In this newsletter, I share summaries of attractive investment ideas sourced from the Value Investors Club and incorporated into my personal portfolio. These summaries will be complemented by regular updates on key developments impacting investment theses. My aim with Idea Hive is to document my own portfolio management process while also enabling readers to quickly grasp and follow attractive investment opportunities.
Today, I am sharing a new portfolio idea: an interesting ‘short’ thesis on SunOpta (STKL). The idea was pitched on VIC in mid-March. You can read the full write-up here.
Short Idea: SunOpta (STKL)
Elevator Pitch: A bet on the expected downturn in the plant-based milk industry.
Current Price: $5.81
Target Price: $4.38
SunOpta is one of the largest plant-milk producers in North America.
The company presents an interesting way to bet on the anticipated negative inflection in the US plant-based milk industry. Explosive growth in plant-based milk sales with the onset of Covid-19 has prompted a number of companies to enter the market to meet massive consumer demand. Given the supply/demand imbalance, plant-based milk producers have significantly increased capital expenditures to boost production capacity in recent years.
However, it seems that we are now close to the inflection point, as the market is expected to shortly shift from under-supplied to over-supplied. Current plant-based milk production capacity stands at 1,247m liters compared to a total demand of 1,278m liters (see table below). A potential catalyst tipping the industry from under-supplied to over-supplied might be STKL management’s plans to open additional manufacturing lines in its largest, recently built Midlothian facility during FY24. These are expected to add over 200m liters of incremental capacity. One of the lines, with a production capacity of 80m liters, was already launched in Q1’24 and is expected to ramp up in H2’24.
The demand outlook also does not look promising for plant-based milk producers. After gaining market share during COVID, plant-based milk has been steadily losing volume share to dairy milk since 2021 (from 7.3% in 2021 to 6.9% in 2023; see table with industry data below). This indicates that the explosive growth in demand was likely driven by COVID.
The demand normalization pattern is also supported by data from Google Trends. See the chart below for the number of historical searches for "plant milk":
These supply and demand dynamics will likely put significant pressure on plant-based milk prices. STKL's filings already show that prices have been steadily tapering off over recent quarters (see table below).
STKL presents an intriguing opportunity to play the expected headwinds in the US plant-based milk industry. The company is very expensive, trading at 17x 2025E EBITDA of $56m, estimated using optimistic assumptions. This valuation seems overly generous for a business that has consistently struggled with profitability and cash flow generation, has a choppy history of growth, and operates in an industry expected to face a downturn. A potential stock re-rating to a still generous 15x multiple would imply a price target of $4.38/share.
There are several potential catalysts for the short thesis here:
Guidance Cuts: Given that the potential industry downturn is not yet fully reflected in the financials, STKL’s management might be forced to cut its guidance over the course of 2024. The company has guided for $88m to $92m in 2024E EBITDA compared to the write-up author’s estimate of $56m using conservative assumptions. Notably, the company has already cut its guidance multiple times during the last year, as highlighted in the write-up:
In March 2023, amid completion of the Midlothian plant, management guided for $97-$103M in EBITDA for FY2023, sending the stock ~10% higher. By August 2023, guidance was cut to $87-$91M, and eventually cut to $75-$77M by November, sending the stock down ~20%+. I believe a similar story will play out in FY2024 with FCF guidance – SunOpta has never generated even $30M annual FCF, yet guides for $35-45M…an increasingly difficult pursuit with their leverage concerns.
Debt Covenant Breach: STKL is likely to breach its debt covenants over the near to medium term. With conservative assumptions, including flat price growth and 4% volume gains, the company would fail to comply with its 4x net-debt-to-EBITDA covenant by Q2’24. Several weeks ago, STKL eliminated dividends on its B-1 preferred shares, indicating impending distress.
Why does this opportunity exist? STKL has historically been a diversified food and beverage manufacturer, involved in beverages, broth, sunflower seeds, fruit-based snacks, as well as plant-based milk. Divestitures of multiple segments during 2019-2023, turning the company into a pure-play plant-based milk producer, have made it difficult for the market to accurately value the stock. Another explanation is that the plant-based milk industry appears to be at a tipping point, with some market participants possibly unaware of the looming industry inflection.