Armanino Foods (AMNF)

Armanino Foods (AMNF, $2.17) sells frozen pestos, sauces, stuffed pasta and cooked meat products. The current CEO, Edmond Pera, took over in February 2009. Since then, revenue has nearly doubled, share count has decreased 8%, and gross margins, operating margins and returns on capital have all expanded. All this fueled a stock price that has compounded at a rate of 31% per year since 2009. Not surprisingly, the small cap investment community took notice to these impressive results. Over the past few years, Armanino has been written up on Value Investor’s Club, otcadventures, multiple times on Seeking Alpha, and it has its own thread on Corner of Berkshire and Fairfax. Because these extensive write-ups already exist, I’m going to give a quick business and industry overview and then focus on why I like AMNF as an investment right now. This isn’t a lengthy write-up, but that’s because the thesis is pretty simple. Armanino is probably my favorite idea in terms of risk/reward that I’ve discovered this year.

Business overview

If you’re like me, your first thought when looking at Armanino was probably “selling pesto to grocery stores and restaurants can’t possibly be a great business.” Well, it’s a better one than I expected. First, getting grocery store shelf space is not easy. It’s even harder if an incumbent in your category (like Armanino in Italian foods) has been around for decades and is a well-known brand. But this same logic applies to non-client grocery stores that already have pestos that sell well. This is why Armanino is big on the west coast, but hasn’t had success expanding along the east coast where incumbents already exist (reminds me of See’s Candies).

On the other hand, already having shelf space on the west coast allows them to more easily expand product lines. A grocery store is more likely to give a successful incumbent more shelf space for a new product line compared to a new brand the grocery store doesn’t already carry. Maintaining this shelf space for decades has given Armanino Foods a recognizable brand on the west coast. Having a recognizable brand in a consumer products category is extremely valuable. All of this adds up to a company that’s been able to achieve returns on capital over 60% every year since 2010. They’ve also been able to push a couple price increases through since 2013 (without affecting growth) which is always a good sign.

While I’m not making any macro calls, I think most investors would agree the current bull market is going to run out of steam sooner rather than later. If that comes to fruition, Armanino is the type of business I’m happy to own during a downturn. Consumer packaged goods are notoriously recession resistant because people have to eat no matter what the economy is doing. From 2007-2009, Armanino increased revenues, expanded gross and operating margins, and increased returns on capital. That’s quite an impressive feat given the state of the world at that time. The AMNF stock has a beta that hovers around 0.24 depending on the timeframe used. Again, this shows the stock isn’t highly levered to what the overall market is doing.

Management

Edmond Pera took over as CEO in 2009 after being COO since 2003 and a director since 2000. I like what Edmond’s done since he took over. First, he takes a very reasonable $350k salary with no equity incentives (and his salary hasn’t increased since 2012). He owns 450,000 shares that are currently worth just under $1 million. Total management compensation was a very reasonable 9% of operating income in 2015. There hasn’t been any new stock option plans implemented since Edmond took over and it’s been years since shares have been issued. There are currently no options, warrants, or preferred stock outstanding. Edmond also got rid of the automobile reimbursement and club membership that the former CEO, William Armanino, allowed for himself. In 2011, the company took out a $2 million dollar line of credit and used it to repurchase shares. Given what the company has achieved since then, that was a great decision that’s created value for shareholders. That line of credit will be fully paid off in early 2017. The only knock against Edmond is that he’s 75 years old. If he dies or retires, he could get replaced by a less shareholder friendly CEO and/or a worse capital allocator.

Valuation

To show the potential of Armanino’s stock price, I want to walk through a relatively simple process to get to a much higher stock price at yearend 2017. I think the market is underestimating how much cash this company is going to generate in 2017 and beyond. Cash flow is currently depressed because of increased capex and paying off a line of a credit, but both of those will be in the rearview mirror by early 2017.

Armanino achieved 9% revenue growth in 2014 and 10.2% growth in 2015. In 2015, they spent by far the most amount they ever have in one year on capex (both on an absolute and relative basis) and they’ve already announced the second half of 2016 will see another large capex spend. Management has made numerous comments the past 1-2 years that this capex build is to add substantial manufacturing capacity to help meet higher demand. In Q1 2016 they began selling to a new large customer and achieved 10.4% year over year growth for the quarter. If they manage 10% growth both in 2016 and 2017 they’ll be right at $42 million in revenue for the full year 2017. If expenses continue to scale as they have over the years (including Q1 2016), they’d have around $5.5 million in cash by yearend 2017. In the past, management has never let cash levels rise above 13% of revenue (they are consistent dividend payers and sometimes purchase stock as well). If they paid out excess cash above 13% of 2017 revenue, that’d be $4.2 million paid out for 2017 dividends. On 32 million shares, that’s just over $0.13 per share in dividends. At a 3.4% dividend yield (what it is today), that’d equate to a stock price of $3.87 roughly 1.5 years from now. At a 4% dividend yield, that’d equate to a $3.29 stock price. Today the stock is $2.17.

Conclusion

I don’t expect the exact above situation to happen as stated (it never does), but the main point is that right now the company has debt and temporary capex increases that will both be paid off by early 2017. By the end of 2017 there’s a good chance the company has a lot more cash than it has today and they’re going to do something with it. They’ve previously been regular dividend payers (they also increase their dividends on a regular basis) so I think this will be a significant chunk of the cash usage. They could also repurchase shares as they have in the past or let the cash build (which decreases enterprise value, not a bad result) looking for an acquisition or expansion. Edmond Pera has made zero acquisitions since taking over in 2009 (he has discontinued a couple business lines though) so I’m not overly worried about him blowing the extra cash on a stupid acquisition.

This is all mainly contingent on the increased capex during 2015 and 2016 paying off. The recent revenue growth gives me confidence this is already happening. Also, Edmond Pera has generally done what he’s said he’s going to do during his tenure as CEO. He has not once struck me as someone to overpromise and under-deliver. Even if they don’t achieve that revenue growth, there’s a large gap between the current price of $2.17 and that future potential price of $3.87. Slower growth and/or higher capex spend is still very likely to result in the company generating more cash than they currently are and they’ve proven they don’t like to hold a ton of cash on the balance sheet. Finally, I think there’s little risk in a consumer packaged goods company such as Armanino, especially over a relatively short period of time.