📍TL;DR

• Amid soaring energy prices and high inflation, European frozen food producer Nomad Foods posted a soft 2022, and expects profits to decline in 2023.

• Bears would argue that a cheap headline valuation is justified by the lack of pricing power shown in this period.

• But since its 2015 founding, Nomad has been quite successful, and we believe management has earned the benefit of the doubt.

• As new initiatives take hold, investor confidence should return. That in turn creates a path toward real upside.

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Since equity markets turned south at the end of 2021, most American food manufacturers have proven a safe haven for investors. But for United Kingdom-based frozen food producer Nomad Foods NOMD 0.00, not so much:

From a distance, the divergent performances make quite a bit of sense. For American investors, foreign exchange alone is a not-insignificant factor. European currencies have weakened over the past 14-plus months, with the euro (Nomad’s reporting currency) down ~7% and the British pound (27% of 2022 sales) off ~12%.

Since the invasion of Ukraine just over a year ago, and the resulting cessation of natural gas supplies from Russia, European energy prices have soared. And though the worst-case scenario was avoided this winter, experts still see cause for concern going forward. Those higher prices, even with substantial government assistance, are pressuring consumers across the Continent, and potentially hitting demand for Nomad products.

Add in a euro zone economy that barely avoided recession in the fourth quarter, and may indeed turn negative in 2023, and the gap here seemingly makes perfect sense. Shares of American food manufacturers have rallied because they are seen, and should be seen, as safe havens in a volatile time. European manufacturers — including, as the above chart shows, giant Nestle SA $NSRGY — are not.

There’s probably some degree of truth to that analysis. But we’d argue it misses a number of key facts, and positive attributes about Nomad even amid external upheaval. Furthermore, we’d argue that it’s precisely that perception that creates the opportunity in NOMD here. This is a better business than investors perhaps realize, and one with the potential to provide exceptional multi-year returns going forward.

source: Nomad Brands website

Introducing Nomad Foods

Nomad is the largest frozen food producer in Europe. Its market share of 18% is more than twice as large as that of its nearest rival. Nomad in fact is the third-largest frozen food producer worldwide, following only Conagra Brands CAG 0.00 and Nestle.

The company’s brands include:

• Birds Eye

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  in the U.K. and Ireland, which offers a huge portfolio of products including fish fingers (or fish sticks, as they're known in the U.S.), vegetables, breakfasts, and desserts;

• Findus, with a similarly large base across seven countries;

• Iglo, the largest frozen brand in Germany, Austria, and other markets;

• ice cream maker Frikom in Serbia; Aunt Bessie’s frozen dinners in the U.K.; and Goodfella’s pizza in Ireland and the U.K.;

• Green Cuisine, a native brand offering meatless products.

Nomad’s brands have some history: Birds Eye’s roots in the U.K. trace back to the late 1930s, and Findus was founded in 1941. But Nomad itself is a relatively young company.

It began as a SPAC (special purpose acquisition company)

The SPAC was co-founded by Sir Martin Franklin, and the idea from the jump was for the SPAC, and then Iglo, to translate his previously-successful strategy to the food space. Franklin's biggest win was the building of consumer products business Jarden through a roll-up strategy. Jarden shareholders saw ~48x returns before the company was sold to Newell Brands NWL 0.00 in 2016 for $16 billion. In large part due to Franklin's track record, well-known hedge fund manager Bill Ackman was an investor in the Nomad/Iglo merger, at a time when Ackman was hot on these “platform businesses”/rollups

And indeed Nomad has been active in the nearly eight years it has been public:

source: Nomad Foods presentation at CAGNY, February 2023

The company has spent some €1.9 billion on acquisitions beyond the initial SPAC merger. As a result, revenues since Iglo have roughly doubled (despite what the slide above says), and Nomad has expanded from serving five categories in seven countries with Iglo to the current eight categories in 22 countries.

Nomad Succeeds

As far as the business goes, the effort has been successful:

source: Nomad Foods presentation at CAGNY, February 2023

Obviously, acquisitions have played a key role in the growth. For instance, 2022 performance seems on its face hugely impressive in a tough market, but the €642 million acquisition of Fortenova Group only closed in September of the year before.

But Nomad has had some success with existing brands. Organic revenue increased each year from 2017 through 2020, and only declined 2.1% in 2021 against a nearly 9% comparison before again turning positive in 2022. Sussing out pro forma EBITDA growth is difficult (currency translation is an issue as well), but it appears almost certain that organic profit growth too has been positive

Certainly, the story told when Nomad launched in 2015 for the most part has played out. That history supports some optimism toward management as well, for reasons that go beyond the headline fundamentals.

