E-Commerce has taken the world by storm and has disrupted many industries. However, one industry, in particular, is often overlooked that we believe has tremendous online potential – the grocery industry. In particular, we like the Canadian company Goodfood Market Corp. (OTC:GDDFF) due to its measurable competitive advantage over the traditional brick and mortar stores. Goodfood will most likely continue to see strong growth in the years to come thanks to its strong brand loyalty, operational excellence, and the ongoing shift in consumer trends.
Overview of the Business
Goodfood Market Corp. is a provider of online subscription meal kits and private-label groceries. Currently, the company has over 300 private label items to choose from as well as 6 meal plans with 35 meals to choose from. Goodfood does a great job of regularly changing up the ingredients and recipes which makes it almost impossible to get bored with their offerings. This also allows the consumer to try new recipes that they would’ve never thought of on their own. Most important of all, as Goodfood customers ourselves, we can attest that the food is fresh and tastes delicious.
The high quality of their offerings combined with the added convenience has allowed the company to generate 91% of their gross merchandise sales from recurring orders. This does not surprise us because the way we came across Goodfood was through word of mouth from a friend of ours who absolutely loved it. Inevitably, we couldn’t help but spread the word too once we became customers. Therefore, it is safe to say that brand loyalty is very strong.
We believe management is competent with the track record to prove it. Goodfood was founded in 2014 and since then has managed to grow its subscription base to 280,000 and capture a 40-45% share of the home meal solution category in Canada. In 2016, revenue was only $2.8 million whereas it was almost $247 million in the last 12 months. They managed to achieve this explosive growth while improving gross margins and EBITDA margins:
(Source: investor presentation)
Please note: GoodFood reports in Canadian Dollars
In addition, the company has reduced its SG&A costs as a percentage of revenue from 37.2% in 2017 to 29.4% in the last 12 months. This combination has enabled the company to generate positive free cash flow in Q2 2020.
Industry Overview and Positioning
Prior to COVID-19, the online grocery industry was expected to see fast growth. In 2018, it was estimated that the Canadian market would grow from $1-$1.5 billion to $3-$3.5 billion in 2023, implying a CAGR of 21%. However, the current market size has now ballooned to $6 billion due to the pandemic. Thus, more than 5 years’ worth of growth has been accelerated. Currently, Goodfood controls 40-45% of the market with HelloFresh SE (OTCPK:HLFFF) being the largest competitor at approximately 50%.
GoodFood also owns Yumm.ca, which was launched in May of 2019. The purpose of Yumm.ca is to offer a cheaper and more convenient meal kit alternative to what they offer through their GoodFood brand. Yumm.ca is the cheapest meal kit option in Canada starting at $6.99 per serving, and the convenience comes from there being fewer ingredients than GoodFood meal kits. This is a positive because it will attract customers of lower incomes that may not be able to pay $9.28 per serving (minimum), and people who want simpler cooking options with fewer ingredients.
What we like about the grocery industry is that it is essential, making it resilient to economic shocks. It is reasonable to assume that the industry will continue to grow as long as the inflation of food prices exists. However, it is also very competitive with lower margins compared to others such as tech. Therefore, it is crucial that operations are efficient. This is where Goodfood’s competitive advantage lies.
Grocery store giants such as Loblaws Companies Limited (OTCPK:LBLCF), Metro Inc (OTCPK:MTRAF), and Empire Company Limited (OTCPK:EMLAF) have thousands of stores across Canada. This gives those companies the advantage of strong brand recognition. It also means that they are able to reach the vast majority of the Canadian population. However, Goodfood is able to efficiently reach 95% of the entire Canadian population with only 6 facilities. This means less money is spent on maintenance CAPEX as a percentage of revenues.
Using depreciation and amortization as a proxy for maintenance CAPEX, we can see that Goodfood and its direct competitor HelloFresh have the lowest maintenance requirements as a percentage of revenue. This is a strong competitive advantage because even though the giants will inevitably place more focus on the e-commerce segment, they still have to maintain their existing stores. As a result, it will be much harder to bring down their maintenance CAPEX to the level of the online pure plays, especially as Goodfood and HelloFresh begin to mature and realize more efficiencies.
Another way to measure the company’s competitive advantage is by comparing the cash conversion cycles.
