Catalyst That Drove Acquisitions in Organic Food, Growth in Chipotle and Panera Bread, Now Benefitting WTER

July 31, 2015


Organic produce, fast casual food and value-added water have this in common – they’re all part of a massive demographic shift towards ‘healthy living’ and generate tens of billions in sales each year. Conglomerates are willing to pay rich premiums to acquire fast-growing companies to capture this growth to buoy their own sluggish sales.

If an acquirer were to buy the Alkaline Water Company (WTER), we believe the Company could fetch as much as a 3x recent market prices. Last year, WTER grew sales 570% year-over-year and has guided for sales growth of 170% for fiscal 2016. WTER sells a value-added water called Alkaline Water and recently began expanding the number of stores carrying their product after gaining title of top-selling alkaline water in Southern California. As they follow in the footsteps of Monster Beverage, we believe they could end down the same road as Fuze or Vitaminwater, both of which were bought by Coca-Cola at rich sales multiples.

In this note we look at compelling and investable trends that are driving healthy living, including consolidation among organic food producers and the emergence of fast casual dining as captured by the likes of Chipotle (CMG) or Panera Bread (PNRA).

Investors Who Foresaw ‘Organic’ Future Laughing All The Way To The Bank

A survey by Consumer Reports shows that 84% of Americans have purchased organic food, contributing to a $35.9B organic food market in 2014. Organic food, which now represents almost 5% of total US food sales, grew 11% last year, while the remainder of the food market lagged behind in the single digits.

Figure 1: Organic food sales nearly quadrupled in the last decade

The organic food market is projected to grow at a compound rate of 14% until 2018, outpacing conventional food which will continue to lag in the low single digits. This high growth has caught the attention of Big Food companies that are looking for growth avenues to buoy their own sluggish sales.

According to Michigan State University Professor Phillip Howard, in the last two decades, there were an estimated 81 independent organic processing companies in the United States. However, by 2007 all but 15 of these companies were acquired by multinational food processors that recognized the underlying consumer lifestyle shift.

Figure 2: Consolidation in organic food industry has helped multinational food processors capture majority market share.

It Pays to Be Healthy

Last September, General Mills (GIS) acquired specialty food maker Annie’s for $820M, rewarding Annie’s shareholders with a 37% premium to where shares traded in the market at the time. With General Mills’ 5-year growth stuck at 3.79%, the food giant wanted to expand its presence in the US branded organic and natural food industry, the fastest growing food segment showing double digit growth in the last decade.

Annie’s natural product offering compliments increasing consumer awareness of healthier diets, which has translated into fiscal success. In 2013, Annie’s reported $204M in food sales, implying that General Mills paid a hefty 4x sales multiple to own this double-digit growth company.

Figure 3: Organic product company acquisitions cost acquirers 2.6x sales

Is Boulder Brands The Next Target?

Consolidation in organic & natural food shows that multinationals are willing to pay for growth given the rise of all-natural products in mainstream diets. As the industry giants face grim growth prospects, buying up smaller brands may prove to be the most prudent use of cash.

Boulder Brands (BDBD) is a natural consumer packaged food company with annual revenues of more than half a billion. Although the company is expecting 2015 net sales to be in the range of $550M, only 6% year-over-year growth, their offering is aligned with the top health and wellness claims such as ‘natural’, ‘organic’ and ‘gluten-free’ (as shown, below). As a result, the company should be well positioned in the medium term to benefit from the lifestyle diet shift.

Figure 4: Boulder Brands Well Positioned With Consumer Trends

Due to weak guidance and slowing growth, Boulder’s shares have fallen 30% year-to-date. This decline may be a buying opportunity for a big food company looking to expand their product portfolio. The top line headwind that the company is currently facing should prove to be immaterial to an acquirer looking for a long term fit. Having a portfolio that is aligned with the top growing consumer trends will help fuel Boulder’s sales past 2015. At historic acquisition multiples, Boulder Brands could fetch takeout offers as high as $22/share, a 175% premium to recent market prices for the company’s shares.

Millennials Making Fast Food Casual

Figure 5: Fast Casual Food Sees 10x the Growth of the Fast Food Industry in New Millennium

Fast casual food is a healthier alternative to fast food on the basis of quality of ingredients, perception of freshness and full view of how food is prepared. Millennials, who make up the biggest demographic of fast casual fans, find themselves less willing to eat conventional fast food from the McDonald’s (MCD) and Wendy’s (WEN) of the world, which are viewed as unhealthy.

Sales of fast casual food has grown 550% since the start of the new millennium, according to data from market research firm Euromonitor. With receipts ranging from $9-$13, fast casual chains typically squeeze 40% more out of each diner’s wallet compared to fast food joints. While there are roughly seven times as many fast food restaurants as fast casual ones, both categories notched the same growth in absolute sales (~$9.3B) from 2010-2013. This shift in consumer preferences has led to the rise of chains like Chipotle (CMG) and Panera Bread (PNRA).

Figure 6: Fast casual growth making a dent in overall restaurant sales allocation

In 2013, fast casual represented roughly 7.7% of restaurant industry sales according to data from researcher Technomic. This figure is up from 6% in 2010 and 1% in 2000. Fast casual brands increased their collective annual sales by 12.8 percent in 2014, a growth rate that was nearly double the next-largest increase from any other restaurant segment.