On the operating side, Nomad as promised has improved performance. When Iglo was purchased, profits actually were heading in the wrong direction. Per the merger presentation, Adjusted EBITDA had declined ~6% between 2011 and 2014. Nomad focused on a series of “Must Win Battles” with its core brands, and appears to have won, with organic revenue inflecting positive.

Capital allocation too has been solid. NOMD soared after the Iglo deal amid (as noted) optimism toward other platform businesses. It then returned to Earth when the likes of Valeant/Bausch and Platform Specialty/Element crashed in mid-2015.

Nomad played the rally perfectly, selling 15 million shares at $20.75 in July of that year. That in turn allowed the company to pay mostly cash for Findus in November, instead of using its suddenly-weaker stock as currency. In 2017, it repurchased 7 million shares in a secondary (that included Ackman’s exit) for $14, and another 9.8 million just above $10. The company then issued 20 million shares at $20 in March 2019, only to realize in early 2020 that M&A options had frozen; the company went aggressively into the open market to buy back shares.

Admittedly, a Dutch tender saw the company back buy back shares above $25 later in 2020, 2019-2020 activity wasn’t perfect from a corporate perspective. But overall, there’s a clear sense of a competent, invested, management team here (a team that remains largely intact from what it was almost a decade ago). And, as we shall see, that’s a hugely important point to keep in mind.

NOMD Stumbles

To be sure, the NOMD stock price would seem to tell a different story:

source: finviz.com

But in fact, to this point, results actually have held up relatively well even against management expectations. 2022 adjusted EPS of €1.68 modestly missed original guidance of €1.71-€1.75. Given the volatility seen last year (that guidance actually was released the same day Russia invaded Ukraine), that performance hardly seems like a massive disappointment.

That said, management has admitted to some market share loss in 2022, as consumers traded down to private-label alternatives. And 2023 guidance looks markedly disappointing. Nomad is guiding for adjusted EPS of €1.50-€1.55, down ~9% at the midpoint and potentially down modestly from 2021 as well.

Part of the issue is higher interest expense after Nomad refinanced existing debt in November. But the company is also spending more on A&P (advertising and promotion) after raising prices in 2022 to protect gross margins.

And so the worry here clearly is that the business isn’t nearly as strong as 2016-2022 results suggested. Perhaps Nomad wasn’t overearning, necessarily, but in the “new normal” of higher energy costs, normalized interest rates, and still-existent inflation, operating margins are going to see significant, permanent impairment.

The market’s anticipation of these factors no doubt explain the absolute decline in NOMD stock, as well as the stark underperformance relative to American peers. Those peers in contrast, and almost without exception, have been able to pass pricing along to consumer. In its Refrigerated & Frozen segment, Conagra took fourteen points of price/mix through the first half of fiscal 2023 (ending May), while volumes declined just 4% over that period.

Per the Q4 call, Nomad for the full year saw a “mid-single-digit” decline in volume, and organic revenue growth of 1.8%. In other words, it posted a larger fall in volume despite a net price increase roughly half that pushed through by Conagra.

Again, the bear case here is that NOMD trades at a massive discount to American peers precisely because, unlike its counterparts across the pond, it is not a safe haven. Performance in recent quarters, and soft guidance for 2023, would seem to support that bear case.

Cheap Helps

Last month, in an article on Canada Goose GOOS 0.00, I wrote:

What I’m referring to is a much more important question (at least for my investing style): what is this business worth?

Right now the answer often feels like, “Who the hell knows?” Looking backwards, which year was the most “normalized” from 2019-2022? Looking forwards, what, exactly, is 2023 going to be on that same fuzzy scale?

NOMD is another excellent example of the challenges in fundamental analysis right now. We have a business that performed well before the pandemic, exceptionally during the worst of it, and now is in the midst of a much more challenging period. So as we look to value the business — and, importantly, gauge its growth prospects — it matters a great deal which of the past five years we choose as the most ‘normal’.

Is this a business headed for a multi-year period where it at best runs in place? Or is the expected profit decline in 2023, irrespective of higher interest expense, simply the result of a company facing a series of temporary(ish) headwinds that will at some point dissipate, allowing something like the 2017-2021 trendline to resume?

