Sunday, January 6, 2013

Where Food Comes From (WFCF)

This post was sparked by a remark I made on Twitter a few days ago. I asked "Serious question: wld u want to see this in 10K? "This rev. source is still in its infancy & we anticipate exponential growth in the future"

The quote came directly from the 10K for Where Food Comes From (WFCF). Not only that, but the company recently changed it's name to "better reflect it's industry-leading brand."

WFCF has a lot of things going for it. The company owns 60% of International Certification Services, with a right of first refusal to the last 40% of shares. As best I can tell, it is one of the few of these firms that seems to actually make money. Apparently, training and certifications for these companies is a time consuming and tedious process.

It was also recently talked up on MicroCapClub, with a nice presentation, which the company touted in a press release. Why companies like this and Nevada Gold (UWN, which I am long) don't simply put it out in a 8K to save money for shareholders, I don't know. There have previously been some odd stock transactions with the founders, but then again, the founders (which is present management) also put their house on the line and have offered to lend the company money to keep it afloat. Years later, there seems to be no need for that as the earnings of the company are solid. Obviously, there is a management team in place (owning a HUGE amount of the company) that wants to see, and believes the company can succeed. They don't seem to want to destroy the earnings of the company with huge salaries either.

And the industry... Oh boy. It's a doosey! Verification of food. That's right! This company is the dream of every person who sleeps better knowing that their food was killed in a humane way, only ate grass, or didn't get injected with antibiotics. Even Kraft, maker of the cheese amalgamation called Velveetarecognizes the importance of food tracking.

Check out what one of WFCF's customers- Chipotle (CMG) has done with marketing the concept:

Do you really want to eat that KFC after being serenaded by Willie Nelson (who probably just had a bowl... from Chipotle) and watching a dreamy scenario of the industrial meat industry getting torn down? Doesn't that make you feel all warm inside!?

One of the items that works really well for the company, is that there is probably a lot of pricing power, which you can read up on in The Undercover Economist. Basically, people that are willing to pay more for organic, grass fed, or Fair Trade products, are REALLY price insensitive- so they are willing to pay the company offering such product, a really high margin. Just look at TOMS shoes. No one can tell me that 2 pairs of shoes, that are little more than an insole with a t-shirt sewn on top should ever cost in excess of $50 bucks (for cheap ones). The things are basically house slippers and a diservice to poor kids- they would be much better off with Chuck Taylors. When you can sell a marked up product that is inferior for the money, that can make for a great high return investment.

Taking this to the household level, a BIG family dinner would probably cost less than an additional 25 cents for a whole lot of utility. PLEASE KEEP IN MIND... this is only for the food verification service. Where Food Comes From could potentially have a lot of pricing power too- just think if they up their price by a single cent!? The only real threat isn't people not wanting the meat that they service, it's people like Whole Foods wanting to go elsewhere... Over a single cent. However, people that are buying beef that the company verifies is likely paying a lot more for food than if they were buying what I would call "industrialized meat."

There are some hitches with this though. The way that I see it is that this is a services company, and as such, would generally demand a lower than market multiple. This isn't the sort of business that if another company wanted to destroy, couldn't do so with $100 million dollars... The CEO notes that they have a lot of unique and repeat customers (who all seem to grow their relationship with the company). And that you have to do enough business to get above $2mm in SG&A to be profitable...

As noted, the company charges 3 cents per pound of beef. Take a look at their margins... They grow pretty heftily with every incremental increase in revenue... With every acquisition, they can probably eliminate a lot of corporate overhead, and essentially buy a book of business to integrate into their own systems. This allows them to buy companies that are barely working, and make them into real profit centers. That's works out well, because with its trailing P/E of 30, there is a really healthy growth rate that is expected for the company...

Unfortunately, BIG margins and BIG growth attract competition... From where I sit, the main problem for the operations of the company is the stability of their revenue.

While the company does work with Whole Foods, it does have others that are working with the company as well... Steritech, EarthClaims (which has one of the worst websites I have seen), and AUS-Meat. This leads to the labels on the food (pictured) that they support, which the company has no name association with. The employees at the Whole Foods that I went to explained it as a program that is done by a non-profit, that is done by Whole Foods, that is actually done by other companies (which, as best I can tell, is pretty accurate.)... Anyway, you can see from the pictures what the labeling looks like for yourself. I'd think that since there is no real branding for the company, people probably already assume that they are doing something great for the world, simply by shopping at a place that has "organicy" stuff. It may be a different case at the high end grocers (which have signage) that the company has attracted (and got a board member from), but the amount of protection they have from being dropped by Whole Foods is a mixed bag and far from certain. The company claims that the industry is all about trust and that getting into the business is hard to do... Which, is a fair claim. I might worry about other established firms coming in on them, but a lot of the farmers that they do business with probably value the relationship and don't want to change things up too much- choosing to focus on their business instead. Again, I would be more worried about a super market chain dropping them due to a bankruptcy or even lower a cost structure.

