|Shares Out. (in M):||401||P/E||0||0|
|Market Cap (in $M):||4,329||P/FCF||0||0|
|Net Debt (in $M):||1,223||EBIT||0||0|
|TEV (in $M):||5,552||TEV/EBIT||0||0|
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Gruma is the largest tortilla and corn flower producer in the world with a dominant position in all the regions it operates in. Gruma’s two main operations are Gruma Corp, its US operation representing 55% of c. revenue and 65% of c. operating income; and GIMSA, its Mexican operation representing 28% of c. revenue and 27% of c. operating income; as well as smaller operations in Europe and Central America. Gruma’s impressive growth story has been fueled by the boom of tortilla consumption outside of Mexico as well as pioneering the use of corn flour to produce tortillas in a cheaper and more efficient manner. Allowing the company to double its revenues while growing operating income by 323% over the past 10 years.
Gruma Corp (55% of revenue, 64% of operating income)
Gruma’s US operations (Gruma Corp) are divided into corn flour (20%) and tortilla (80%), with corn flour being produced under the Azteca Milling brand and tortillas through the Mission, Guerrero and Calidad brands. Gruma Corp has a 34% market share of the overall tortillas produced in the US but has a 56% market share of tortillas sold through retail, with General Mills being the second largest player at 15%. Not only is Gruma the largest player but it is the only vertically integrated player who produces its own corn flour while at same time Azteca Milling supplies corn flour to 85% of the market, this gives Gruma a superior cost structure and relative pricing power.
Gruma Corp will enjoy a significant demographic tailwind with Hispanic Population in the US expected to grow 62% by 2050 representing more than 1/3 of the entire population according to Statista. Not only is the Hispanic population growing at a faster pace than any other, but the rest of the US population is becoming more and more inclined to incorporate tortillas as a part of their regular diet (breakfast burritos, wraps, tacos, etc.). The boom of Mexican food over the past 10-20 years has been impressive, Mexican restaurant food chains like Chipotle and Taco Bell have grown at impressive rates, Chipotle tripled its total restaurants over the past 10 years, while growing revenues by 267%. All these restaurants use corn and flour tortillas as one of their primary ingredients, this trend is expected to continue into the future and will help boost and sustain Gruma’s long term growth.
In the most recent quarter (2Q20) Gruma Corp managed to increase its volumes by 5% and its revenues by 14%, while maintaining its operating margin at 14.7% despite the additional Covid-19 related costs (MXN 370 million at company level). Excluding the additional incurred cost due to Covid-19, Gruma Corp’s operating margin would have been 16.2%, 151 basis point higher than last year. The company attributes this to a better sales mix between channels, with retail, the higher margin side of the business, representing a larger share than foodservice, and a better mix within retail towards higher priced SKUs. Management made a strong point during its earnings call that this trend is here to stay and that people in the US, of all ethnicities, are becoming accustomed to consume tortillas in the household as part of their regular diets, as opposed to just consuming tortillas when going out to Mexican restaurants (serviced by Gruma through the foodservice channel). On average Americans consume 1.7 tortillas a day, this is still significantly below the 6 tortillas consumed daily in Mexico, this leaves a lot of room to grow for US tortilla consumption. This trend of shifting tortilla consumption to the household will help maintain Gruma Corp’s higher margins in the long run.
GIMSA (28% of revenue, 27% of operating income)
GIMSA is the leading corn flower producer in Mexico with a 75% market share under the MASECA brand, followed by MINSA with a 20% market share. Using corn flour to produce tortillas was pioneered in 1949 by GRUMA’s founder Roberto Gonzalez Barrera, since the corn flour method has transformed the tortilla industry. Corn flour allows for tortillas to be produced industrially at a much faster and cheaper pace. Despite this, corn flour is only used to produce 35% of tortillas in Mexico, thus the potential for additional conversion to this method offers GRUMA attractive potential for consistent and gradual growth.