We’ll get to our answer in a moment, but in the meantime it is worth noting that the market clearly is pricing in a greater chance of the first explanation. Even on an absolute basis, NOMD is cheap. Shares trade right at 11x the midpoint of 2023 adjusted EPS guidance ($1.62 as converted at the current exchange rate). Price to free cash flow is ~12x, given guidance for 90-95% free cash flow conversion this year (in line with past results; the below-70% figure in 2022 was an outlier).

And on a relative basis, NOMD looks cheap as well. For reasons that go beyond geography, American peers aren’t perfect comparisons. But the more established manufacturers often trade at mid-teen multiples and low 20s P/E and P/FCF. Even Conagra, one of the sector’s cheaper plays, is at 11x EV/EBITDA and 13.5x the midpoint of FY23 EPS guidance.

Choosing A Side

Of course, if an investor believes in the bear case, and believes that long-term margin expectations need to come down, those low absolute multiples are of little interest. From that perspective, NOMD is a value trap, not a value play.

But it seems far too simple — and far too early — to write this business off. Again, Nomad has posted years of consistent, solid growth, both organic and inorganic. It did through a period that was not exactly easy, either: most notably, Brexit created headaches (and costs) for a cross-Continent manufacturer. It’s now facing an unprecedented number of significant headwinds in multiple markets.

And the company hasn’t really had a chance to fully react yet. It took pricing in 2022, of course — but, per management, private-label competitors chose to take share instead. That will change over time, and a plan (detailed at CAGNY last month) to increase advertising behind the brands’ value proposition should allow Nomad to recapture at least some of the lost share. A continuing emphasis behind Green Cuisine offers another potential source of growth; that brand has increased sales nicely in a category that (in Europe as in the U.S.) appears to be going backwards.

More broadly, this is a management team that, as emphasized earlier, for the most part has done what it said it was going to do. It is a team that has earned the benefit of the doubt. It’s reinvigorated multiple brands after acquisitions already; it simply needs to do the same with its own brands after this period. And with free cash flow bouncing back in 2023, even with profit pressure there will be room to either return to M&A or get aggressive with the stock below $20. There are a lot of levers to pull to create value, interest rates are (mostly) locked in from here, and there is still some level of defensiveness to the underlying business even in such a chaotic environment.

There’s one more fundamental aspect to the story worth considering. The comparison to CAG, in particular, raises a question: why not just buy that American stock instead? After all, Conagra just raised guidance for the full fiscal year. Though its balance sheet is slightly more leveraged, its EBITDA margins and ROIC are both better.

It’s a fair question, but we’d argue there’s a simple answer: for Nomad, 2023 looks like a trough, not a peak. For U.S. rivals, as impressive as performance has been, that is certainly not the case (and the risk of some kind of peak after double-digit price increases is absolutely real).

Between the attractive valuation and the defensive nature of the business, there should be some downside protection here. Meanwhile, the potential upside is significant. After the Fortenova acquisition, Nomad saw a path to €2.50 ($2.66) in adjusted EPS by 2025. After Q4, chief executive officer Stéfan Descheemaeker walked that back somewhat, pointing to higher interest expense — but he argued that “operationally” the company was still on path to that level.

Even a low-€2 print, combined with the restoration of investor confidence, suggests more than 100% upside here. (Think 17x €2.10/$2.24, which gets the stock to $38.08, 114% upside.) Success with the new strategy, some amelioration of inflation (which is already occurring), buybacks and/or M&A all can get the company to that level. Even if the targets slip a year or two, investors here still do quite well, with annualized returns in the mid-teens.

It’s difficult to truly pin down fair value here. But to our eye, fair value discounted back, pretty easily clears $20. In this market, that looks attractive.

We’d close with one final point: we’ve been here before. NOMD looks like another consumer-facing U.K. company, and one of our better calls to date: Haleon HLN 0.00. Haleon too faced skepticism about the environment in Europe, as well as litigation risk that appeared overblown. As those concerns eased, the stock has raced higher; it's up 26% since our recommendation in August.

We’ve also been here before with NOMD itself. As mentioned, the stock tanked in 2015. That occurred not because of anything Nomad had done but because a) it had run a bit too far to begin with and b) investors decided they didn’t like platform businesses after all. Shares would go on to quadruple from the lows.

This is not the same situation, but there are echoes. At some point, investors are going to be intrigued by European stocks again. When they are, we expect Nomad to have executed well enough for the stock to be near the top of the shopping list. Investors will likely do well to own the stock before that happens.

As of this writing, Vince Martin is long shares of Haleon. He may initiate a position in Nomad Foods in the near future.

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