The formula is as follows
CCC = DIO + DSO − DPO
DIO=Days of inventory outstanding
DSO=Days sales outstanding
DPO=Days payables outstanding
The cash conversion cycle measures how long a firm will be deprived of cash if it increases its investment in inventory in order to expand customer sales. The lower the cash conversion cycle, the better. As we can see, Goodfood’s CCC is negative which means that cash is not tied up at all into inventory. This is because they order inventory after orders have been placed for the week which results in quick inventory turnover. In addition, they convert their receivables into cash very quickly (DSO) and then decide to pay their suppliers after 43 days on average. It is worth noting that Goodfood actually has 90 days to pay its suppliers without any penalties. This is significant operating leverage over the brick and mortar stores that allows the company to use its cash for growth initiatives instead.
(Source: investor presentation)
Another advantage of their just in time inventory is that it greatly reduces food waste. Not only is this environmentally friendlier, but it also helps boost margins. The brick and mortar stores have to order their inventory in advance in order to stock their shelves. Given that food spoils fairly quickly, it is inevitable that a decent amount of it will have to be thrown out throughout the year when it’s not sold.
Now, there are some advantages for the stores. For example, Loblaws has partnered with Instacart which allows for online orders without having to invest in the infrastructure. Instacart is basically the Uber Eats of grocery shopping. You place an order, an Instacart contractor receives the order, does the grocery shopping for you, and then delivers it to your door. Although this sounds like a great way to play the online grocery market, we believe there are some huge drawbacks. To begin with, the orders are fulfilled by random people which Loblaws has no control over. If the worker is not great at picking fresh fruit/produce to the satisfaction of the customer, the customer will feel ripped off. We have actually heard people complain about this very issue which has led them to have the perception that the stores are just trying to get rid of their expiring products through their online platform. Another big drawback is that on busy days, the Instacart contractors are usually working on multiple orders at once. Since the workers drive around in their regular everyday car, this can be an issue for those who order frozen foods. We have heard friends complaining about their orders taking too long to arrive. This resulted in the frozen food being completely thawed by the time they received the order.
Goodfood on the other hand is in complete control of product delivery. The food is stored in an insulated box and transported in the appropriate vehicles. Moreover, their food is sourced directly from farmers which means that the products are very fresh, thus reducing the risk of the customer feeling ripped off.
Goodfood has turned out to be a COVID-19 winner in 2020. We believe that the increased demand for Goodfood and the industry is here to stay.
(Source: investor presentation, data from RBC Capital Markets Equity Research)
As you can see, 54% of the people surveyed claim that their willingness to purchase groceries online has been permanently increased, with 22% still unsure. However, there is no reason to doubt that the unsure category won’t eventually be swayed to increase their online spending. As the second question demonstrates, the willingness for online shoppers to continue purchasing has been trending higher since 2015. We believe that combining this trend with Goodfood’s 40% market share and first-mover advantage will allow the company to better capture new customers as the industry grows.
Furthermore, Goodfood’s investment in automation and lower cost structure will help shield them from the giants. What we mean is that even if the larger players do eventually take market share away from Goodfood, the company’s stronger margins will allow it to achieve better growth relative to its competitors. Moreover, losing market share in a fast-growing market isn’t the end of the world, especially when the starting point is between 40-45%. For example, a 30% share of a market that can easily double still translates into strong revenue growth. However, we don’t believe that competitors will have an easy time capturing market share from Goodfood because its lower cost structure will eventually translate into savings for the customers. As we have seen in other industries, it’s only a matter of time before online prices become cheaper than in-store prices.
Lastly, the company has a service called Goodfood WOW. With this service, customers can order meals or groceries any day of the week and receive their food either on the same day (orders before 11:30 am) or the next day. With Goodfood WOW, the company can compete with services such as Instacart in terms of speed while at the same time having full control of the product’s delivery. This service comes with a fee of $9.99 per month and a minimum order of $35 to avoid shipping fees. The company also claims that they can offer products up 15% cheaper than national grocery chains by partnering with local farms and businesses. We believe that Goodfood WOW is a fantastic solution for people who are busy, looking for cheaper alternatives, or that simply want the convenience.
Goodfood has yet to generate a full year of earnings or free cash flow. Thus to value what the company is worth today, we will use relative valuation. Specifically, we will use the price to sales ratio. Goodfood will be releasing its fourth-quarter results in November. Luckily, Goodfood has already announced that its subscriber count at quarter’s end was 280,000. This will help us estimate the company’s revenue for the quarter.
