📍 TLDR

• A brutal 2022 in the wake of pandemic-driven growth has sent COOK down 66% year-to-date.

• Yet, from a fundamental perspective there’s room for more downside.

• A leveraged balance sheet leaves no room for error, and has forced near-term choices that will have long-term effects.

• A buyout offer at a rival catalyzed a 52% rally; another ugly quarter should set that rally in reverse.

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Traeger COOK 0.00 is in trouble. The question is if that broad fact is enough to short Traeger stock.

There’s a reasonable argument to avoid a short here. The challenges facing the manufacturer of wood pellet grills are hardly hidden. COOK is down by two-thirds so far this year. It’s fallen 77% from the $18 price of its initial public offering in July of last year, and 87% from all-time highs reached soon after.

Meanwhile, an ugly 2022 is being driven (at least in part) by factors beyond the company’s control. Lockdowns and government stimulus payments during the pandemic pulled demand forward. Input costs remain elevated. Consumer spending has pivoted toward experiences and away from products. There is some hope that pressure will ease in 2023 and beyond.

Perhaps most importantly, Traeger by all accounts makes an attractive product. Its Net Promoter Score, a measure of customer satisfaction, is the highest in the grill category, per figures cited in the company’s S-1 filing. Online reviews appear largely positive.

Even with those impediments, however, the short case here looks solid with earnings due on Wednesday morning. Valuation still looks potentially stretched. External factors play a role in 2022 results — but, importantly, the company’s response to current challenges will have clear repercussions in 2023 and beyond. And while Traeger grills are attractive, an enterprise value just shy of $1 billion remains far too high for what still looks like a niche product.

As well, COOK has rallied 52% in just three weeks. The catalyst appears to be news of a buyout for rival Weber WEBR 0.00. The case for a short is that Q3 earnings might shift investor attention away from the sector and back to Traeger, reminding investors why they were so busy selling COOK stock in the first place.

Introducing Traeger

Founded in 1987, Traeger invented the wood pellet grill. Instead of gas or charcoal, the grill burns compressed hardwood pellets. Those pellets are moved to a fire pot by an auger; a fan circulates heat (and smoke), while a controller maintains an even temperature.

It is, as the company puts it, a “set it and forget it” manner of cooking. The system also allows for tremendous flexibility: a Traeger can be used for hours of smoking, or a quick barbecue of a steak.

That flexibility has helped drive wood pellet grills to steady share gains over time:

source: Traeger Q2 2022 investor presentation

Traeger benefits financially from the nature of pellet grills as well, notably through the sale of pellets. Consumables accounted for 17% of 2021 revenue. Accessories were another 13%; a bit over one-third1 of that total came from Bluetooth meat thermometer MEATER, which Traeger acquired for $78.3 million (net of cash acquired) last year.

The Bull Case for COOK

Those attributes of the product and the company could underpin a thesis that the market is overreacting to a nasty 2022. The company has grown nicely since its founding, and did so even before the pandemic. Interviews with CEO Jeremy Andrus (formerly the head of headphone maker Skullcandy) suggest the business was doing ~$70 million in revenue when it was acquired in 2014. (Andrus went in alongside a private equity firm; Traeger was recapitalized in 2017.)

Per the S-1, in 2017 Traeger generated $262 million in revenue; two years later, the figure was $363 million. Clearly, the business was able to grow on its own without the amplifying impact of lockdowns and stimulus checks.

Admittedly, 2022 has been ugly. Initial guidance for this year disappointed, sending the stock down 12%. The outlook was then slashed after Q2. Traeger projects revenue will decline ~17% this year; Adjusted EBITDA should plunge more than 60%.

But in context, that performance is not necessarily surprising. Higher input and shipping costs have pressured gross margins. The Q2 guidance cut came amid elevated levels of channel inventory — itself an effect of the pandemic, as both Traeger and its biggest customers built up inventory to protect against supply chain interruptions and shipping costs.

