Grupo Bimbo Not Quite In The Sweet Spot Just Yet (OTCPK:GRBMF)

It’s been a rough year for packaged foods companies, with some names (Campbell Soup (CPB), Flowers Foods (FLO),and Kellanova (K)) down more than 20%. Mexico’s Grupo Bimbo (OTCPK:BMBOY)(OTCPK:GRBMF)(BIMBOA.MX) has done better than most, declining only slightly since the start of the year and about 7% since my last update on the company (the ADRs have been closer to flat), but even here there are ongoing worries about the longer-term impact of higher prices on market share, the opportunity to drive more organic margin leverage, and the potential impact of GLP-1 drugs on the snack business.

I find this a trickier stock call today. I shifted to a neutral stance early this year (that prior article) on concerns that there just wasn’t enough left in the tank to fuel exciting price appreciation. I can make an argument for the shares being undervalued today, and I do think there are still multiple positive drivers in play, but I can’t really find a compelling argument to get more aggressively positive on the name now.

Will Anti-Obesity Medications Change The Landscape?

I’ve seen a lot of sell-side reports and mass-market media articles lately talking about the potential impact of GLP-1 drugs (Eli Lilly’s (LLY) Mounjaro and Novo Nordisk’s (NVO) Ozempic and Wegovy) on consumer behavior, and specifically consumption of snacks. Given that Grupo Bimbo generates a meaningful percentage of revenue and profits from various snack items, it’s a worthwhile discussion to have (at least in brief).

At the risk of gross oversimplification, these drugs work by altering the user’s appetite and slowing stomach emptying, leading to reduced appetite and reduced food intake that drives weight loss. Weight loss of over 10% is pretty common for most users, and weight loss in excess of 20% is certainly possible.

What is more interesting and relevant here is that multiple third-party surveys of GLP-1 users have shown that the change in food intake is disproportionately skewed toward snack items – one survey from Morgan Stanley showed that more than 60% of respondents said that they’d decreased their consumption of salty snacks, cookies (and similar baked sweets), and other sweet snacks, while a study from Lilly of Mounjaro users showed a greater than 50% reduction in calorie consumption from carbohydrate sources.

It stands to reason that if you’re in the business of selling snack items, reduced consumption of snack items will have a negative impact on your business. I do believe, though, that this analysis does lend itself to oversimplification. While usage of GLP-1 drugs is likely to greatly expand in the coming years (there are production capacity limits today), not all snack consumers will go onto the drugs and “reduced consumption” does not mean no consumption.

Likewise, the impact of GLP-1 drugs is a U.S.-led phenomenon for the time being – snack items are about 40% to 50% of the U.S. business, and a larger part of the Mexican business, but it will take time for GLP-1 usage to ramp up in Mexico and the small LatAm and European businesses are not as dependent upon snack items.

Summing it all up, I do think Bimbo is looking at a changing consumption landscape, but the changes will take time to manifest. Moreover, not only are there still product innovation opportunities (healthier baked snack items), but Bimbo can still grow its share of the market that remains, as many of its snack food brands in the U.S. still skew more heavily toward Latin American consumers and have low brand awareness with non-Latin consumers.

Cost Pressures Should Ease, But El Niño Remains A Risk

Bimbo actively hedges its input costs, but higher prices have nevertheless had a noticeable impact on the business. Gross margin was still on the decline in the second quarter on both an annual and sequential basis (down 60bp yoy and 40bp qoq) and is down about three points from prior highs.

Commodity cost inflation, as well as costs for inputs like packaging, has been easing, with wheat prices down about 30% year-to-date lately. With that, management has been guiding to commodity cost tailwinds in the second half of the year, particularly in the fourth quarter. On the other hand, the El Niño weather effect seems to be ramping up and this could create new headwinds in 2024 if key grain-growing regions see weaker rainfall. Given the company’s typical hedging behavior, I would expect that the company is actively locking in lower commodity prices now, but may see gross margin tailwinds flip over again to headwinds later next year (2H’24).

