In April 2020, I purchased shares of plant-based meat company Beyond Meat (NASDAQ: BYND). I didn’t buy shares because I’m a vegetarian. To the contrary, I’m still pretty fond of animal protein. Rather, I purchased shares of Beyond Meat, because I had developed an investment thesis — a case for what I believed would happen with the business and how it would create market-beating shareholder value.
By having a concrete investment thesis, you can judge a company’s performance over time and measure business results while ignoring stock price fluctuations.
Well, I’ve been measuring Beyond Meat’s performance since I bought the stock, and a major tenet of my thesis may have already been invalidated.
Here’s my thesis
According to Gallup polls, the percentage of vegetarians in the U.S. declined from 1999 to 2018 and represented just 5% of the population. That means a small and shrinking opportunity. That’s why Beyond Meat attempts to create alternative meat products so realistic that even non-vegetarians like myself would occasionally buy some.
Consider that Beyond Meat wants its products to eventually be cheaper than animal protein. Assuming the smell, taste, texture, and nutritional profile was comparable, you’d expect the majority of consumers to purchase Beyond Meat’s products — not occasionally, but frequently, to save money.
However, the problem with lowering prices is it hurts profit margins unless there are commensurate cost reductions. Beyond Meat’s management has a long-term commitment to a 30% or better gross profit margin. And for 2019 and 2020, its gross margin was 33.5% and 30.1% respectively, living up to that target despite lowering prices.
Beyond Meat does have a path to lower costs. The company manufactures its own products, and its factories have high fixed expenses. Therefore, to reduce overall input costs, more volume is needed. And Beyond Meat has done an admirable job of getting its products placed in more and more outlets. When it went public, Beyond Meat products were available in only around 31,000 outlets around the world. At the end of 2021, that number expanded to 130,000.
This was my investment thesis in 2020 in a nutshell: Beyond Meat can appeal to a broad consumer base, gain mass adoption by underpricing animal protein, maintain profit margins through efficiencies of scale, and reward shareholders with both outsized revenue growth and earnings.
Here’s what’s falling apart
To be clear, much of my thesis is playing out. However, there’s one glaring shortcoming: Beyond Meat’s gross margin has been falling. Look at the last five quarters:
Why is this important? Let’s assume a company generates $1 billion in annual revenue at a 30% gross margin. This company would earn $300 million in gross profit. However, if gross margin falls to 10%, this company would need to generate three times as much annual revenue just to achieve the same gross profit as before. Margin matters.
Beyond Meat management has listed a variety of reasons for the big gross-margin drop, including higher logistics costs and inventory write-offs. But the more troubling reasons include lowering prices and discounting items in store.
This is a problem, because Beyond Meat had previously delivered lower product prices while maintaining its gross margin. And this was my thesis. Lower prices are essential to achieving greater adoption from consumers. But if the company can’t do it while maintaining its gross margin, then lowering prices is detrimental to its financial health.
Some might point out that results for the first quarter of 2022 were hit hard by the release of Beyond Meat Jerky, the first product release from its partnership with PepsiCo. Management said this single product pulled gross margin down by 940 basis points. But these launch costs are somewhat justified, considering the product is in a new category, and it’s been generally well received.
However, Beyond Meat’s margin still would have declined sequentially even when factoring in the impact of the jerky.
Beyond Meat expects to grow full-year net revenue 21% to 33% in 2022. That’s solid growth, but it’s only part of what will make Beyond Meat a long-term winning investment. It also needs to grow earnings, and right now, it’s seeing serious pressure on its gross margin.
To be clear, management expects this margin pressure to continue in the current quarter before moderating in the second half of 2022. I wouldn’t buy shares until we see that improvement. And if significant improvement doesn’t happen in the second half of the year, then it may be time for me to admit my investment thesis is broken, causing me to sell my position in Beyond Meat stock.
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