Normalization should help. Container costs are already coming down. In July, Traeger cut costs, including via layoffs of about 14% of its salaried staff. Those layoffs and other efforts should save ~$20 million on an annualized basis. The company is working on design changes that can lower production costs and further improve margins.

Assuming Traeger can get back to top-line growth — even from a lower base — and restore some of its lost margin, presumably there should be an opportunity here for investors willing to take the long view.

The Macro Question

One core problem with the bull case, however, is that revenue stands a good chance of being depressed for some time to come.

There was a dramatic amount of demand pulled forward in 2020 and 2021. From 2017 to 2019, revenue increased by 38%. Over the next two years, sales soared 117%.

Industry conditions played a huge role. Andrus said after Q2 that the category as a whole went from low-single-digit annualized growth to “mid to high teens” in 2021.

The combination of flush consumers and pandemic restrictions no doubt provided an even stronger tailwind to Traeger, whose models are at the high end of the market (the average price was $839 in 2020 and increased the following year). Consumers may even have been more comfortable with the more complex product given more free time to understand its intricacies.

That tailwind has reversed — but the overhang should last for some time to come. Like so many pandemic winners, Traeger compressed many years of growth into a short span. The impact doesn’t simply unwind in a few quarters once owned and channel inventories are worked through.

But that’s not the only macro issue. Traeger is already seeing pressure in its sub-$1,000 price points, where consumers are more price-sensitive in an inflationary environment. Higher unemployment and/or weaker growth suggest that pressure could move up the ladder. With Traeger’s patent expired, lower-priced competition can undercut on price. That competition includes China’s Z Grills, a former manufacturing partner of Traeger that has become a rival.

The issue isn’t just with grills. Consumable revenues are already stalling out. They’re roughly flat year-to-date despite a higher installed base. One issue with Traegers is not the upfront cost, but the price of fuel. Each 20-pound bag (per the company) provides just 6 to 20 hours’ worth of cook time. Those bags cost a minimum of $20. Similar concerns surround the accessories business.

The Stock Is Expensive, Too

Combine those macro concerns with the pandemic overhang and there are real concerns about growth in the mid-term. Despite the plunge, COOK is still not cheap.

Based on the midpoint of full-year guidance, COOK trades at 25x Adjusted EBITDA2. There is some room for margin improvement, admittedly. The cost savings plan probably provides an incremental ~$15 million benefit against guided EBITDA of $35 million to $45 million. Container shipping costs could add a couple of hundred basis points to gross margin, potentially another ~$15M-$20M (~200-300 bps).

That’s still only getting EBITDA to the $70M-$75M range, suggesting a 13-14x EV/EBITDA multiple. Capex and interest expense alone (both ~$25M annually) leave precious little in the way of free cash flow.

This is a stock that is still pricing in growth. Long-term, there’s some potential for that growth to arrive. Mid-term, however, the challenges seem likely to linger well beyond the next two quarters.

Balance Sheet Problems

That’s particularly true because Traeger’s response to 2022 is going to impact its growth potential going forward. The company’s balance sheet has forced the company to focus on the near term at the expense of the long term.

At the end of Q2, Traeger had net debt of $465 million3, per the Q2 call. That's a 7x trailing twelve-month net leverage ratio — but as guidance shows, that ratio is going to get much worse.

Traeger has gotten some breathing room in terms of its covenants, moving to a maximum leverage ratio of 8.5x, and on that call CFO Dom Blosil explained that EBITDA as defined by the credit agreement is higher than the figure reported to investors. But the company has clearly taken steps to protect its profits and stay within even the loosened covenant.

Last year, Traeger announced Traeger Provisions, which offered high-end, ready-to-grill meals. Management talked up the offering on the company’s first conference call in November, noting a potentially huge increase in lifetime customer value. But Provisions was suspended as part of this year’s cost-cutting.

