Real Good Food Stock: Massive Revenue Growth, But Significant Risks (NASDAQ:RGF)
The real good food company (NASDAQ:RGF) forecasts sales growth of more than 80% in 2022 and invests in growth markets such as the high-protein foods market. I believe the future of the company is sweet, however the current the valuation per share seems too expensive. Under normal conditions including sales growth close to that of the high protein foods market, I got a valuation of $4.69. In my view, the risks of contracting customers, co-manufacturer relationships, and rising interest rates could drive down free cash flow. As a result, the stock price may fall to prices below the current market price.
Real good food
Real good food short a frozen food company offering high-protein, low-sugar, gluten-free and grain-free products. According to the latest quarterly report, the company specializes in entrees, but it also sells breakfasts, pizzas and snacks.
If I can cut to the chase, I write about business because the tips is impressive. Management expects to deliver nearly 84% sales growth in 2022 and an adjusted gross margin close to 17%. Ignoring the valuation of the company, it is a company that is growing at a very decent rate.
Under normal circumstances I got a valuation of $3.57-$4.69
In my opinion, if management successfully communicates with the market that chooses The Real Good Food products, revenue growth will tend to increase. The mission of the company was clearly established in the annual report:
Our mission is important to us because we believe that a growing number of consumers are looking to make healthier food choices, but face limited options when it comes to the convenience of products found in the frozen food aisle. Source: 10-K
In my view, under normal conditions, The Real Good Food is likely to trade near the growth of the global food and beverage market. Market experts believe the market will trade near 5.8%.
According to the latest research study, the demand for the global Food and Beverage Metal Cans market size and share was valued at around USD 27,419.5 million in 2021 and it is expected to surpass a value of around 38,456, 8 million USD Mark, by 2028, in a compound annual growth rate of approximately 5.8% during the forecast period 2022 to 2028. Source: At 5.8% CAGR, global food and beverage cans market size
By using the the expectations of other analysts and market sales growth, I believe sales of $459 million in 2031 are achievable. Note that I have included double-digit sales growth from 2023 to 2026 and 5.8% sales growth from 2027 to 2031. I have also included a conservative EBITDA margin of around 6% and a positive net profit from 2024.
With conservative changes in receivables, inventory changes and investments of approximately $7-20 million, free cash flow in 2031 would be $17 million. My numbers included free cash flow of over $12 million from 2025 to 2031. My exit multiple is 11x EBITDA, which I consider conservative and equal to the industry median. Eventually I got an equity valuation of $92 million and a fair price equal to $3.57.
As of May 12, 2022, there were 6,169,885 Class A common shares of the registrant and 19,577,681 Class B common shares of the registrant, with a par value of $0.0001 per share, outstanding. Source: 10-Q
The Real Good Food also operates in the global high-protein foods market, which is growing at nearly 7%. In my view, if management is successful in investing in this market, sales growth could be close to 7% in the long term. With that in mind, I ran another scenario with sales growth above 7% from 2027.
The global high protein foods market size is projected to increase USD 27.49 billion from 2019 to 2024 and is expected to grow at a CAGR of 7% according to the latest Technavio market report. Source: high protein food market
My results were a bit better than the previous case scenario. Assuming an outflow of 11x EBITDA, the implied valuation equals $4.69.
Risk factors: customer concentration, need for new co-manufacturers, manufacturing capacity and rising interest rates
The Real Good Food is still a small entity, so there’s a lot that could go wrong. First, the company suffers from significant concentration risk. Two supermarkets represented, in 2021, more than 70% of the total amount of sales. If any of these supermarkets leave The Real Good Food, the drop in sales could be substantial. As a result, the company’s valuation would decrease.
We have been and continue to be subject to significant customer concentration risk. During the year ended December 31, 2021, Costco and Walmart represented approximately 71% of our net sales, collectively, and approximately 51% and 21% of our net sales, respectively, for the year ended December 31, 2021 Source: 10-K
The Real Good Food also manufactures certain products in manufacturing facilities with co-manufacturers. Management is building new capabilities, but the company plans to continue to rely on external manufacturing facilities. In short, The Real Good Food needs to collaborate with other partners to manufacture. If it loses one or more manufacturers, production could drop, and so would income:
The loss of one or more of our co-manufacturers, or our inability to identify new co-manufacturers, could harm our business and impede our growth. For the year ended December 31, 2021, up to 30% of our products were manufactured at various facilities operated by our co-manufacturers. In 2021, we began manufacturing at our factory in Industry City, and while our growth strategy involves improving our overall manufacturing and production capabilities over time, we also plan to continue to rely on our co-manufacturers to provide us with a portion of our production capacity for the foreseeable future, and we may identify new co-manufacturers to provide additional capacity or flexibility. Source: 10-K
It should also be considered that management may overestimate future demand. Too much capacity or too little capacity could affect future financial terms. The valuation of the company could be affected:
If we do not accurately align our manufacturing capacity and production capabilities with our current or future demand, or if we experience disruptions or delays in scaling our manufacturing facilities, operations, results of operations and our financial condition could be materially adversely affected. Source: 10-K
Finally, The Real Good Food could also suffer from possible increases in interest rates. Note that in the annual report, management noted that some of the company’s debts include a variable component. The total amount of debt is not significant, but future interest charges could lower the company’s free cash flow:
The interest rate on the Company’s secured credit facility and certain other indebtedness has a variable component, and which reflects the market for such instruments on a given date, and as such, the carrying value of such indebtedness approximates its fair value. Source: 10-K
In my pessimistic conditions, I assumed -15% sales growth in 2027 and -5% from 2028 to 2031. My EBITDA margin would also be close to 5% from 2028 to 2031, and the operating margin would not exceed 2%.
With a discount of 12.5% and an exit multiple of 10x, implied equity would be close to $12 million. The fair price could be $0.5.
As of March 31, 2022, The Real Good Food reported $12 million and assets/liabilities close to 1x. In my opinion, the total amount of cash is substantial, but management may need to raise more capital to pay for marketing expenses as well as fund sales growth. A possible increase in the number of shares could lead to a fall in the share price.
The total amount of liabilities is not important, but in my opinion, it is relevant to note the revolving line and the other lines of credit. If the total amount of debt continues to rise, stock valuations will likely decline.
The Real Good Food is a company that should be watched closely as its revenue growth forecasts are quite impressive. Management expects double-digit sales growth well above the market. With that, I think the current valuation is too expensive. Given future free cash flow, under normal conditions, I think a valuation of $3.57 to $4.69 per share seems fair. More investment in the high protein food market will likely increase future free cash flow. However, I cannot justify the current valuation, above $4.7 per share. In my worst-case scenario, which I consider quite unlikely, the stock price could even drop below $2-$3.