Middleby Still Simmering

By Stephen D. Simpson, CFA | November 16, 2011 AAA

Wall Street is full of perverse incentives; one of them is that you sometimes find yourself rooting against a company you otherwise like. I would be more than happy to own shares of growing food service equipment supplier Middleby (Nasdaq:MIDD), as I believe the company is taking share with innovative products and has a lot of growth opportunities, as its customers go international. However, I also don't ever like to pay too much for a stock, so it seems that I have to wish for some bad news, to create a bargain opportunity in this name.

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An OK Third Quarter
Middleby did OK in the third quarter, but this stock is not typically priced to reward OK. Revenue rose 23% as reported, and acquisitions were once again a major component of the company's growth. Absent those deals, organic growth was more on the order of 6%. On a business segment basis, commercial food service did it all as revenue rose over 10% and offset the nearly 26% decline in food processing.

Profitability was likewise no better than lukewarm. Gross margin ticked up slightly, while operating income rose 16%. For the quarter, Middleby saw a sizable jump of 38% in sales expenses. (For related reading, see A Look At Corporate Profit Margins.)

A Mix of Who's Who and "Who?"
The nature of the food service business is that these companies serve well-known international chains, like McDonald's (NYSE:MCD) and Yum! Brands (NYSE:YUM), but also rely on a lot of mom-and-pop operators and regional chains. For the most part, a lot of the well-known restaurant chains are doing pretty well, in terms of traffic. What's more, companies like Dunkin' Brands (Nasdaq:DNKN) and Brinker (NYSE:EAT) are active in adding new products and new equipment, and Middleby has built a solid reputation for being able to develop new equipment with specific food applications in mind.

On the other hand, let's not kid ourselves that it's a great market for restaurants, just yet. Plenty of well-known names have declared bankruptcy and the failures of smaller companies has plenty of gently-used equipment on the market.

Still Room to Grow Both Ways
It is worth noting that Middleby's goodwill is almost equal to its shareholders equity. After all, plenty of companies tried to build themselves with acquisition binges, only to prove incapable of growing organically and paying for those deals. There are also companies that have made serial acquisitions and built themselves into enduring market leaders. In other words, a high amount of intangible assets on the balance sheet is a risk factor, but proves absolutely nothing in and of itself ; it's a classic case of correlation versus causation.

Food service is still a highly fragmented industry, both on the food side, where Sysco (NYSE:SYY) is the elephant, and on the equipment side, where Middleby goes up against the likes of Illinois Tool Works (NYSE:ITW), Dover (NYSE:DOV), Manitowoc (NYSE:MTW) and Electrolux, as well as smaller companies, like Standex (NYSE:SXI) and John Bean (NYSE:JBT).

What that means is Middleby has earned enough of a reputation, that companies like Yum and McDonald's trust them and will take them overseas with them. It also means that there is still ample capacity to add products and product categories with selective deals, though Middleby should expect these large rivals to have similar plans.

The Bottom Line
I'd love Middleby at a cheaper price, but I won't chase a company just because it has a compelling growth thesis. It is certainly possible that an eventual economic recovery will boost restaurant foot traffic and lead to a wave of pent-up equipment purchases, but I'm already expecting some of that in my model. With a 10 or 15% sell-off, I'd certainly reconsider this stock, but at this price and valuation it's just a back-burner idea, for me. (For more on valuation, see Equity Valuation In Good Times And Bad.)

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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