In a bid to diversify away from Chinese suppliers, Traeger planned to open a factory in Mexico that was supposed to boost margins going forward. That factory is being shuttered. International expansion was a core pillar of the long-term strategy; that’s going to have to slow, because the company doesn’t have the resources to invest properly.

As noted, Traeger decided to aggressively build inventory last year. On the Q3 2021 call, Blosil defended the risk created by the decision, saying:

“It’s all good inventory, right? And so, at the end of the day, we’re going to sell through it. We don’t have challenges with obsolete inventory.”

But because the balance sheet is so stretched, Traeger is ramping promotions in the second half of this year to move that non-obsolete inventory. That in turn adds to demand worries in 2023 (and beyond) and potentially resets customer pricing expectations.

The biggest potential impact, however, could be on marketing. Traeger is pulling back on broader, top-of-the-funnel brand spend this year, focusing instead on “performance-based marketing”, as Andrus put it on the Q1 call. It’s presumably also going to have to reduce its so-called “market assault” strategies, in which the company focuses intently on a fixed number of geographies. Expanded assortments and floor space at Home Depot HD 0.00 have been successful, but may see their own reduction given the home improvement giant may want to allocate space to higher-velocity, lower-ticket items.

A core pillar of the argument from Traeger management has been, essentially, that the product sells well once customers know it exists and works well. If that argument is correct, the top of funnel cuts, in particular, suggest a multi-year impact; there will be fewer customers aware of the company to target with performance-based marketing strategies down the line.

The balance sheet obviously is an issue from a purely financial standpoint. Traeger needs a reasonably quick expansion in margins to satisfy its lenders. The cost savings and design improvements might help, but given that Traeger is allocating second-half container savings to promotions, investors can’t simply model in several hundred basis points of expansion in 2023. In a worst-case scenario, Traeger winds up in significant financial distress once peak selling season passes in Q2 2023.

But, that aside, the balance sheet clearly has impacted Traeger’s go-to-market strategy as well. Management cannot invest where it would like because it needs to conserve cash. (Inventory reductions will help, but Traeger also needs working capital ahead of a seasonal peak in Q1. There’s remaining contingent consideration for MEATER as well, carried at $14.7 million.) Even a 14% headcount reduction is not insignificant for a company trying to grow market share against a myriad of rivals.

In a competitive industry facing a challenging period, it seems too optimistic to believe that these short-term responses won’t matter to long-term performance.

The Case For A Short Ahead Of Earnings

Despite these issues, COOK shares are up 52% since October 14th.

A broader rally, which has boosted a number of formerly struggling stocks, is one factor. But the bigger catalyst might be the buyout offer at rival and fellow 2021 IPO Weber WEBR 0.00. On Oct. 25, Weber's largest shareholder made a non-binding proposal to buy the company out for $6.25 per share. WEBR now trades above that level, suggesting the market sees room for a higher negotiated price.

No doubt that offer has read across to Traeger, whose story looks broadly similar. (Incredibly, WEBR’s fundamentals in terms of EV/EBITDA and leverage ratio are even worse. Weber has launched its own cost-cutting program in response.) COOK in fact gained 13% the day the Weber offer was announced, and it’s added another 4%-plus since.

We’d argue it’s much easier to buy the hope of an offer in the wake of the Weber news than in the wake of another ugly earnings report. It also seems unlikely that Traeger’s current owners (who sold shares in the IPO) are willing to make a similar offer.

In other words, Q3 weakness doesn’t need to be a surprise to be a disappointment. A quarter that doesn’t have an offer, doesn’t provide a change in strategy, and doesn’t show much more than Traeger moving some incremental product at a discount is enough to end the momentum here.

It should be enough to get the stock back toward a ~10x multiple to 2023 Adjusted EBITDA, which to our eye looks a lot like the lows around $2.50. And that’s probably the quarter Traeger is going to deliver, because it doesn’t really have any other choice.

As of this writing, Vince Martin has no positions in any securities mentioned. He will likely initiate a short position in COOK early this week.

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