The frozen food aisle is heating up.
Once a sleepy, no-growth corner of the market, frozen food sales have been a bright spot lately for several beleaguered consumer packaged food companies. The trend toward convenience and improved product offerings began several years ago, but the pandemic pushed the segment into high gear.
Nomad Foods (NOMD) represents a pure-play on frozen food. Formed as an acquisition vehicle by a consortium of high-powered investors, Nomad’s stated purpose is to consolidate the fractured frozen food industry in Europe. With its large cash war chest, sensible bolt-on approach to acquisitions, and secular tailwinds, Nomad seems on track to achieve its goals.
Source: Nomad Foods/BirdsEye
Management and Background
For many investors, a bet on Nomad is really a bet on billionaire hedge fund manager Noam Gottesman and British business executive Sir Martin Franklin, who together formed the company in 2014. The buyouts started in 2015, when Nomad acquired Iglo and Findus. The company went public the next year. In 2018 Nomad added the Goodfellas pizza and Aunt Bessie’s brands to its portfolio.
Collectively the founders, who share the chairman role, and CEO Stéfan Descheemaeker, a veteran food and retail executive, own 12 percent of the shares. Franklin is well-known as one of the world’s great capital allocators, with a long track record of success in creating value for owners. Along with Warren Kanders, Franklin founded Benson Eyecare in 1992, later selling the company to French optics giant Essilor for a 23-fold return. Franklin went on to co-found Jarden Corporation in 2001, which generated a 30 percent annual CAGR under his tenure as chairman until it was sold to Newell Brands (NWL).
Despite Franklin’s history of deal-making, many investors reacted with skepticism at news of the Nomad venture. At the time, frozen food sales in Europe had been slipping over the previous five years. As one critic described the business model to the Financial Times, “it is one shrinking top-line company buying another shrinking top-line company, believing that it can use cheap debt to make the numbers work.” It seemed unclear why Franklin and Gottesman were seeing value where other investors saw a money pit.
Tailwinds and the Pandemic
As it turned out, Franklin and Gottesman were ahead of the curve. Nomad certainly hasn’t been a case of a shrinking top-line company. Frozen food was staging a comeback even before the pandemic; in 2018, the U.S. frozen food industry grew 2.6 percent as consumers reacted positively to improved product offerings and moved more toward convenience. That same year, Conagra Brands (CAG) acquired Pinnacle Foods in what was widely interpreted as a bet on frozen food.
The pandemic put frozen food’s renaissance into overdrive. According to the American Frozen Food Institute, sales nearly doubled in the initial weeks of the lockdown. Throughout March and April, sales were up 30 percent from 2019. In the first quarter of 2020, Nomad’s sales rose 10.5 percent over the prior year to €683 million.
Although the pandemic won’t last forever, the overall positive trend is projected to hold for years to come. Freedonia Focus Reports estimates that the category will grow at 2.4 percent annually in the U.S. through 2024. The British Frozen Foods Federation found that younger consumers are gravitating toward frozen, with 40 percent of 18-24 year-olds stocking up on frozen variants of vegetables, fruit, meat, and fish.
Bolt-On Strategy and Performance
As regular readers know, I’m no fan of mergers and acquisitions. Studies have shown consistently that M&A destroys value; the promised “synergies” almost always prove a figment of management’s imagination.
But as I outlined in my article “An M&A Strategy That Builds Competitive Advantage And Outperforms,” this isn’t always the case. A select few companies have produced monster returns by making many small, bolt-on deals over a long period of time. Although one deal might not move the needle much, over time a company can produce enormous economies of scale and dominate an industry.
Nomad’s express goal is to be the “consolidator of choice within the frozen food industry and beyond,” as stated on its website. With a war chest of €1 billion, the company is well-positioned to make more acquisitions and return capital to shareholders. Although not a fast-growing business, frozen food remains incredibly cash-generative. During the first six months of 2020, Nomad raked in €243 million of free cash flow. Management also announced its intention to repurchase €500 million of Nomad’s shares, explaining that there weren’t any deals available at attractive prices.
As of the latest quarter, Nomad has defied the critics to notch 14 consecutive quarters of organic sales growth. Organic sales surged 12.3 percent, and gross margins expanded to 30.3 percent. Descheemaeker highlighted the successful rollout of Nomad’s plant-based Green Cuisine brand, which he expects to grow to €100 million by 2022.
Over the last three years, Nomad has compounded earnings at approximately 10 percent annually, growing net income from €164 million in 2017 to €219 million TTM. During the same period, sales grew at a 5.5 percent CAGR. In 2019, the company achieved a 7 percent return on equity.
When Nomad went public, Franklin articulated a lofty vision of the company’s future. “Nomad will not just be a frozen food company,” Franklin told FT. “This is our Trojan horse into the retailers…with brands that people like.” Since then the company has dialed back its ambitions, instead focusing on the frozen food space and returning capital to shareholders amid premium pricing for acquisitions.
At 22 times earnings, the stock seems richly valued for an industry that’s projected to grow at 2.5 percent a year in the U.S. Even with continued 10 percent annual growth, it would take 12 years to break even on the investment, and there isn’t much reason to expect that growth will accelerate from here.
Still, Nomad is probably a safer and better value proposition than the stock market as a whole. Since Nomad’s IPO, the stock has slightly overperformed the market average, with a 105 percent total gain against the S&P 500’s 82 percent rise. The company is a solid bet on a stable, cash-rich industry that isn’t going anywhere. Management is taking a prudent approach toward acquisitions, apparently passing on a number of deals due to high costs and instead returning capital to shareholders. Because of these factors, I find it credible that the company will continue to outperform.
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.