Aswath Damodaran | Jun 13, 2019 02:55AM ET
In a big year for initial public offerings (IPOs), with Uber (NYSE:UBER), Lyft (NASDAQ:LYFT), Pinterest (NYSE:PINS) and Zoom Video Communications Inc (NASDAQ:ZM) to name just a few, already having gone public and more companies waiting in the wings, it is ironic that it is not a tech company, but a food company, Beyond Meat Inc (NASDAQ:BYND), that has managed to deliver the most dazzling post-IPO performance of any of the listings. As the stock increased seven-fold, investors who were able to get into the stock at the offering price have been enriched, but those who jumped on the bandwagon later have also reaped extraordinary returns. The speed and magnitude of the stock price rise has left many wondering whether investors have over reached and whether a correction is around the corner.h3
The Meatless Meat Company/h3
Let's take a look at what Beyond Meat's products are and the market opening it is exploiting, before diving into a story and valuation for the company. The company, headquartered in Southern California, and founded in 2009, makes plant-based (pea protein) products that mimic burgers and ground meat in taste, texture and aroma. In the prospectus that it filed leading up to its IPO, the company argues that its production process is revolutionary and new, and is responsible for its capacity to replicate animal-based meats.
While Beyond Meat is a leader right now in the specialized sub-category of meatless meats, it faces a formidable competitor in Impossible Foods, another young start-up producing its own plant-based versions of meat-like products. Since it is very likely, especially after Beyond Meat's explosive market debut, that Impossible Foods will be going public soon, it is inevitable that there will be comparisons between the two companies. While I have done my own taste test, taste is in the mouth of the beholder, and this article perhaps has the most even-handed comparison of the two companies' products. Both companies have also adopted similar strategies of enlisting fast-food companies as product adopters, with Impossible Foods showing up on Burger King (Impossible Whopper) and White Castle menus, and Beyond Meat countering with TGI Friday's, Carl's Jr. and Red Robin. Other companies are taking note, including companies like Amy's Kitchen, a long standing producer of organic and vegan offerings, and companies like Tyson Foods (NYSE:TSN) and Perdue that derive the bulk of their revenues from meat, but see opportunity in this new market.
Both Beyond Meat and Impossible Foods have been helped by a shift away from meat to meatless alternatives, and that trend has been driven by three factors:
None of these three factors are likely to fade away. In fact, I think that we can safely assume that they will only get stronger over time, accelerating the shift from meat to meatless alternatives.
All of the talk about the shift to vegan and vegetarian diets can sometimes obscure two basic facts about this market and its underlying trends:
The big question that we face is in estimating how much the shift towards vegan and vegetarian diets will continue, driven by health reasons or environmental concern (or guilt). There is also a question of whether some governments may accelerate the shift away from meat-based diets, with policies and subsidies. Given this uncertainty, it is not surprising that the forecasts for the size of the meatless meat market vary widely across forecasters. While they all agree that the market will grow, they disagree about the end number, with forecasts for 2023 ranging from $5 billion at the low end to $8 billion at the other extreme. Beyond Meat, in its prospectus, uses the expansion of non-dairy milk(soy, flax, almond milk) in the milk market as its basis, to estimate the market for meatless meat to be $35 billion in the long term.
At the time of its public offering, Beyond Meat had all of the characteristics of a young company, not much separated from its start-up days, with revenues of $87.9 million, operating losses of $26.5 million and common equity of -$121.8 million. Its first earnings report, delivered to rapturous market response, reported a tripling of revenues and a narrowing of operating losses, but even with it incorporated, the company remains a small, money-losing company.
To value young companies, I first have to put my optimist hat on, and with it firmly in place, my story for Beyond Meat is that it is catching the front end of a significant shift towards vegan and vegetarian-based diets. The key parts of my story are below:
Is there a risk in this investment? Absolutely, and you may be surprised that my cost of capital is only 7.46%, but that reflects my assessment of risk in this investment, as a going concern and as part of a diversified portfolio. As a money-losing company that will require about $500 million in capital over the next four years to deliver on its potential, there remains a significant chance of failure, and I estimate the probability of failure to be 15%.
With the story in place, the valuation follows and the picture below captures the ingredients of value:
With my story, which I believe reflects an upbeat story for the company, the value that I obtain for its equity is $3.3 billion, yielding a value per share of about $47. At the end of June 10, when I completed my valuation, the stock price was close to $170, well above my estimated value. What the stock dropped almost $41 on June 11 to $127/share, it still remained over valued.
As with any young company, the value of Beyond Meat is driven almost entirely by the story you tell about the company, and in this case, that story revolves around two key inputs. The first is the revenue that you believe the company can generate, once mature, and that reflects how big you think the market for meatless meats will get and Beyond Meat's market share of the market. The second is its profitability at that point, which is a function of how much pricing power you believe the company will have. While I have assumed that Beyond Meat will deliver about $3 billion in revenues in 2028, with an operating margin of 13.22%, your story for the company can lead you to very different estimates for one or both numbers:
The shaded cells represent break-even points, where you could justify buying Beyond Meat at the price ($127) it was trading at on June 11, 2019. Put differently, if your story for the meatless meat market and Beyond Meat's place in it leads you to revenues of $5 billion or higher with an operating margin of 20%, you should be a value investor in the company.
As you can see from the what-if analysis on Beyond Meat's value, the value that you obtain for Beyond Meat is determined mostly by how large you believe that market for meatless meats will end up being. In fact, there are some investors whose primary reason for investing in Beyond Meat is as a bet on a macro trend towards vegan and vegetarian diets. That said, it is worth remembering that investors don't get payoffs from making the right macro bets, but from the micro vehicles (individual investments) that they use as proxies for those bets. To get the pay off from a correct macro call, there are two additional assessments that investors have to make:
In my Beyond Meat valuation, I have implicitly made assumptions about both these components, by first allowing operating margins to converge on those of large food processing companies and then making Beyond Meat one of the winners in the meatless meat market, by giving it a 25% market share. My defense of these assumptions is simple. I believe that the meatless meat market will evolve like the broader food business, with a few big players dominating, with similar competitive advantages including brand name, economies of scale and access to distribution systems. I also believe that Beyond Meat and Impossible Foods, as front runners in this market, will use their access to capital to scale up quickly. Their use of fast food chains feeds into this strategy, with bulk sales increasing revenues quickly, allowing for economies of scale, and name-brand offerings (Impossible Whopper at Burger Kind, Beyond Famous Star burger at Carl's Jr.) helping improve brand name recognition. I will undoubtedly have to revisit these assumptions as the market evolves and some of you may disagree with me strongly on one or both assumptions. If so, please do download the spreadsheet and make your best judgments to derive your value for the company.
h3 A Trading Play/h3Early in a company's life, it is the pricing game that dominates and it is futile to use fundamentals to try to explain a stock price or day-to-day changes. This table, from one of my presentations on corporate life cycles, illustrates how investors and trades view companies as they move through the life cycle.
For a young company like Beyond Meat, making the transition from start-up to young growth, it is all pricing all the time, with stories about market size driving the pricing,. This trading phenomenon is exacerbated by the fact that it is one of the few pure plays on a macro trend, i.e., a shift in diets away from meat to plant-based options. That leads me to two conclusions. The first is an unexceptional one and it is that you will see wide swings in the stock price on a day to day basis, for little or no reason. That is a feature of priced stocks, not a bug, as mood and momentum shift for no perceptible reasons. The second is that selling short on a stock like this one (small, with a small float) is a dangerous game, since you are unlikely to have time as your ally, and while you may be right in the long term, you may bankrupt yourself before you are vindicated.
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