Saturday, January 24, 2009

A quick look at Middleby Corp.

The Middleby Corporation (MIDD) is a leading manufacturer of commercial kitchen and food processing equipment that competes with divisions of Illinois Tool Works (ITW), Manitowoc (MTW) and United Tech (UTX). Founded in a merger of two companies in 1985, Middleby has grown by acquiring competitors and complementary brands and, through superior management, improving operational efficiency and sales. The current CEO Selim Bassoul owns 5% of outstanding shares and is well respected as a manager. He has led Middleby from obscurity to a darling stock of Fools (the Motley sort) and small cap investors everywhere. Middleby has had quite a run, with revenue growth averaging 18% annually over the last 9 years, with net margins improving from 1.6% in 2001 to 9.6% as of 9/27/08.

Middleby made 8 acquisitions from 2005-2007 and another 6 in 2008, including the crown jewel of TurboChef. Middleby bought TurboChef in the 4th quarter, 2008 in a combined cash/stock deal. Therein lies the rub against Middleby; To come up with the cash portion of the deal, they’ve increased their debt to approx. $257M on a $497.5M line of credit. According to the most recent 10-Q, they are charged the higher of LIBOR + 1.25% or Prime + the Fed Funds rate, which is currently 3.35%. While this is certainly cheap, many feel it is poorly timed given the economic uncertainty and Middleby’s industry, which is highly competitive and sensitive to economic conditions.

However, the annual interest on the $257M debt is only $8.5M, which is covered 8.5 times by Middleby’s $72.5M free cash flow (FCF) for the trailing twelve months (ttm). Cap Ex is light at $5M, meaning Middleby doesn’t require lots of capital to continue operating. On the downside, Middleby’s balance sheet isn’t worth much. With debt to cap at 68%, limited liquidity and the majority of assets comprised of goodwill from their numerous acquisitions, Middleby has a negative tangible net worth. So what you’re buying is really the strength of their brands and their ability to grow earnings. Mr. Bassoul’s track record on this front is very, very good. Also, Middleby has historically utilized debt in their acquisitions and has paid down this debt quickly from free cash flow.

From a valuation perspective, Middleby is trading at 5.2x FCF (ttm), for a free cash flow yield of 19%. Assuming a normal valuation of 9x-10x FCF, which is reasonable for a growth stock, the market is pricing in a 42%-47% drop in FCF from last year. While anything is possible in the current economic climate, it appears that the bad news is priced into the stock. Even if free cash flow is cut in half to $36M, Cap Ex plus the interest payments on their debt adds up to only $13.5M, leading me to believe that Middleby will survive all but a catastrophic meltdown in business spending. The current price of $22 per share presents an attractive entry point for a long term investor, although considering the present market volatility, the price could reasonably fall another 10%-20% in the short term. Those interested in owning Middleby would be wise to establish a position and buy more as the opportunity presented itself. As always, do your own due diligence.

Disclosures: I have no position in any stock mentioned in this article.