Description

MGP Ingredients

Investment Merits:

We believe that the current market price of MGPI offers an attractive entry-point to the patient investor with a multi-year time horizon. Factors include:

• Favorable macro trends in the alcoholic beverage industry where MGP is ideally set up to have an advantage.

• A proven management team under the guidance of a strong and experienced board has already created value by significantly improving margin years ahead of the original plan.

• A strong balance sheet with low leverage that will help as management transforms the business from commodity-like to high returns on capital business.

Background:

Despite the name, MGP Ingredients is a leading supplier of premium American whiskeys, distilled gin, and vodkas; specialty wheat proteins and starches; industrial alcohols found in cosmetics, vinegar, and sanitizers; as well as fuel.  The company manufactures its products from two facilities – Lawrenceburg, Indiana and Atchison, Kansas.  It holds a 30% non-operational ownership in Illinois Corn Products (ICP JV) which produces low margin commodity alcohol products that go in food and fuel applications.

Favorable Macro Trends:

MGP derives 83.4% of its revenues from the distilled products segment (alcohol beverages and industrial alcohols) and the rest from its ingredient solutions segment (food additives).  Given below are some favorable macro trends working in MGP’s favor:

• Although whiskey consumption was over 100MM cases in 1970, it dropped over 50% by 2000, despite a US population growth of around 50% (Figure 1).  Since 2009, however, whiskey has since regained some of its lost shares from other alcohol beverages (Figure 2).   MGP’s Lawrenceburg is the largest independent distiller in the US, and production of whiskey dominates in this location.    

• Specifically, within the distilled spirits category, bourbon whiskey is growing at a higher rate –squarely in MGP’s territory.  The chart in Figure 3 shows its growth since 2002.

• About 70% of rye-based whiskey is produced in US is from the Lawrenceburg facility.  Since 2009, this category has recorded a 41% annual growth (Figure 4).

• Grain neutral spirits (vodka, gin) are growing at a lower rate. Both facilities of the company participate here, representing around 35% of the overall US market share for gin and 25% for vodka (Figure 5).

• MGP’s legacy ‘Ingredient solutions’ segment participates in the following trends: non-GMO, high dietary fiber, protein, and plant-based proteins.  Ingredient solution is a low margin business, and it contributes about 18% of the company’s revenues and an even lesser amount to its bottom line.

Figure 1:  US Consumption Whiskey vs Non-Whiskey (1970-2000) Source: DISCUS.org

Figure 2:  Whiskey (12-bottle) Case Growth Since 2009, Source: DISCUS.org

Figure 3: American Whiskey Demand, Source: DISCUS.org

Figure 4: Rye Whiskey, CAGR - 41%, Data from DISCUS.org

MGP is a major player in Vodka/Gin (White goods). It maintains a significant market share as seen in the company’s presentation below:

Figure 5:  MGP's Share of US Alcohol Beverage Production

Strategy and Improved Execution

After a prolonged proxy fight, the company replaced its top management and board.  Management over the past decade wavered in its strategy and did not seem have a strong grip on the products MGP planned to focus on. All this changed upon the arrival of the company’s first non-engineer CEO, Gus Griffin.  He is a two-decade veteran at Brown Forman, and he managed their Jack Daniels brand globally.  He has a solid knowledge of beverage alcohols, and in our view, he is perfectly suited to execute the strategy.  His goals are as follows: a) maximize the value of MGP’s production by focusing on value vs volume, b) capture a larger share of the value within the value chain, c) invest for growth, d) manage risks better, especially commodity inputs, and e) build MGP’s brand.  Listed below are a few accomplishments due to the efforts undertaken by the new management.

• MGP’s execution of its strategy helped the company improve its margins by achieving five year targets per the original plan of growing the operating margin by 4x in just over one year.  

• The company grew its ‘barreled distillate’ inventory of aged whiskey significantly, the results of which will be evident on the P&L in future years.  Figure 6 graphs the growth in MGP’s aged whiskey inventory.  As shown in the illustration, the value of aged whiskey increased over 3x in past six quarters.  Aged inventory can potentially be sold for at least 3x the value recorded on the balance sheet.

• MGP re-entered the branded space after a two-decade absence by introducing two of its own brands: Metze Select Rye Whiskey and Till Vodka.  Market reception to the reentry was encouraging and, in management’s words, ‘beyond our wildest expectations’.  The reception from the media and industry organizations was good.

