Middleby Not On The Value Menu

By Stephen D. Simpson, CFA | August 12, 2012 AAA

I've followed restaurant and food service equipment provider Middleby (Nasdaq:MIDD) for a long time now, and the stock has never been what a value investor would call "cheap." That's unfortunate, as this is an uncommonly interesting growth story in a segment of the market where growth investors don't often go shopping. While I would not chase this stock, I would recommend that investors keep it on a watch list and take advantage if and when a pullback comes around.

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Another Beat, Another Raise
Middleby continues to do well in what remains a difficult restaurant environment. Revenue rose 25% as reported this quarter, though organic growth was more on the order of 5%. Even at that relatively modest growth rate, though, Middleby stacks up well with established rivals like Illinois Tool Works (NYSE:ITW), Dover (NYSE:DOV) and Manitowoc (NYSE:MTW).

Due in part to a mix shift towards more food processing sales, margins suffered. Gross margin dropped about a point from last year, while operating income rose 17% and operating margin also dropped by around one point.

SEE: A Look At Corporate Profit Margins

Waiting For More Deals
Middleby has been a remarkably active acquirer throughout its corporate history, and the company seems to have a winning formula. Middleby typically targets companies with around $20 million in sales, but the company has been less active this year. Middleby bought Turkington, a maker of automated baking equipment, back in March, but has been relatively quiet since then.

Given how many significant technologies the company has bought-in over the years, including its spin fry technology and ventless cooking systems, I doubt that the company is done.

SEE: Biggest Merger And Acquisition Disasters

A Good Mix and a Growing Reputation
All in all, it's hard to describe the restaurant industry as healthy outside of quick service restaurants (QSRs) like McDonald's (NYSE:MCD), Yum Brands (NYSE:YUM) and Wendy's (Nasdaq:WEN). That said, chains seem to be faring better than most, and about 60% of the company's sales come from chain restaurants.

I think this is noteworthy, not only for the relatively greater financial stability of chains, but also as an emerging trend in the industry - more and more chains are announcing menu overhauls and store refurbishments, and that introduces the opportunity for Middleby to sell more new equipment. At the same time, the company is building a reputation as a go-to vendor in many key equipment niches.

SEE: Top 5 Fast Food Value Menu Deals

The Bottom Line
There are a handful of valid objections to the Middleby growth story and valuation. First, it is quite evident that Middleby has bought a lot of its growth. While its organic growth rate still compares well to many established names in the industry, the market does not reward mid-single-digit revenue growth stories with double-digit EBTIDA multiples. Consequently, Middleby must continue to identify and execute on growth-stimulating deals.

Also, the company's acquisitiveness comes at the cost of its balance sheet. Although Middleby's debt is not too worrisome relative to its cash flow, and the company's return on capital suggests debt-funded acquisitions are value-accretive, investors have been burned before by debt-funded acquisition-fueled growth stories.

I'm frankly comfortable with how Middleby runs its business, but I'm less comfortable with today's multiple. The company may well generate low-teens compound free cash flow growth for the next decade, but even that level of growth doesn't support a fair value high enough to make the stock appealing today. Consequently, Middleby remains an interesting stock to own, but not one that I'd buy without a pullback first.

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

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