Food-service equipment manufacturer Middleby (NASDAQ:MIDD) has taken advantage of major growth opportunities in its industry to produce extremely strong returns for shareholders. Coming into Wednesday night's second-quarter financial report, Middleby investors wanted that favorable trend to continue, and they expected solid earnings growth from rising sales. Yet Middleby's results showed that the company brought in far less revenue than expected, and even though earnings performed reasonably well after making adjustments for one-time items, investors appear to be nervous about the prospects for the food-service industry going forward. Let's take a closer look at how Middleby did and why shareholders reacted badly to the report.
Middleby cools off
Middleby's second-quarter results weren't disastrous, but some of its performance fell short of expectations. Revenue rose by 2.7% to $436.3 million, but investors had expected almost $30 million more in sales that would have resulted in more than triple the growth rate Middleby actually achieved. Net income of $54.3 million was up 12% from year-ago figures and worked out to $0.95 per share, which was a nickel less than the consensus estimate. After taking into account restructuring expenses and foreign-currency impacts, adjusted earnings of $1.02 per share topped the $1 forecast, but it's likely that investors had already taken those impacts into account in their projections.
Even worse was the fact that Middleby's weak sales were bolstered by acquisitions. If you take out revenue from newly acquired businesses, organic sales fell by about 5%. Currency impacts amounted to a three-percentage-point hit to revenue as well.
Looking more closely at Middleby's major segments reveals a lot of movement stemming from its acquisitions. Sales for the major Commercial Foodservice Equipment Group segment rose by 9.4%, with about half of the increase coming from purchases of Desmon, Goldstein Eswood, Marsal, and Induc. The Residential Kitchen Equipment Group also saw revenue increase by 6.5%, but as we saw last quarter, the acquisition of U-Line accounted for all of the gains, and organic sales actually fell 14% year-over-year. The Food Processing Equipment Group once again lagged behind the rest, with a 20% hit to revenue even before accounting for Middleby's Thurne acquisition.
Elsewhere, Middleby had mixed success on the cost side of its income statement. Gross margins posted about a half-percentage-point gain, and selling and distribution expenses decreased substantially from last year's second quarter. Even a slight rise in general overhead expenses wasn't enough to keep overall costs from declining slightly, helping to produce more profit growth.
CEO Selim Bassoul tried to cast the results in a positive light. "Our chain restaurant customers [are] adopting our new and innovative technologies," Bassoul said, "as they seek to improve the efficiency of their restaurant operations." Bassoul also highlighted how its success in integrating new acquisitions smoothly contributed to profits, especially in the Commercial segment.
What challenges does Middleby face?
Still, Middleby clearly has some obstacles to overcome. Bassoul blamed lower Food Processing Equipment segment revenue on the timing of large orders, suggesting that the company's future pipeline of sales could make up for this quarter's weakness in the long run. Profit margins also increased for the segment, highlighting efforts to make the most of its opportunities.
Also affecting sales was Middleby's decision to discontinue certain non-core products connected with its Viking acquisition. "We are excited about the growth potential for the new lineup of Viking ranges, cooktops, ovens, and refrigeration," Bassoul said, and he believes that sales for the Residental segment should recover nicely once its products start to gain acceptance in the marketplace.
Nevertheless, despite the optimistic long-term assessment, investors were far from convinced about Middleby's future. In the first hour of after-market trading following the announcement, the stock fell more than 5%. Shares are priced highly enough that investors want to see clear signs of short-term outperformance that were missing this quarter, but for those with a longer-term perspective, the decline could provide a valuable opportunity to consider buying shares at a slightly cheaper price.