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Middleby Is Frying the Shorts

by: Alan Brochstein August 08, 2008 | about stocks: MIDD    

Alan Brochstein

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It was almost a year ago that I first wrote about Middleby (MIDD), when I described the company as "one of the most exciting companies that no one has ever heard of."  As of the close Thursday, the stock has declined about 20% from 62+ to about 50. 

Over the same time-frame, the Russell 2000 fell about 17% and the S&P 500 fell approximately 19%, so the stock has been a modest disappointment (and quite volatile, making an all-time high just shy of 79 in December before plunging to a low of about 39 in July).  Well, on Friday, things are going to most likely change.  Actually, they did in the after-hours Thursday, with several trades at 55, up about 10% from the close.  I think we could see 62 again, perhaps on Friday.

Before I tell you why this stock could end up about 25% on the day, let me share some background for those not familiar with the story.  As I mentioned in the article a year ago, the company sells cooking equipment to restaurants.  A lot of it is mundane, but some is exciting - energy savings, efficiency improvement, trans fat reduction. 

The company has been run for several years by an extremely dynamic and visionary CEO.  It has been very aggressive on the acquisition front, and international growth has been very strong off of an increasingly larger base.  The company's valuation has been signficantly lower than historical norms.  Shorts have been all over this one - 5.6mm shares short as of mid-July.  There is no convertible debt or equity-financed acquisitions pending, so this is a real short.  A huge short - the stock trades like 300k per day and has just 17mm shares outstanding. 

While I think the shorts are quite wrong, I have to admit to being afraid as a long investor myself (as well as having the stock as a member of my Top 20 Model Portfolio).  Here are some of the reasons I believe the shorts have crowded into this one:

  • Macro environment challenging for their clients (restaurants, a lot QSR)
  • Organic growth weak
  • Capital spending can be deferred
  • Stainless Steel prices clobbering the company
  • Estimates coming down sharply
  • Company has heightened integration risks due to large number of deals closed over the past year
  • Balance sheet has deteriorated following acquisitions (and share repurchases)
  • CEO sold a lot of stock at higher prices last year

It looks like the shorts may be wrong on this one.  The company reported a large beat on the top-line, which led to a massive EPS beat:  1.01 compared to .88 consensus.  Integrations seem to be going quite well.  The call is tomorrow, but the tone of the press release was very favorable.

Here are the reasons I expect a stampede:

  • Shorts could cover - if only 20% do, that is over 3X daily volume
  • Longs on the sideline scared by macro environment could get involved now
  • The stock is very inexpensive

The chart below details several valuation metrics:

Midd

Download MIDD.jpg

The 12.4 PE is at a 5-year low.  EV/EBITDA is the lowest it has been in some time and reflects perhaps growth concerns.  Even before today, analysts were looking for 20% EPS growth next year.

Disclosure:  Long MIDD

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This article has 8 comments:

  •  
    Aug 08 11:33 AM
    Man, I didn't realize how many people DON'T follow MIDD. Fantastic earnings and there's only two press articles about it and one blog entry (this one). 35% short is kind of scary, but I'm not too worried. I had hesitated on this one when Jim Jubak put it in his picks, then watched over the following weeks when it climbed to near 80. Then it came back down as everyone thought "oh, we're in a recession so restaurants are going to suffer, thus Middleby will suffer". I got it for 52 back in June when it came back down, and am I glad I got a second shot at it at a bargain-basement price. Even with today's +10% its still a bargain. I think the shorts are going to get burned on this one. MIDD is solid in its industry, and the fact that they have had 11 positive surprises out of the last 14 quarters would make me think twice about shorting them.
    Reply
  •  
    Aug 08 12:04 PM
    The leader of this company is a tiger. He is priceless and will continue to lead this company to more profits no matter the environment. It is amazing the short interest, more amazingly is how the shorts continue to bet against him in the face of his success.
    Reply
  •  
    Aug 08 12:28 PM
    Anyone who was shorting when it neared $80 definitely made money on the slide down to $50. But that ride is over.
    Reply
  •  
    Aug 08 12:41 PM
    Thanks for your comments, guys. I was half asleep when I posted this last night and literally just quit writing. I should have shared my views about valuation, as this is really a long-term call and not just a short-term short-buster play.

    I think that the stock is worth $70 today based upon 16X 2009. More importantly, I expect that the mutiple can increase to 18X next year and expect 2010 EPS to be in excess of $5, perhaps $5.50. The call today went well and reinforced my very favorable views on the strategies and leadership of the company. I actually bought some more stock before and after the call.
    Reply
  •  
    Aug 08 12:42 PM
    It was bloated at 80, I don't know if it would be now. This is a solid long term play and will keep adding on weakness.
    Reply
  •  
    Aug 08 03:56 PM
    I agree. This stock has plenty of gas left.
    Reply
  •  
    Aug 14 06:14 AM
    The stock didn't quite make it (yet) to the level I envisioned, but it remains above the close. A few days after the earnings release, the company announced its second largest acquisition attempt ever and the largest one should it close as is likely (Enodis was the large one that failed). The target, OVEN, has been controversial to say the least. The company's products are highly regarded, but it has a history of an inability to show profits.

    MIDD is paying a little under 2X sales, which some have viewed as expensive. I tend to look at Enterprise Value rather than just the equity portion, and one quickly realizes that the lack of debt at OVEN leaves this as a discount to MIDD on this basis. MIDD believes that they can take enough costs out of the business that a $7mm EBITDA loss over the last 12 months would be a $21mm profit.

    This is right up MIDD's alley, as they have a long history of successful acquisitions and integrations. OVEN, as Selim says, has "paid the price" to get into some large customers. The products are highly regarded and complementary to those of MIDD. There is little doubt in my mind that MIDD will do a better job than OVEN did with the same assets. MIDD didn't need to do the deal and doesn't do bad deals. I have heard the CEO speak of OVEN on a past call as having products aligned with

    Did they overpay? Given how hot the M&A area is for this industry, the company risked waiting in my opinion. I look at the price similar to the way I look at a young pharmaceutical company - this deal is very similar. The best analogy is that OVEN was like a company that had received FDA approval but was just a one-trick pony. Imagine that they had an allergy drug, but their salespeople could only sell that allergy drug. Along comes SGP, with a stable of allergy drugs and other medicines that it markets to doctors and buys the company. Alas, sales take off. SGP incurs much lower overhead than the small pharma company alone incurred in selling the drug. This is likely the same story here. Yes, just looking at profitability certainly makes it look like a risky deal, since OVEN wasn't making money. Even looking at sales can make one question the value. At the end of the day, though, this is an asset purchase, not an operating company buy. I expect the market to figure this out rather quickly.
    Reply
  •  
    Aug 14 06:16 AM
    whoops - a strange truncation above - should read "aligned with the vision of MIDD to deliver innovative products that reduce energy usage or increase the speed of cooking."
    Reply
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