Optimistic About Landec's Initiatives, Sodium Hyaluronate Products (LNDC) | Seeking Alpha

2022-04-22 22:08:05 By : Ms. winnie yu

ekinyalgin/iStock via Getty Images

ekinyalgin/iStock via Getty Images

Landec's (NASDAQ:LNDC ) Lifecore business grows at 14% y/y, and the management is making significant efforts to streamline the organization. In my view, it is the best time to learn about Landec's business model. Using certain market estimates, moderate growth expectations, and WACC of around 7.5%, my best-case scenario results in a target price of $25. Other investment analysts have a target price of $15. In my all case scenarios, the company is cheap at the current valuation of $7.5-$10. When traders learn about Landec's sodium hyaluronate-based products, the demand for the stock will most likely drive the valuation up.

Landec Corporation designs, develops, and manufactures products for food and biomaterials markets:

The company's most relevant business segment focuses on the sale of fresh packaged salads and vegetables. However, the company also sells avocado products and sodium hyaluronate-based products:

In my opinion, most investors will be interested in Lifecore, which focuses on formulating biomaterials. The company appears to be an expert in the Hyaluronic Acid market, which is currently growing at a very decent pace. Lifecore reported double-digit growth in the last few years. It is an exciting time to look at Landec Corp.

Landec Corp. will most likely try to increase its operating margins by maximizing its efficiency and productivity. If the management is sufficiently smart, it will try to streamline the organization by using lean manufacturing practices. Notice that the company is already implementing many strategies in order to improve FCF margins. One example is the centralization of various offices into the company's Innovation Center in Santa Maria, California, in 2020. In my view, with more of these practices, FCF will most likely increase:

In fiscal 2021, the company focused on redesigning strategic initiatives, developed and elevated internal talent, and reduced overall headcount to improve efficiencies. Source: 10-k

Besides, it is also remarkable that the management appears to be divesting non-core assets to refocus its activities. In 2021, the company commenced a strategic process to sell a salad dressing manufacturing facility in Ontario. Besides, the management also communicated its intention to sell its Hanover manufacturing facility. I believe that Landec's new strategic direction is about to bring a significant amount of cash, which could be used to hire new employees or design new products. In my view, traders will most likely see FCF generation in the coming years.

I am also quite optimistic about Lifecore's business model. The company manufactures and sells pharmaceutical-grade sodium hyaluronate. I studied the sales growth reported by Lifecore. In 2021, this business segment reported a sales growth of 14%. Interestingly, the global sodium hyaluronate-based products market is expected to grow at only 7.5% y/y. I believe that sales figure of Landec Corp. will most likely grow quite a bit because of this business segment:

The global sodium hyaluronate-based products market is expected to expand at a CAGR of 7.5% from 2021 to 2028. Source: Sodium Hyaluronate-based Products

If we also note that the packaged salad market is expected to grow at 7.6%, and the avocado market grows at 6% y/y, I expect revenue growth of 7.6% from 2022 to 2032:

Packaged Salad Market Size is Estimated to Grow with a CAGR of 7.6% During 2021-2026. Source: Packaged Salad Market

Avocado Market is projected to expand at a value CAGR of 6.2% throughout the period of assessment (2017-2027) Source: Persistence Market Research

Along with the previous figures, I also assumed an EBITDA margin of 5.5%-7%, a tax rate close to 20%-25%, D&A of around $35 million, and capital expenditures close to $40 million:

Finally, the FCF would increase from $1 million in 2021 to close to $30 million in 2032. The FCF margin is very moderate. Notice that I am not expecting FCF/Sales ratio of more than 1%-2%.

If we use a WACC close to 6.5%, the DFCF would grow from $1 million to close to $14 million in 2032. The sum of the FCF would stand at $62 million:

I ran several case scenarios with different exit multiples and the same 2033 FCF of $32 million. If we use an exit multiple of 25x, the implied share price would be equal to $10. With an exit multiple of 34x, the fair price would be closer to $25. Currently trading at $8.5-$10, under the assumptions made in this case scenario, LNDC is right now cheap:

I am not concerned about the company's ability to repay its debt. As of August 29, 2021, the company reported $445 million in total assets, along with long-term debt worth $123 million and a line of credit worth $32 million. If we assume a debt of $155 million and 2025 EBITDA of $50 million, the company's debt/EBITDA is close to 3x, which does not seem scary:

With that about the company's financial status, let's note that the company disclosed some risks. The most relevant, in my view, is that the company signed credit agreements with several covenants that may restrict the company from doing certain profitable activities like mergers and sale of assets. If debt holders don't allow these activities, shareholders may not get the best return from Landec Corp. In that case scenario, perhaps investors may decide to sell shares, and the share price will decline:

We are party to two credit agreements, which contain a number of covenants that limit our ability and our subsidiaries' ability to, among other things, incur additional indebtedness, pay dividends, create liens, engage in transactions with affiliates, merge or consolidate with other companies, or sell substantially all of our assets. The terms of our credit facilities may restrict our current and future operations and could adversely affect our ability to finance our future operations or capital needs or to execute preferred business strategies. Source: 10-k

It is also especially relevant that 49% of the total Landec's sales are represented by five customers. Besides, Costco Corporation (COST) and Walmart, Inc. (WMT) are responsible for 16% of the total amount of revenue. It is very risky. If one of these customers decides to negotiate its business terms with Landec or the company loses one client, the FCF margin would decline significantly. As a result, the share price would most likely decline.

The image below includes my assumptions considering the covenants and the concentration of clients. I used a sales growth of 6.55%, an EBITDA margin between 5.5% and 7.5%, and a tax rate of about 20%:

Besides, I also included depreciation and amortization of about $35 million, capital expenditures close to $40 million, and changes in accounts payables of $3.5 million. As shown in the table below, 2032 FCF would be equal to $23 million:

If we use a WACC of 7.5% and FCF from $21 million in 2022 to $23 million in 2032, the sum is equal to $41 million:

Putting everything together, with 2033 FCF of $25 million, an exit multiple of 20x, close to $1 million in cash, and more than $100 million in debt, the implied share price is $5:

Market estimates include 3.4% and 3.8% sales growth in 2023 and 2024 along with a positive EBITDA from 2021 to 2024. With that, investors are also expecting a significant amount of capital expenditures, so the free cash flow is not expected to be positive until 2023:

With regards to the target price of other analysts, the average target of a total of 5 analysts was equal to close to $13. The highest target was also equal to $15. To sum up, my numbers are very different from that of other market analysts, and most investment analysts believe that the company is undervalued at $7.5-$10:

Source: Landec Financial Data Forecasts Estimates

Landec is operating in markets with significant market growth, and is also making efforts to streamline the organization. In my view, if the management continues to sell non-core assets, and invests heavily in Lifecore Medical, both revenue and FCF will trend north. Under my best-case scenario, the company may be worth close to $25. There is a downside risk, but the upside potential is more significant. In my worst-case scenario, the company could be worth $5.

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Disclosure: I/we have a beneficial long position in the shares of LNDC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.