Market research firm NPD Group estimates that fast casual will grow in the double digits through 2022, while the rest of the restaurant industry will flatten out at around half a percentage point.

Figure 7: Chipotle’s rich valuation multiples indicating investors expect growth to continue

This continuing trend has supported the expected 22% growth rate in Chipotle’s earnings and the 390% gain in Chipotle stock in the last two years. The company’s valuation multiples, as a result, have been on the high end of all industry metrics, indicating that investors expect the growth to continue.

Health Shift in Beverage Industry Leading Investors Away From Household Names
In 2014, sales and consumption of bottled water, the number 2 packaged beverage in the US market made strong gains on the number 1 category, carbonated soft drinks, according to reports from Beverage Marketing Corporation (BMC). Bottled water has increased its “share of stomach” of the overall beverage market from 14.4% in 2009 to 17.8% in 2014 (below).

Figure 8: Water on the verge of overtaking soft drinks as #1 beverage

With the rise of “healthy living”, BMC predicts that bottled water will overtake soft drinks by 2016. Last year, bottled water achieved unprecedented highs in consumption (up 4% YoY) and sales (up 5.7% YoY). In comparison, carbonated soft drinks saw a 1% decline in consumption.

The world's largest beverage companies are ill prepared for this generational shift, with their product portfolios concentrated on carbonated soft drinks. Therefore, investors must seek alpha in smaller names like The Alkaline Water Company (WTER) as large brands like Coca-Cola will be looking to fill the top line void with high-growth products through acquisition.

2 Consecutive Years of Triple Digit Sales Growth Could Put WTER On Acquirers’ Radar

Sales of Alkaline88, WTER’s flagship product, grew 570% year-over-year in 2014 on the back of shelf expansion to 16,000 retail locations. Demand for Alkaline88 has been spurred by consumers becoming increasingly aware of their health and wellness. This shift has positively translated to adoption of value-added waters, including WTER’s Alkaline88.

Figure 9: Increased health awareness resulting in WTER’s upward sales trajectory

WTER expects revenues in excess of $10M for fiscal 2016, which implies growth of at least 170% compared to fiscal 2015. While the Company has guided and reiterated sales for fiscal 2016 to be at or above $10M, we believe that it’s likely that the company will exceed this figure for the following reasons:

WTER has increased production capacity threefold over the last year by adding new co-packing plants and machinery throughout the country. The increase in capacity should quickly increase production capacity to $2M of water wholesale per month or an annual run rate of $24M. With strong demand for Alkaline88, increased production capacity and continued retail store expansion, we believe WTER’s $10M guidance for fiscal 2016 sales is conservative and on the lower end of what investors can reasonably expect from the Company.

If Coke Bought WTER, They Could Pay 200% Premium to Recent Market Prices

As with consolidation in organic food in the last decade, we believe a similar trend is occurring in the beverage space. In 2014, Coca-Cola’s North American sales were flat due as consumers shifted away from carbonated soft drinks. To make up for the lack of growth in this slowing category, Coca-Cola, Pepsico (PEP), Dr Pepper Snapple (DPS) et al. will need to spend on acquisitions.

Figure 10: Companies with Fast Growing Products Fetch High Price Tags in Beverage Industry

Historically, fast-growing companies in the beverage industry have been acquired at an average of 5X sales (see why Coca-Cola would pay more than 3X WTER’s current market price).

If WTER were acquired at the average of four notable acquisitions in the beverage space, shares would have a take-out value of $0.43, or be worth roughly 3X recent market prices. This relies on the Company’s forward guidance of $10M in sales for fiscal 2016 (which ends on March 31, 2016 or Q1 of calendar 2016).

If consolidation among organic food companies, or the rise in fast casual dining names is any indication, value-added water producers could be next on the acquisition block. We think the Alkaline Water Company (WTER) is an exciting and compelling way to capture upside created by the multi-billion dollar health & wellness movement. At the very least, we view shares of WTER as trading at a 68% discount to what a large beverage company would potentially pay to own them outright.

About One Equity Research

One Equity Research is a leading provider of proprietary and in-depth research crafted by respected financial analysts and domain experts. Our team includes trained finance professionals with diverse backgrounds that include equity research, investment banking, and strategic consulting at preeminent firms. We distribute our research through mainstream media partners and to subscribers of our Intelligence Service. To learn more please visit http://www.oneequityresearch.com/

This research note has been prepared by One Equity Research LLC on behalf of The Alkaline Water Company (the "Company") as part of research coverage services. One Equity Research has received 1.5 million restricted shares of common stock from the Company as consideration. In addition, One Equity has received twenty nine thousand nine hundred fifty five dollars from LP Funding, a consultant to the Company, for coverage of The Alkaline Water Company as of the date of this note and expects to receive additional compensation in the future. This research note is not an offer or solicitation to buy or sell the securities of The Alkaline Water Company. The note is for information purposes only, and is not intended to (and is provided explicitly on the condition that it not) be used as the sole basis to make any investment decision. Investors should make their own determinations whether an investment in any particular security is consistent with their investment objectives, risk tolerance, and financial situation. Please read our full disclaimer at http://www.oneequityresearch.com/terms/

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