Lamb Weston

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Lamb Weston is a leading global producer, distributor, and marketer of value-added frozen potato products, sold under the Lamb Weston brand.

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.

Lamb Weston is primarily known for its frozen potato products. It’s important to recognize they don’t grow potatoes. Instead, they process potatoes grown by other companies, which limits the ability to control supply or input costs, which could impact profitability in certain conditions.

Lamb Weston operates in 2 segments, North America and International, with the former contributing about 67% of total net sales. The rest come from the International segment.

Business Overview and Competitive Landscape

Lamb Weston (LW) is a major player in the frozen potato industry, processing and distributing various products like french fries, hash browns, and mashed potatoes. Their operations are segmented into North America and International, reflecting their global reach. However, they also have some joint ventures that are included in their books, with most of the sales stemming from North America. Here is a more detailed explanation of the business:

  • Revenue Distribution: Most of Lamb Weston’s revenue comes from its North American segment, serving large chain restaurants, retail stores, and foodservice distributors. The international segment serves similar customers, with a particular emphasis on quick-service restaurants.
  • Industry Trends: The frozen potato industry is characterized by a stable, yet competitive environment. While demand is predictable and relatively consistent, changing consumer preferences (such as a shift toward healthier eating) and increasing global competition (from companies like McCain Foods) may affect the industry. Also, there has been a significant amount of inflationary pressure within the last few years.
  • Margins: They seem to struggle from an inability to fully pass on all of the additional costs to consumers. As stated in the latest earnings call, margin expansion was expected, with operating profit anticipated to show “good growth”. However, the company has also stated that their pricing strategy involves passing on costs, but that could be limited by contract provisions with customers, limiting flexibility, so this may not last for long if the inflationary pressure eases. The company has also stated their production facilities are at 80% capacity.
  • Competitive Landscape: The company faces competition from other large-scale frozen potato producers and from smaller players within the different regional markets. Differentiation is difficult, so there can be price wars when there is oversupply in the market, with competitors like McCain Foods. However, the company also relies heavily on strategic partnerships and acquisitions for growth.
  • What Makes the Company Different?: While LW does not grow its own potatoes, it seems that their moat is mainly based on distribution networks and scale, both of which allow them to provide greater stability of prices, and a reliable supply, that some of their competitors might not have. However, this is a weakness too, as they cannot control production costs, while many of their customers have an option of choosing other suppliers and can have more negotiating power.

Financial Analysis

Here is an analysis based on the latest quarterly reports. This information can change based on new reports. Be sure to use recent, rather than old, financial data for your analysis.

The report contains many one time items and non-recurring expenses. Always pay attention to the notes in the report before forming an opinion on the company and its financial health.

  • Profitability: Net sales for the fiscal year 2022 were $5.13 billion (compared to $4.26 billion in 2021), with the company posting a profit of $344 million(compared to a loss of $135 million in 2021). For the first fiscal quarter of 2023, the net sales were reported as $1.397 billion, with a profit of $124 million. Gross profit also increased year-over-year by about 14-20%. However, the adjusted EBITDA margin and net margins saw some decline over last year due to higher production costs. The return on equity is low at about 10%, compared to the high of 30% that the company enjoyed in 2001, but is trending upwards. The company’s operating margin is at around 12.5%, which is lower than their peers like McCain.
  • Cash Flow: Lamb Weston had positive free cash flow for 2022 ($252 million) and also for the first quarter of fiscal 2023 ($194 million). In the latest report the company noted that they had completed about $500 million in stock repurchases, so this is something that investors should keep in mind if the company is unable to use its cash to make more future investments due to aggressive buyback programs.
  • Balance Sheet Health: The balance sheet shows a relatively stable financial position. With current assets at $2.7 billion (including inventory) and total liabilities at $3.6 billion, the current ratio at below one. While this is relatively good compared to their competitors, a decrease in current assets could pose some problems for future growth if not managed correctly, but currently it is adequate. Long-term debt is about $2.4 billion, and they have a history of paying their debt as it becomes due, so all seems fine in that respect, too, and it can be classified as a healthy balance sheet for an industrials company. The company’s equity of $3 billion is also solid.
  • Recent Concerns and Controversies: The company mentioned in the recent earnings call some issues with supply chain, especially for products that use palm oil, where there have been some difficulties obtaining these products. However, the company seems to have taken steps to mitigate these risks. The company also faces some challenges with a new ERP system in North America, where they are having to work through implementation issues that have caused minor delays in production, but all seem to be solved by the next quarter. The company is undergoing a major restructuring as part of a cost-saving program, which has resulted in some one-off costs. The company is also trying to manage inflationary cost pressures, especially relating to input costs, by increasing pricing and efficiencies, and it remains to be seen how that will play out. There have also been higher energy costs, but those seem to have been managed and are not considered to be a major concern. The company continues to focus on volume increases and improving operating efficiency and expects a return to the margins from 2019.

