Kitwave – another ‘Zulu’ in the making? Surely not.

KITWAVE Epic: KITW. Aim listed. Mkt Cap £170m

Apr 25, 2023

Twitter: @rebelHQ

Below is just some thoughts, it isn't investment advice or incitement to buy in any way, just my views - please do your own thorough research. I’m not an analyst, I’m just a private investor looking after my own money. Nothing I do or say is meant as advice or should be taken as such. Here I publish my ideas and research that I have done and discuss the way I invest. Anything written here needs to be verified for its accuracy. Assume any stock I write about I likely own, so my views are biased. Inevitably I will get things wrong, ,As the Rag N Boneman said, I am only human after all, so do your own research. Everyone is responsible for their own decision making and what they buy and sell. Subscribing and reading this article means you accept the above and you take full resposibility for your own actions and decisions. Small Cap stocks can be illiquid and vary hard to sell at times when demand is weak so caution is required.

The only tip you’ll get from me is to wear a hat when it’s raining.

Founded 35 years ago in 1987, following the acquisition of a single-site confectionery wholesale business based in North Shields, United Kingdom, Kitwave is a “Delivered Food Wholesale Business”, as opposed to cash and carry. Kitwave specialises in selling and delivering impulse products, frozen, chilled and fresh foods, alcohol, groceries and tobacco to approximately 42,000, mainly independent, customers. Kitwave made its Aim stock market debut on 24^th May 2021. Independent stores are convenience stores, restaurants, pubs, cafes, schools, care homes and leisure centres. They do not compete on price, they complete on service, reliability and guaranteed delivery on time from their own fleet. Range, availability and service is their USP, a full range of everything you might see in a store.

With a network of 30 depots, Kitwave supports delivery throughout the UK to a diverse customer base, which includes independent convenience retailers, leisure outlets, vending machine operators, foodservice providers and other wholesalers, as well as leading national retailers. Kitwave are the 14^th largest food wholesaler in the country according to The Grocer although on this year’s turnover they are likely 11^th or 12th

The company floated in May 2021, which was when a number of co’s floated on Aim and duly plummeted due to earnings ratios either being too high in a market that was de-rating or the affect of Covid/Ukraine, or over-hype. Kitwave was not one on them and bucked the trend, in fact, they actually had a little pop at those that had floated and plunged in 2021 in their year end results:

"Since Kitwave's IPO in May 2021, the Group has continued to go from strength to strength. Unlike many of the other companies that joined AIM at a similar time, Kitwave has significantly outperformed market expectations, despite the challenges of the pandemic and the more recent inflationary cost pressures."

The Group's growth to date has been achieved both organically and through a strategy of acquiring smaller, predominantly family-owned, complementary businesses in the fragmented UK grocery and foodservice wholesale market. Food wholesalers have always interested me having seen the performance of Makro who were taken over by Booker on a forward PE of 18 and Booker who were subsequently taken over by Tesco for cash on a forward PE of 25.7 for a total of £3.7bn, another stock I sold too soon. Booker fitted the Jim Slater Zulu criteria in the run up to Tesco bid. Kitwave has a highly successful acquisition strategy, having acquired and integrated 10 wholesale distributors into the Group since 2011. The current market is fragmented and made up of lots of small businesses below the Top 30 as shown in the list above. Many of these may be quite small or may specialise in certain foods like Polish or foreign brands, most easy to acquire with Kitwaves’s size. Many family owned and may well want to sell up at a very reasonably low rating after the trauma of Covid. The whole industry is fragmented and ripe for acquisitions and as much as Kitwaze are acquirers, I suspect that down the line they will be acquired themselves by the likes of Booker or perhaps a Sainsbury or those larger wholesalers competing with them.

Kitwave’s Hightlights

The business model is ‘buy to build’. Kitwave have a model of acquiring smaller wholesalers on low PE multiples and driving big synergies. All acquisitions are paid for out of free cash-flow so no dilution. This is the only type of buy to build model to invest in imo. It’s very much the Judges plc model for those that know and remember that marvellous buy to build stock. I bought Judges at just 110p in Aug 2009, the thread I started is probably still there on ADVFN. I sold when they reached £8 and £15 from memory, today they are £94 a share or nearly a 100 bagger – if I had just held on! There lies a lesson. This is a fantastic business model. Don’t confuse this with buy to build companies that acquire through issuing shares – that model is highly dilutive and fails to provide the growth many dream of in my opinion. Shares given to pay for the acquisition and to previous owners for earn outs or as incentives to stay with the acquirer as long term incentives just dilute any increase in earnings in most cases and leave the dilute eps growth weak if not nonexistent. I also had great success with Furure Plc FUTR. These were at a low of 11p when I bought (110p in new money after the share consolidation) and soared to £38. I sold at £18 after 3 years. Future were starting to acquire with shares or part shares rather than cash at that point which for me then killed the model.

I’m not suggesting Kitwave will emulate the performance of Judges Plc or Future Plc their operating margins are nowhere near as strong for a start, but both JDG and FUTR had much lower operating margins in their earlier years as a buy to build. Kitwave do have 20% return on capital tho which is higher than both JDG and FUTR. The synergies and compounding of earnings from those synergies does make for stronger growth without dilution and greater PE expansion imo. Kitwave use Judges Plc model in that the acquisitions are made out of genuine free cash-flow. As a great example they have recently acquired Westcountry Foodholdings Limited for £29.5m, when they had free cash-flow last year of £26.5m. So nearly all of the profits acquired from the acquisition go right to the bottom line, no dilution. Further more, just like Judges Plc, they acquire cheaply. Westcountry were acquired on 4.4 times EBITDA excluding the cash. Just like Judges if not more so, the acquisitions are often in a different food arena be that geographic or the type of product of the acquired business. Westcountry is a fresh food supplier, MJ Baker acquired a year ago is a frozen food supplier. This gives Kitwave superb opportunities to cross sell products to new and existing customers and boost sales and profits. Sales of the marketplace in which Kitwave operates were estimated to be worth approximately £31 billion in 2022. Both acquisitions will be earnings enhancing from day 1 as you would expect if the PE was less than half that of Kitwave and acquired out of cashflow.