First, we need to estimate what Goodfood’s revenue per subscriber might be. Given that the company is seasonal, revenue per subscriber is typically lower in Q4 than in the first three. Let’s start by looking at the historical revenue per subscriber broken down into each quarter:
As we can see, 2019 revenue per customer was lower than in 2018 for all quarters, whereas 2020 was higher than in 2019 but lower than in 2018.
The exception is Q3 which is the only one that got a boost from COVID-19 resulting in an increase of ~20% from 2019.
Since the pandemic has not gone away, we will assume that Q4 will also get a boost. However, it will be to a lesser extent because it’s historically a slower quarter and COVID-19 cases had been less severe.
Instead of 20%, we will assume 10% to bring the estimated revenue per subscriber up to $248.60 from $226.50.
Q4: 280,000 × $248.60 = $69,608,000
We believe that multiples within a range of 1.75 and 2 are reasonable for Goodfood.
Therefore, the fair value for the stock today is:
If you use the current USD/CAD exchange rate of about 1.33, GoodFood Market Corp is worth anywhere from $5.50-6.29 USD.
We would like to clarify that we believe the stock will be a great long-term success that will climb much higher than our price range. However, due to the fact that COVID-19 has significantly boosted this year’s revenues, as well as the ongoing uncertainty, we don’t think that trying to forecast revenue beyond the next quarter will yield useful results. Therefore, what we are presenting is what we believe to be a fair entry range for the stock based on all the information given today. We would also like to note that both the analyst consensus price target for the company along with its 52-week high are above C$9 per share.
Competition: There are low barriers to entry in the food business which is why there are already so many competitors for Goodfood, and the amount of competition will almost surely keep rising as it has been. It is hard to differentiate yourself in the meal kit industry as the business idea is simple; deliver ingredients to people’s doors. There are many companies doing the same thing which can have consumers scratching their heads when deciding which is the best meal kit service. As a result, there is a big emphasis on branding to win over customers, which results in high marketing costs. A meal kit service that is unable to keep its customers happy can have catastrophic results such as when Blue Apron lost 24% of its subscriber base in Q2 of 2018.
Another competition risk is non-subscription-based meal kits. Recently, Chick-fil-A entered the meal kit industry, but they do it a bit differently by not having a subscription service. This is convenient for customers as they can order a meal kit without having to commit to or adjust any future delivery schedules. While Chick-fil-A’s meal kit is still very limited, the real danger could be other big restaurants copying this idea, creating even more competition for subscription-based meal kits.
So far, Goodfood has done a good job competing in their industry but it is not guaranteed that they will continue this success. Therefore, it is very crucial for Goodfood to keep marketing themselves effectively.
Debt: Goodfood had positive free cash flow last quarter but has not had a full year of positive FCF yet. If they can’t keep generating positive FCF going forward, they might run the risk of not being able to meet their future debt obligations unless they raise extra capital. In the scenario that they cannot raise extra capital, they will most likely have to cut marketing costs, which would hinder their growth. At the moment, debt is not a major issue as they have about 78 million in cash, which is more than enough to cover their long-term debt of about 56 million.
To measure the risks associated with Goodfood Market, we calculated the downside deviation and downside beta using daily prices of the past year (252 trading days). The daily downside deviation of the stock is 2.232%, which translates to an annualized downside potential of 35.43%. This compares to the daily upside deviation of 3.382% which is 53.69% annualized. The ratio of upside to the downside is 1.51 which is ideal for bulls.
Also, we calculated the upside and downside beta for Goodfood compared to the TSX index (because it is a Canadian company) and compared to the S&P 500 index.
Compared to the TSX index:
Upside beta: 0.078
Downside beta: 0.027
Up/down ratio: 2.89
Compared to the S&P 500:
Upside beta: 0.426
Downside beta: 0.067
Up/down ratio: 6.32
Therefore, in terms of systematic compared to either index, there is more upside correlation during the good times than there is downside during the bad, which is another checkmark for the bulls. There is a low correlation to the overall market, making this a good stock for someone who wants to be less correlated to the major indexes.
E-commerce will overtake the grocery store industry the same way it has overtaken others due to the ability to operate more efficiently than the traditional brick and mortar stores. The Canadian online grocery store market is in its infancy with Goodfood poised to see strong growth going forward. Although HelloFresh is comparable to Goodfood in terms of efficiency and market share, we prefer Goodfood because it is much smaller in market cap which translates into the potential for higher stock price appreciation.
Disclosure: I am/we are long GDDFF. 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.
Additional disclosure: We are long GoodFood’s Canadian ticker (FOOD:TSX) and its convertible debentures (FOOD.DB:TSX).