Moat Assessment

Lamb Weston has some characteristics of a business with an economic moat, mostly attributable to their scale and extensive distribution capabilities. However, these are not considered strong enough to classify them as having a wide moat. For example, smaller distributors will always be able to deliver directly to consumers, without having the large network that Lamb Weston does, but the consistency of supply that the company can provide, and that it can deliver at a lower price, does give it a slight edge over some players. With that said, the pricing power of the company is also limited, as shown in its inability to fully offset inflationary pressures, and thus it is not truly durable. I rate the moat a 3 / 5, as there is an argument for a weak-wide moat, but also for a weak-narrow moat. Given the uncertainties, a rating of a narrow moat will be better.

Understandability

The business is easy to understand from an operational perspective: the company takes potato products and processes them into various different forms, such as french fries. However, the financials are complex because of the interplay of different supply/demand chain disruptions, as well as the volatile nature of prices, making the financials of the company difficult to analyze. Therefore, I would rate this a 2 / 5.

Balance Sheet Health

The balance sheet health is good, but not excellent, due to the limited working capital and low quick ratio. In the grand scheme of things, the company is in a great position, however. The company has a history of repaying its debts and their equity is solid, so I will rate this a 4 / 5.

Risks to the Moat and Resilience

  • Technological Disruption: While unlikely, advances in food-processing technology could create new competitors or render LW’s current processes obsolete, reducing the value of their large distribution network. However, it is difficult to see this being something that drastically alters the industry, so this is not a major threat.
  • Changes in Consumer Preferences: If there is a significant shift towards consumption of healthier options, or away from frozen potato products, that might have a negative impact on revenues for the long term. However, it is unlikely, and is more probable that they will adapt by expanding their product portfolio.
  • Commodity Price Fluctuations: Because the company does not own its own farms, they do not control raw materials input costs, leaving them vulnerable to price fluctuations. There also appears to be a problem for the company of passing on costs to the final consumer. Any significant rise in input costs could squeeze margins and profitability. However, there seem to be some contracts already in place that protect against this to some degree.
  • Overreliance on a few key customers: While diversified, the company depends on a few very large food service and retail chains, and any loss of partnership with those could cause major drops in revenues. This is an inherent problem with large cap consumer staples.
  • Supply Chain Issues: Any problem in the supply chain of raw materials will impact the company. It is reliant on a limited number of suppliers to get their product, and any breakdown in this aspect could lead to higher costs and lower output. This is more pronounced if the company is unable to completely pass on extra costs. However, they are trying to create a more resilient supply chain and reduce disruptions.

Overall, Lamb Weston is a decent business with a narrow moat that is primarily based on its distribution capabilities and strong customer relationships, but it does not have complete control over input costs, which is a potential area of concern. The company has been improving performance metrics in recent years. A disciplined and long-term oriented investor will find them to be a good investment option.