GIMSA’s biggest competition are local tortilla shops who use the traditional method to make tortillas directly from corn. Both methods use corn as their primary input, creating a favorable situation for GIMSA in the case of fluctuations in the price of corn. When corn prices are high GIMSA’s corn flower becomes more attractive than the traditional method while at the same time passing through some of the price increase to its clients, pushing both GIMSA’s volumes and revenues higher while putting downward pressures on the margin given the higher cost of production. On the other hand, when corn prices are low, GIMSA loses some of its volumes and revenue to the traditional method but can sell its product at a much higher margin. This puts MINSA in a win-win situation where no matter the cost of corn the company’s operating income never falls.
This dynamic can be better observed in the graphs above. Between 2010 and 2012 the average price of corn was high, at $6.20 dollars per bushel, driving the company’s margins lower to an average of 13.5% largely offset by the higher volumes and revenue operating income still grew. Opposingly between 2013 and 2015 corn prices fell to an average of $3.50 per bushel driving the company’s margins significantly higher to an average of 18.0% somewhat offset by the loss in revenue and volumes, the company’s operating income grew from MXN 2,095 million to MXN 2,765 million.
Not only is the competitive landscape for GIMSA very favorable but the demand for its product is incredibly defensive and stable. Tortillas are an essential part of Mexican culture and its rich gastronomic tradition:
· 99% of Mexicans consume tortillas
· 68% of Mexicans consume tortillas every day
· An average Mexican consumes 90kg of tortillas a year, equivalent to 5-6 tortillas every day
High Quality Asset Trading at an Attractive Valuation
Given its dominant position in a secularly growing industry which is very defensive by nature. Gruma is able to generate superior returns on capital employed and higher margins than the rest of the Mexican food space.
We find Gruma’s valuation to be extremely attractive. Gruma trades at 8.9x EV/EBITDA against its 5 year average of 10.5x; and at P/BV of 3.5x against its 5 year average of 4.3x. While its US peers trade and average of 15x EBITDA. Gruma Corp is 100% US based and as the largest part of Gruma’s business should warrant a valuation similar to what it US peers trade at, we find the 40% discount to be extremely overdone.
FCF Ramp Up
After an intensive Capex period between 2016 and 2018 spending an average of 4,700 million pesos per year, the company lowered its capital expenditure levels to 1,765 million pesos in 2019. Improving FCF generation from 3,740 million pesos in 2018 to 5,900 million pesos in 2019. This has allowed the company to buy back 7,000 million pesos since it started buying back shares in 2018, reducing its share count by 8%. Looking forward the low amount spent on capital expenditures in 2019 is not sustainable, instead the company expects to spend an average of 4 billion pesos a year over the next 5 years, leading to an expected FCF ramp up of 5.5 billion pesos in 2020 (5.6% yield) to 7.5 billion in 2025 (7.6% yield)
The bulk of our thesis lies in Gruma Corp, a 100% US operation with secular growth trends, high margins, important competitive advantages, and highly defensive nature being significantly undervalued relative to the rest of the food space in the US. Its valuation being highly punished just for being part of a Mexican holding company where overall valuations are much lower. The average packaged foods company in the US trades at a 15x average EV/EBITDA multiple while Gruma trades at 8.3x 2020 estimated EBITDA.
Doing a simple valuation exercise extracting the potential value of Gruma Corp from Gruma’s current market cap, we see that Gruma’s US operations would have to be valued at 12.3x EV/EBITDA, still an unjustified 18% discount to its average peer group in the US, for you to get the rest of Gruma’s operation (Mexico, Europe and Central America), which make up 36% of the company’s earnings, completely free.
Using a SOTP model to reach a fair value price for Gruma applying what we consider conservative multiples for each of Gruma’s businesses (slight discount to the industry average of each region) we reach a target price of $344.76, implying a 43% upside to today’s market price.
Million MXN (except share price)
· Sustaining margin expansion in the US over a couple of quarters, proving it was not a one-off benefit from the lockdown will lead to a multiple rerating of the stock
· Continue beating analyst growth expectations over the next few quarters, thanks to favorable trends in tortilla consumption outside of Mexico
· Declining Capex beyond 2020 will lead to greater FCF generation
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