While gross margin pressures have continued to weigh on profits, the company’s efforts to improve operating execution have continued to find success. Overall company gross margin declined 60bp (to 50.9%) in the second quarter, but EBITDA margin improved 50bp to 14.0%, with 20bp improvements in Mexico (18.6%), the U.S. (11.0%), and Europe (7.7%), and a 160bp improvement in Latin America (9.9%). Operations in Brazil and Argentina have been performing particularly well, and improved operating execution has been a driver/theme that I’ve mentioned several times in the past with Bimbo – the company successfully improved the performance of the U.S. operations in recent years and has been doing the same in Brazil and Argentina more recently.

I’ve been impressed with Bimbo’s performance here and I do think more upside is possible, but I also think there are limits on how much more the company can reasonably achieve on this line item. I do think further incremental progress is possible in the U.S. and Mexico (many companies across a range of industries have shown that ongoing margin improvement is possible), but I think “incremental” is the key word here. I see more margin improvement potential in LatAm and Europe, but I do think that progress could be gated by operating scale and volume improvements, and that’s likely a story that needs more time to play out.

Pricing Versus Volume Share Could Be A Risk To Monitor

While management has talked about prioritizing volume growth, recent Nielsen data suggests they have work to do. Bimbo’s sales have outgrown their industry comps across multiple categories over the last year (by around 100bp), but that has been driven by aggressive double-digit pricing, as volumes have actually trailed by about 250bp.

In the bread category, for instance, Bimbo has seen low-to-mid single-digit growth over most of the last year (Flowers has been similar), while private label brands have been growing at mid-teens rates as customers trade down to cheaper options. The company has likewise been losing some share in sweet snacks (to private label, as well as Hostess Brands (TWNK) and Little Debbie), though gaining share in salty snacks.

Food company managements have made bold claims about maintaining pricing, but I think the share losses to private label (across many categories) are forcing a re-think and I think pricing will eventually crack for at least some companies. Specific to Bimbo, I think a measured approach is necessary – perhaps passing along some cost inflation relief (if/when it comes) but also using promotions to soften the blow of maintaining higher list prices. Given Bimbo’s longer-term goals of gaining share in markets like snack foods, I don’t think volume losses should be (or will be) regarded lightly.

The Outlook

Core results from Bimbo have largely met my expectations this year – revenue has been a little softer, but that has been driven by currency translation, and EBITDA performance has been better than I expected. Gross margin performance has been pretty much in-line for me, as I was less bullish than the Street on prospects for cost inflation relief this year.

With all of that, I’ve made modest changes to my model – my 2023 revenue estimate is now about 3% lower (largely due to currency) and my 2024 estimate is about 2% lower. Over the long term, I’m still looking for around 4% annualized growth as the company looks to gain share in categories like snacks and continue to expand in markets like Europe. The aforementioned risk of market shrinkage from GLP-1 drug usage is not explicitly in my model, but it’s definitely something I’m thinking more about these days.

On the margin side, outperformance has led me to increase my expectations; my EBITDA margin estimate for FY’23 is now about a point higher and my FY’24 estimate is about 50bp higher. Long term, I still expect free cash flow margins to reach the high end of the mid-single-digits, driving a roughly 150bp improvement over the next decade in average FCF margin versus the trailing decade and double-digit FCF growth.

Between discounted cash flow and margin/return-driven EV/EBITDA I believe the shares could be modestly undervalued today. Cash flow suggests an okay high single-digit annualized total potential return, while the shorter-term EBITDA approach suggests maybe as much as 15% upside today.

The Bottom Line

Are those returns enough to make Bimbo a “Buy”? I think it’s borderline, and given my near-term concerns about price-driven volume declines in the U.S. market and longer-term threats from anti-obesity medication, as well as an uncertain outlook on commodity prices tied to El Niño, I lean more toward “Hold” than “Buy” today. That said, I do still like the Bimbo story and I think management has consistently executed on its self-improvement plans. Were the shares to continue to sell off, it’s a name I’d certainly revisit.

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