The Chefs’ Warehouse, Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

The Chefs’ Warehouse, Inc. is a specialty food distributor, serving a wide range of independent restaurants, caterers, and other foodservice operations.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: The Chefs’ Warehouse (CHEF) primarily operates as a specialty food distributor, catering to the culinary industry, particularly independent restaurants, caterers, and other foodservice businesses. They source and distribute a diverse portfolio of high-quality products, which often includes specialty ingredients. The company’s reach extends across the United States, the Middle East, and Canada, as evidenced by their operations, which span numerous metropolitan areas including New York, Los Angeles, and Chicago.

Revenue Distribution:

The company segments its revenue by product category. Within their specialty segment, they sell proteins (meat, poultry, and seafood), dairy products, produce, pastry items, and ingredients. The specialty division constitutes the majority of total revenues and is often sold through a network of independent sales representatives.
They also have a broadline category that consists primarily of center of the plate proteins, produce, frozen foods, and other staple items used by all types of restaurants. This division is typically sold through more traditional delivery processes.
The business serves a variety of customer types including: independent restaurants (the primary focus), country clubs, catering services, bakeries, hotels, and other culinary businesses. They have over 70,000 stocking keeping units.

Industry Trends and Competitive Landscape: The foodservice distribution industry is fragmented, competitive, and sensitive to economic cycles. Consolidation is an ongoing trend, especially among smaller distributors, as they seek to gain economies of scale and efficiency. Large national players are now expanding into local markets and smaller niche players try to be everywhere and service smaller restaurants. The industry is also affected by changes in consumer preferences, health and safety regulations, and the adoption of technology, particularly in the supply chain, as well as labor cost and management which continues to be a challenge.

There is no real single market share leader that captures most of the market, but more rather smaller players, with strong local ties, compete on service and price. Competitiveness is high because the switching costs are low and that results in price wars.

What Makes CHEF Different:

Focus on Specialty Foods: CHEF differentiates itself by concentrating on hard-to-find ingredients. Their ability to source these products, often from smaller, independent suppliers, provides a unique value proposition.
Customer Service Orientation: The company positions itself as a partner to chefs, offering tailored service through experienced sales reps. They also work closely with chefs to understand their needs and to develop customized solutions.
Distribution Network and Scalability: CHEF operates a wide distribution network across the US. The company has invested in technology to enhance the supply chain operations, to minimize inventory holding costs, and to lower shipping times. They focus on “last-mile delivery”.

Financials Analysis:

Revenue Growth: The company has a strong track record of revenue growth. While the company’s revenue was $1.93 billion in FY 2020, it increased to $2.6 billion in FY 2022, this trend has continued growing in 2023. This growth is driven by organic sales increases and strategic acquisitions.

For the first quarter of 2024, Net sales increased by 8.6% compared to the previous year and organic growth grew by 6.1%.
Q2 2024 Organic growth came in at 6.1% also, net sales up 4.4%, but growth in specialty products fell to 1.8%. Overall growth is still strong with new customers coming and sales expanding as their existing customers also grow.

Gross Profit and Margins: Gross profit and margin have shown considerable improvement. The consolidated gross margin was 24.1% for the second quarter, an increase of 128 basis points from the prior year. This gross margin was supported by improved procurement and distribution, and new product introductions.

In Q1 2024, gross profit increased from 23.6% to 24.1%, an increase of 50 basis points.
In Q2 2024, gross profit margin increased to 24.1%, an increase of 128 basis points.
While gross profit margin has increased over the last 2 quarters, pricing remains a critical area where they are attempting to maintain and improve margins.

Profitability: While top line growth is strong, bottom line profitability has been less consistent.

For Q1 2024, net income was -$13 million. While net loss was expected, it was still disappointing to the management.
Net income was positive for Q2 2024 and a small net profit was reported. But the previous year net income was very much higher compared to this quarter.
The high level of interest expense is depressing profitability and making the debt repayments difficult.

Financial Health:

Liquidity:
Total cash as of March 2024, was $34 million, which is still quite low for a company of this size.
Revenues have increased to $2.6 Billion in 2023 and will probably increase further in 2024. That also means that the cash flow should be at least 10 times higher than current cash reserves.
Working capital seems to be a little lower as well.
Solvency:
The company does not have a strong debt to equity, though its debt is high overall.
Total liabilities are almost at par with total assets. A large part of liabilities are loans, which are a drag for any cash flows and puts the company at risk.
The company has made major acquisitions in the past and has also grown organically by taking on more credit.

Recent Concerns and Management Commentary:

Interest Rates: Elevated interest rates are a large headwind, significantly increasing interest expenses and affecting overall profitability. Management is working to deleverage and focus more on profitability than on debt-driven growth.
Margin Pressures: Pricing pressures due to increased competition and fluctuating market conditions are limiting the company’s margin expansion. Management is looking for improvement through efficiency and product optimization.
Food Inflation: Food prices have remained very high, which can impact the restaurant industry, who are the customers of CHEF. That, in turn, can impact CHEF as well. However, management is focused on providing good value to the restaurants through differentiated products that they may not be able to find easily elsewhere, and hence can be sold for a higher price.
Supply Chain Issues: While the supply chain disruptions of recent years have faded, their effects are still being felt throughout the economy. In some instances, lead times are still unpredictable.

Moat Rating Justification: 2 / 5

CHEF possesses some moats, but they’re not particularly wide. Here’s the breakdown:

Intangibles (Brands): The company doesn’t have powerful brands that create pricing power.
Switching Costs: Customers can easily switch to different suppliers, so switching costs for its clients is low.
Network effect: Not applicable in a significant way.
Cost Advantages: While they try to drive prices down through supply chain improvements, their prices are in line with other distributors. Also, their focus on differentiated product offerings may create higher costs.
Size: Given the company’s size, they have some advantages with network, but it is not as good a moat as large, national companies. Verdict: CHEF has a narrow moat created through specialized product selection and distribution, and differentiated customer service. They don’t have a particularly powerful brand, unique distribution channels or large market share in every location. It is a low margin business, so if prices increase from supplier side, or competitors engage in a price war, they would suffer.

Legitimate Risks to the Moat:

Competition: Competition is extremely intense, particularly from other distributors, and new entrants with better processes may gain market share.
Commoditization: If CHEF fails to maintain unique offerings, its products could be treated as commodities, leading to price wars.
Economic Downturn: During an economic slump, restaurant sales will fall, thereby reducing demand for CHEF products.
Inflation: Rising prices in supply chain will be difficult for CHEF to pass to customers since they compete on price, which may erode profit margins.

Business Resilience:

The company operates in a relatively stable sector. Food service is a basic need and they serve mostly independent restaurants that provide that service.
They also serve some diversified businesses that have good margins and are not that dependent on consumer trends. These include: Hotels, caterers, and bakeries.
Given the company’s supply chain and sourcing infrastructure, they are able to recover more quickly than smaller companies, hence the business is resilient.
They are also focusing on improving operating margins which would help their financial picture and make their business resilient.

Understandability Rating: 2 / 5

The business model is relatively straightforward, as they are a distributor and not a retailer or a manufacturer. However, their financial statements, particularly the number of revenue and operating expense adjustments, make it complex to analyze their financial statements, resulting in a 2/5 complexity rating. They have a complex structure with diverse product offerings that they source from different suppliers which may make it difficult for an individual to follow.

Balance Sheet Health Rating: 3 / 5 While not in bad shape, their balance sheet could be better. They have a high debt and low cash flow, as a result, I have ranked it as a 3/5. If they manage to improve profitability, reduce debt levels and increase cash flow, then they would gain a better financial picture.