• In order to tap into the increased demand for craft distillers, the number of which has doubled in just three years, and to increase MGP owned aged inventory, the company has doubled its warehouse space through capital expenditures of $24MM.  

• The company has taken steps to reduce the volatility of input costs on the company’s bottom-line performance.  To this effect, the company has hired Tom Pigott, an industry veteran with hands-on experience.  In addition, the management’s efforts to develop its own brands will help further mitigate the effects of fluctuating input costs.

Figure 6: MGP's Barreled Distillate (Whiskey) for Aging (Source: MGP 10Ks and 10Qs)

Financials

MGP’s distillery segment contributes 83.4% of its revenues, and it will be the main value driver going forward.  Under Gus Griffin, MGP’s performance has improved significantly, as shown in the financial data presented below (Table 1).  The following are a few noteworthy observations:

• Operating income, EBITDA, and margins have shown a dramatic recovery as the company's strategy of value vs. volume has taken hold.

• Company-owned barreled inventory (at cost) has risen significantly.  Since the inventory upon aging can be sold at over 3x its cost, we believe it will make its mark on the income statement starting 2018.

• A spike in capex will likely taper off as the doubling of the company’s warehouse capability is now nearing completion.  With this expansion, the company’s storage space will match up to its distillery capacity in Lawrenceburg.  While the ROI of the invested capex will be noticeable in a couple of years, its progress can be monitored based on a ramp up of barreled distillate.

• Once current expansion plans are complete, hopefully by the end of FY 2016, we expect capex to return to more normalized levels under $10MM.  Operating cash flows will be available to pay down debt and possibly increase quarterly dividends.  

  Table 1:  MGP Financials

• The Distillery segment is a major driver for MGP’s sales and operating profits today (shown in Table 2), and it will likely contribute even more in the foreseeable future.  Although the Ingredient solutions segment is not a significant contributor, if trends like non-GMO and protein diets pick up, ingredient solutions segment can help further boost MGP’s operations.

           Table 2: MGP Business Segment Financials

Valuation

We estimate the performance of MGP over the next three years (Table 3) with no contribution of the ICP JV.  We believe that in the next two years, the company should be valued at a higher multiple - more like an alcoholic beverage company like Brown-Forman, Constellation Brands, etc., rather than a food ingredient business.  We believe the barreled distillate owned by the company in 2019 is conservative, and if accurate, it will create significant upside, especially if management is successful in delivering on its brand promise.  As an illustration, Brown-Foreman (owner of several brands like Jack Daniels, etc.) at a market capitalization of $20BN has a barreled distillate of $571MM on its balance sheet.  While this is not an apples-to-apples comparison, we believe that the market capitalization of MGP could be higher than $560MM if some of our thesis plays out.

          Table 3: Estimates

Risk Factors

• Reversal in macro trends is the main risk factor in our view.  That said, we are comforted by the fact that these trends are decades long, although we monitor the trends periodically.

• Commodity prices for corn and wheat can fluctuate, so it is important to monitor them.  However, this will be a less of a factor in the coming years because of management’s planned transition into higher value products.

• Natural disasters such as tornadoes can cause disruption to the company’s current plans.

References

The following URLs, previous VIC posts and SEC filings were helpful understanding MGP’s story.

• http://cheersonline.com/2016/02/02/8-trends-that-drove-the-distilled-spirits-market-in-2015/

• http://fortune.com/2014/02/06/the-billion-dollar-bourbon-boom

• http://www.discus.org/assets/1/7/SupportingCategoryTables2015.pdf

• http://www.fredminnick.com/wp-content/uploads/2012/11/WA0413_MGPI.pdf

• http://www.usdrinksconference.com/assets/files/agenda/U.S.%20Beverage%20Alcohol%20Trends.pdf

• http://www.discus.org/assets/1/7/Bourbon_and_Tennessee_Whiskey_2014.pdf

• http://www.valuewalk.com/2015/12/mgp-ingredients-mgpi/

• http://tinyurl.com/hc5b2bh

Catalyst

Catalysts

• Introduction of company-owned Whiskey brands like Metze Select introduced in 2015.

• Further ramp up in MGP-owned barreled whiskey inventory.

• Further acceleration in macro trends.