Chefs’ Warehouse (NASDAQ:CHEF) is a company that distributes specialty foods to various customers including fine dining restaurants, hotels, and culinary schools. Products in scope include custom cut beef, artisan charcuterie, cheeses, seafood, and raw ingredients such as oil and flour. The company works with over 2,200 suppliers and serves approximately 34,000 customers.
The company was hit very hard by COVID, considering that a majority of its customers were not operating at some point in the past calendar year. Moreover, many industries that the company serves did not benefit as much from lockdowns as quick-service restaurants. As a result, the company’s stock lost almost all its value during the March crash. However, the stock has gone up 8x since then and has trended upwards consistently in the past few months. We hold a bearish view of the company considering that growth strategies may not work for many years to come, and the company’s balance sheet isn’t optimal for another round of acquisitions.
(Chefs’ Warehouse Stock Market Chart, 2020)
The company’s growth strategies will be affected by macroeconomic trends
The company’s number one growth strategy is to “increase penetration with existing customers (Chefs’ Warehouse 10-K, 2020).” In other words, the company hopes to increase recurring revenue per customer by deploying internal sales professionals to work closely with members of the customers’ teams. This way, the company is able to learn first-hand what kind of new products that customers are looking for.
We do not believe that this strategy will work in the next few years because of the impacts created from COVID-19. Many restaurants have not reached pre-COVID sales levels, and this is a feat that may not be achieved until next summer if the vaccine is effective. Therefore, increased customer ordering through Chefs’ Warehouse is highly unlikely, no matter how good the company’s sales professionals are.
Moreover, we believe that one reason why restaurants order a variety of foods is to experiment with new menu items or create limited-time menu offerings. This will naturally increase the size of the order. However, during a time where restaurants are struggling to make ends meet, it might not be the ideal time to be experimenting with new items. Customers may also under-stock rather than the opposite to reduce food-wastage costs for the medium-term. This is because “4 to 10 percent of food purchased by restaurants is wasted before reaching the consumer,” and cost-cutting initiatives will surely target an unnecessary waste of resources.
The company’s second growth strategy is to “expand our customer base within our existing markets (Chefs’ Warehouse 10-K, 2020).” We believe this will be incredibly hard in the next few years because of the specific markets that the company operates in. The company’s primary markets include: “New York, Washington, D.C., Los Angeles, San Francisco, Las Vegas, Miami, Portland, Columbus, Cincinnati, Chicago, Vancouver, Edmonton, Toronto, Seattle, Sacramento and Texas (Chefs’ Warehouse 10-K, 2020).”
All of these cities are highly-dense and restaurants within these areas are heavily dependent on business travel traffic, and tourist traffic. We believe that permanent changes in corporate culture, especially the fact that workers can now work remotely, will reduce corporate spending, especially for fine-dining restaurants. This effect will be highly material on these restaurants and Chefs’ Warehouse because fine-dining restaurants primarily target individuals with prestigious jobs. Moreover, given that the company already serves over 34,000 different locations, we are unsure of truly how much growth there is left to do especially in the primary markets.
Global consultancy McKinsey estimates that it may take fine dining 4 whole years to recover, which doesn’t serve well for either of Chefs’ Warehouse’s strategies.
Earnings Estimates convey a ridiculous forward P/E Ratio
(Seeking Alpha Earnings Estimates)
We understand that the company has seen impressive growth in net income and revenue in the last 5 years, but given the potential stagnancy in certain food industries for the next 5 years, it is a bit outrageous to justify a forward P/E ratio of 60.44x.
An EPS estimate of 0.41 in fiscal year 2022 would mean that earnings levels would have to return to pre-COVID figures, which may be a tough task especially if there is no organic growth for the company. We believe that an EPS performance closer to the low estimates of 0.25 is much more likely, especially considering that there is a pending recession.
The company’s growth has been fueled by acquisitions, and balance sheet health may hamper future M&A activity
The company states that “a significant portion of our future growth is dependent upon ability […] to penetrate new markets through acquisitions (Chefs’ Warehouse 10-K, 2020).”
We believe that the company’s interest expenses will be a burden for the foreseeable future as quarterly interest expenses have hovered around $20 million, and operating income was $57 million at its peak in 2019, and obviously, the company hasn’t come close to that figure since the pandemic started. In the most recent quarter, the company posted a net income of negative $35 million despite revenues growing 26% quarter-over-quarter. The company’s liabilities/assets ratio is 68% which is pretty healthy ($725 million vs. $1.06 billion), but net goodwill accounts for around 20% of total assets, and intangible assets account for 33% of total assets. The company’s inventory balance of $124 million may also be subject to write-down considering that food is highly perishable.
Therefore, the company will need to raise debt to fund acquisitions, and in this particular economic environment, it may be tough to realize the benefits of an acquisition given that acquired companies may not be prospering either. We expect to see organic revenue growth to increase at a single-digit pace at best for the next few years.
The company’s growth story is still impressive, and the management team has plenty of experience to point the company in the right direction
The company’s management team has a “collective experience of more than 90 years at The Chefs’ Warehouse, its predecessor and other foodservice distribution companies, our founders and senior management are experienced operators and are passionate about our future (Chefs’ Warehouse 10-K, 2020).” Therefore, despite pessimistic economic conditions, the company may come up with new strategies to increase earnings and revenue.
In summation, the fact that the company operates in a competitive industry, combined with the fact that fine dining may take years to recover, forces us to hold a bearish view of the company. We are unsure of how the company’s two main strategies would work, especially in this particular economic environment, and other strategies including cutting prices would only lower profits. Finally, the forward P/E ratio is quite high based on historical averages and overall uncertainty.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.