Something else to consider is that this is an industry that often has a lot of non-profit tendencies... What happens if that mentality moves into this profit center, and the food verification industry goes non-profit, or even governmental? Is there a guarantee that this company will be OK? Not really, but, I wouldn't think that it would be something that the company couldn't weather... This isn't a conspiracy or anything.

Regardless, this industry seems ripe to grow for a long time. This seems like a way to even bet on the growth of Whole Foods and the organic market in general (despite it not making up more than 10% of WFCF's revenues)... Whole Foods carries a P/E of well over 35, indicating a market acceptance of the idea that the good food industry should thrive. More directly though, what happens if WFCF can land a contract with Trader Joe's? Ruth's Chris? Kroger? Or dare I say, Wal-Mart!? I don't think this is a far stretch, especially since even Wal-Mart, which strives to cut costs everywhere they can, sees benefit in tracking some of their fish products, which I would imagine would be a hit in their Corner Market style of stores... The company seems to already have enough farms that they work with that they work with to be able to scale up.

Given the growth potential for the industry, it leads me to wonder... Why doesn't the company figure out some way to get a commercial a kin to the one that I linked to earlier (see below, for good measure), on the Super Bowl? It could be a huge game changer and be the modern day equivalent of "The Jungle." Super Bowl ads aren't cheap, but surely a consortium of third party verifiers, co-ops, and grocers would get on board as they would all benefit greatly.

Any media attention that this could generate has the chance to be a double-edged sword for the company (though, probably not the industry). Obviously, the company has the moral high ground... Until they screw up. To me, the biggest concern is similar to what led Warren Buffett into American Express: What happens if the auditors of the company screw up and food, that they have verified, has mad cow or some other terrible disease? It may be a stretch, and the public may not blame them, but we live in an era where the new media can destroy companies on a whim... PRXI, anybody? WFCF does have diversification of product verification though- so, there is a bit of a hedge I can't imagine them messing up with beef would translate to them not verifying some sort of vegetable. Potentially pork or something of that nature, though.

But maybe at the end of the day, people don't care who certifies their food. They just want a label on it so that they can sleep at night, thinking that they aren't slowly killing their families with meat that's tainted with things other than just a ton of saturated fat. I don't guess there is any way of telling until some event like that happens. As others slowly come into the market, this could become a commodity sort of product. Do the auditors have non-compete clauses?

Even with my hangups, there probably shouldn't be a big hang up on the exponential growth comment or even the likelihood of them not getting consistent revenue... Either through growth to the industry or acquisition.

In light of all this, I find myself not long the stock, as I am trying to wrap my head around the growth rate.

It just seems too damn expensive! But then again, I am notoriously cheap with these sorts of things... Especially when there isn't a ton of depreciation or hidden assests that obfuscate earnings or book value. This is basically a bet on WFCF transforming into the cash churning machine that it has a lot of potential to turn into (and, has had a decent amount of success doing in the past few years).

If it were priced as it was a year ago, with an earnings multiple of closer to 10, even 15, I would probably bet a lot on it... Who knows though, it could be that I am just too contrary for my own good, and the fact that the stock has already been talked about makes me not like it nearly as much.

But, who knows, maybe we'll see it come back to earth, or I will get my head wrapped around its growth story. It does happen from time to time, which is one of the reasons I try to I follow stocks. Until the price to obvious value gets more in line with what I want for a margin of safety though, I will be missing the boat.

EDIT: As Ian from MicroCap Club pointed out in the comments section, I did omit their tagging business (which in their 10K they talk about being pretty low margin- even talking about suppliers of tags). I didn't feel much of a need to talk about that any since this piece was about the growth story. Though, I realize that could have been a touch misleading. I don't agree with all the points he makes (such as 20% growth for their presently core business), but his comments are noteworthy. Read them, do some research, and see what you think.

EDIT 2: Here is a cool site to look at industry developments and such.

Disclosure:  I have no position in regard for or against any of the entities mentioned. I reserve the right to change my positions at any time. This post is my opinion. Always do a ton of your own research before even contemplating anything that I say, do, write, or so much as think about.

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