer reorganization. Moreover, Middleby is launching a raft of new products in the fall.
All told, the stock is being moved around by sentiment about its growth initiatives. Whenever a growth stock is subject to uncertainty -- and most growth stocks are -- you can expect some volatility. No one knows for certain how the take-up of the "kitchen of the future" by large restaurant chains will ultimately be. Furthermore, successfully reorganizing the dealer network, while also launching new products, is also far from a given.
All of this shouldn't be taken as a negative by investors. There's a lot to like about Middleby, and its long-term prospects look good; just don't expect a smooth ride all the way.
