Vital Farms (VITL) has been on my watch list after it went public on the final day of July. When the company went public, I checked on the prospects for this interesting company as it is a play on ethical farming. The company is a leader in a potentially transformative industry and just reported a solid set of quarterly results, the first quarter after its public offering.

While the guidance for the remainder of the year looks soft, this is likely a combination of a deliberate cautious guidance and partial reversal of COVID-19-induced momentum seen in the second quarter.

The Thesis

In July, I concluded that Vital Firms is a very interesting ethical food company which provided a potentially interesting long-term investment opportunity. Founded in 2007 by the Stewart family, the company has a mission to bring ethically produced food to the table, being better for people, animals and the planet. The company started with superior eggs, and after this product was quickly picked up by Whole Foods, it started a great growth trajectory of the company.

The company is challenging the incumbent food model through a range of 200 small family farms as eggs from these farms get distributed to the company’s Egg Central Station with a capacity of 3 million eggs per year, from which these quality and natural eggs are sold across the country. Believing in the Conscious Capitalism model, the company believes that the model benefits all stakeholders, something which is gaining a lot of supporters these days.

The total US shell egg markets is pegged at $5.4 billion with the company having just around a 2% penetration rate. The pasture-raised market is just $177 million, yet this is the strength of the company as this is a rapidly growing market which allows for expansion into adjacent markets such as pasture-raised butter, liquid whole eggs and hard-boiled eggs.

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In terms of the valuation, the situation was as follows. Nearly 8 million shares were sold at $22 per share, 10% above the midpoint of the preliminary offering range. With a diluted share count of 39.2 million shares trading at $36 on their opening day, the equity valuation has risen to $1.41 billion. With net cash seen around $100 million, operating assets were valued at $1.3 billion at $36.

The company has seen rapid growth, as its revenues have tripled from $45 million in 2014 to $141 million in 2019, with sales up 32% last year. While the sales trends are encouraging, the company saw 2% gross margins deleverage in 2019. Amidst some higher operating expenses, operating margins fell 4 points to just 2.4% of sales, coming in at $3.3 million in dollar terms.

I was quite compelled with a 44% increase in first-quarter sales to $47.6 million as operating profits fell from $4.3 million to $2.9 million, as margin pressure observed in 2019 was seen at the start of this year as well.

At the time of the IPO, the company guided for an 80% increase in second-quarter sales to $58 million as the encouraging news was that operating margins are expected to more than double to $8.2 million, marking some real leverage again. Using that quarterly guidance to calculate an annual run rate, I pegged sales at $232 million and operating earnings at $33 million. I must say that second-quarter results might be “inflated” somewhat by the COVID-19 crisis, actually creating a boom to short-term results.

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At $36, valuations had expanded to 5.6 times annualised sales and 50 times earnings, far higher than peer Cal-Maine Foods (CALM) at 1.4 times sales (although this is a “normal” operator). Recognizing the valuations were very high, I decided to acquire a tiny stake at the start of August. This was done on the back of a watch function, while valuations were too high to buy a large stake with any confidence.

That being said, with many industries ripe for disruption, identifying the future leaders in large market segments creates room to identify and create new long-term value compounders, with Vital Firms being potentially such a future leader.

The Numbers

Second-quarter numbers were released in September, and they came in a touch stronger than guided for at the time of the IPO. Second-quarter revenues rose 84% to $59.3 million. It was further impressive to see operating profits of $9.1 million coming in around a million higher than guided for at the time of the IPO, with net earnings coming in at $5.9 million.

Net cash on a pro-forma basis does indeed come in around $110 million as the 39.4 million shares outstanding now trade at $35. This values equity at $1.38 billion and the enterprise valuation at $1.27 billion, all in line with the numbers at the time of the IPO.

Of interest is the guidance which calls for 2020 sales of $205-$210 million and adjusted EBITDA seen at $14-$16 million. With revenues of $107 million so far this year, that suggests just around $100 million in sales in the coming two quarters, marking some declines from the second quarter. This is either the result of a cautious guidance or actual anticipation of somewhat softer results, certainly in terms of margins.

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A Final Thought

With this being the first quarterly results as a publicly traded company, I do think that management wants to start comfortable and therefore guide in a conservative manner, but time will only tell. Hence, I see no reason to add on just a very tiny position at this point in time, although this company remains incredibly interesting to keep an eye on with the guidance looking soft, but I feel comfortable that management is setting a cautious tone.

The secular growth story remains intact, yet little over a month since the company has gone public, the second-quarter results were a little stronger than guided for, as this gives me confidence that the growth story is intact and that management is guiding soft as a deliberate choice, as Vital remains a leader in a potentially disruptive industry.

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Disclosure: I am/we are long VITL. 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.

Additional disclosure: Very modest long position.