|Shares Out. (in M):||38||P/E||0||0|
|Market Cap (in $M):||622||P/FCF||0||0|
|Net Debt (in $M):||199||EBIT||0||0|
Primo Water Corporation is a distributor of both bulk water and water dispensers to consumers.
THE BUSINESS - The Company segments revenue into three buckets:
Refill – Primo operates a network of 25,000 locations. These machines look similar in size to a soda vending machine and allow consumers to re-fill their own 5-gallon or smaller water jugs for $0.25 to $0.50 per gallon. The majority of these machines are located outside of a gas station, grocery store or drug store.
Exchange – Primo operates a network of 13,400 exchange locations inside retailer partner stores such as Lowe’s, Wal-Mart, Office Depot, etc. In these locations, consumers can purchase pre-filled 5-gallon jugs of water and return their empty 5-gallon jugs. This model is essentially identical to the barbeque propane gas tank exchange business offered by most of these same retailers. Typically consumers pay $5.00 to $7.00 per 5-gallon jug.
Dispensers – Primo sells water dispensers at 7,300 locations. Wal-Mart, Home Depot and Lowe’s are a few of the larger chains that carry Primo dispensers. The dispenser price ranges from $50 on the low end to $300 on the high end. High end dispensers offer a range of extra features, such as the ability to make coffee with K-cups.
Primo was originally only focused on the Exchange and Dispenser business until its merger in December 2016 with Glacier Water Services (“Glacier”), the market leader in Refill. The merger created a powerhouse in the bulk water business, with a dominant retail market share of approximately 90% in Refill and Exchange and approximately 70% in Dispensers. Primo was founded by Billy Prim, a successful entrepreneur from North Carolina who had built the propane exchange business called Blue Rhino that completely revolutionized the way that propane was sold. Billy Prim serves as Executive Chairman of Primo.
Unit volumes across the various Primo segments are quite large. The Refill and Exchange businesses last year sold over 500 million and over 60 million gallons of water, respectively. In the last four years, Primo has sold approximately 2.2 million dispenser units.
MACRO DRIVERS - Primo has benefited and will continue to benefit from several important market trends. First, water consumption in the US has grown rapidly and now represents 33% of total beverage consumption. Water has been gaining market share from unhealthy soft drinks as consumers shift to healthier beverages. Second, the tap water quality in some parts of the US has declined, as many municipalities have aging water infrastructure, but no money to fund the significant costs associated with improving their water systems. Third, even if these municipal water systems were replaced, old pipes in many homes would continue to cause contamination. The recent stories about water quality in Flint Michigan generated national headlines, but many other cities and towns also have very poor water quality. Interestingly, with all the focus on the positive health benefits of water and the growing concerns over tap water, US households are only between 5-10% penetrated with water dispensers – we view this as a significant opportunity!
OUR EDGE - When we began analyzing Primo, we noted that both legacy Primo and Glacier had long histories of losing money as they had both been in aggressive growth mode and were sub-scale. We believed the market failed to realize that the merger would allow the two previous money losers to become very profitable. Further, we saw several opportunities on the horizon that we felt were unappreciated by the market including: the potential for water price increases on their Refill business, the potential volume uptick associated with rolling out cashless payment processing on Refill machines, efficiencies from marketing cross-pollination of legacy Primo retailer partners with Refill machines and legacy Glacier retailer partners with Exchange, and the opportunity to refinance the high cost debt on Primo’s balance sheet. In Fiscal 2016, the combined EBITDA for Primo and Glacier at the time of their merger was about $38 million. This year, less than two years later, we estimate the combined business will generate over $60 million of EBITDA. Looking forward, we believe that Primo can achieve approximate $100 million of EBITDA by 2022. The improving profits will accrue to shareholders at an even higher rate than would normally be the case due to $248 million of federal and state NOLs that will virtually eliminate any significant tax payments over the next several years.
The opportunities to increase the earnings power of the business were apparent to us based on several of our past investments and our geographical location. First, the opportunity to increase pricing was similar to what we saw play out at Redbox, the DVD rental kiosk business. Second, the opportunity to implement cashless payment processing and the resultant volume uplift is directly related to another position in our portfolio, USA Technologies. USA Technologies offers vending machine retrofitting to add cashless payment options and its vending machine operators have seen strong sales uplift once the cashless payment option was installed on their machines. Third, the retailer cross-selling opportunity jumped out at us given the strength of Glacier locations but the complete lack of Primo Exchange locations on the west coast. Finally, the opportunity to significantly reduce Primo’s interest expense through a debt refinancing / pay down was something that had played out favorably at other small-cap companies.
RECENT EVENTS - In order to address this last opportunity, Primo announced on May 14, 2018 that it was selling stock through a secondary offering, later priced at $14 per share. The Company plans on using the proceeds to pay down its high cost debt and credit facility and take out a new credit facility that we estimate will generate annual interest savings in excess of $10 million per year. The other benefit of the stock offering was that it provided the Primo management team with a good reason to go on the road to tell their story and attract new investors. The stock reacted very favorably to these developments and the increased share count has already improved the trading liquidity in the stock.
VALUATION - As we think about the next several years for Primo, we expect the Company to generate substantial free cash flows, magnified by the NOL tax shield, which we estimate will result in the nearly full repayment of all debt outstanding by 2022. By 2022, we forecast that Primo could generate $100 million annually of adjusted EBITDA. Given the strong interest in water as an investment theme, it would not surprise us if the market then valued Primo’s EBITDA stream at 15x multiple, equating to roughly $40 per share in 2022. If you don’t yet have a Primo Water dispenser at your house, we’d recommend you get one!
The earnings power of this valuable franchise will show through. Every macro driver around water and water quality is tailwind!