Kitwave’s impressive year end results were released in February:

· Revenues of £503.1 million (FY21: £380.7 million)

· Gross profit margin increased to 20% during the year (FY21: 18%)

· Adjusted operating profit of £21.5 million (FY21: £7.1 million)*

· Profit before tax increased to £17.8 million (FY21: £2.1 million)

· £26.5 million net cash generated from operations (FY21: £7.9 million)*

· Pre-tax operational cash conversion of 105% (FY21: 85%)*

All in all this delivered 20p eps for 2022.

The founder of Kitwave, Paul Young, (tho not the singer he once was J) is still CEO and still biggest shareholder with 15.6%. There is also a good spread of institutional investors in there including Chris Mills ’Harwood Capital, Liontrust and Premier Miton.

In the 15 months since January 2022, eps forecasts have risen from 12p to 25.9p. Stockopedia suggests only 22p eps but they seem to be missing Canacord’s 25.9p eps forecast for this year. Sharepad’s forecasts have 25.9p eps for 2023. Unusual, and again, like Judges Plc, Kitwave is a cash buy to build that pays a dividend which is currently 9.75p or 3.6%, a much higher yield than Judgres has ever paid.

In February 2022 Kitwave acquired chilled foods wholesaler M.J. Baker Foodservice Limited the west country's leading independent foodservice supplier for £24.5 million in cash. Acquired on a PE of 6 including £6m cash on the balance sheet and £1m property. Founded in 1999 and based in Newton Abbott, Devon, M.J. Baker offers over 3,500 products in ambient, chilled and frozen foods, together with alcohol, confectionery and non-food items. The leading brands are complemented by a range of products under the Bakers Best Buy lines.

In December 2022 Kitwave acquired WestCountry Food Holdings Limited, a specialist fresh produce wholesaler to the foodservice sector for £29.0 million in cash. Established in 1856, WestCountry is a leading wholesaler of local, regional and imported fresh produce in the South West of England. The WestCountry business has developed an unrivalled network of dedicated, high-quality local growers of seasonal fresh produce, as well as direct supply links with national and international fresh produce markets says Kitwave.

WestCountry reported audited turnover of £29.7 million and profit before tax of £3.9 million for the financial year ended 1 January 2022. As at 1 January 2022, WestCountry had net assets of £11.0 million. The acquired balance sheet includes c. £7.8 million of cash and a freehold property with a book value of c. £1.2 million. The multiple being paid for the Acquisition, excluding cash and the value of the freehold, is c. 4.4 times annual run rate EBITDA. The Board believes that the acquisition will be immediately earnings enhancing

Both of these acquisitions have synergies and cross selling opportunities which compound sales and earnings imo, making the earnings multiples that they have been acquired on look remarkably good value. The company has a strategy of acquiring approximately one business a year, integrating it well and making sure they are fully integrated before then rinsing and repeating. We can expect one or two acquisitions each year, depending upon size.

Once acquired, Kitwave grow the customer base and range of products for greater basket sales. Greater sales mean they can strengthen relationships with suppliers and achieve better terms and/or rebates on costs, raising margins. With a new warehouse in Wakefield they now have full nationwide distribution. Online ordering has gone from 22% in 2021 to 35% in 2022, together with an order tracking and customer tracking data offering. It is worth noting that the company says online ordering has an average order value 8% higher than traditional order methods. They also have their own wholly owned delivery fleet of 550 vehicles. With the fall in the diesel price of 30p a litre since the company’s year end, I estimate they are saving £800 a year in diesel costs per lorry at an average of 15,000 miles p.a. say, around £500k for the fleet which likely offsets any increase in driver wages.

Kitwave never acquired WestCountry Foods till 2 months after year end and will bring in near £30m sales for a full year so say £24m for 10 months this year 2023. Sales were £503m last year, so they must achieve way north of £530m sales this year yet broker forecasts based on £501m sales this year clearly looks too low on Stockopedia. Canacord’s £570m looks more like correct here too imo. The current PE is 10. Since October 2021, eps forecasts have risen from 12p to 25.9p for 2023 (Canacord). Stocko looks out of date at 22p With the sales and eps forecasts looking out of date on Stockopedia this may have helped contribute to the current low valuation imo.

Kitwave scores well on Stockopedia despite forecasts looking like under estimates.

Kitwave also have some excellent key metrics

Earnings growth is stunning, just going by Stockopedia the CAGR for dilute EPS is 41.5% even on what appears to be an under estimate of earnings going fwd. The PE of 10 gives a PEG below 0.25 which is extremely low. It is rare that I find potential Jim Slater style Zulu stocks but this may be another candidate imo.

MANDATORY

1. Five Year Record (5 years positive earnings growth - X- But for the interruption from Covid, sales may have continued a strong uptend imo
2. Low PEG Factor (PEG below 1 - ie 10% eps growth on a PE of 10 or less) – A PEG of 0.25 -Tick
3. Optimistic Chairman's Statement - Tick
4. Strong Financial Position – Tick - £43.6m net debt but with £20m+ Free cashflow they could halt acquisitions and pay all debt off in 2 years if they wanted.
5. Competitive Advantage Tick – increased scale and range means they can out-compete many of the small delivery wholesalers that they aspire to take over imo.

IMPORTANT

6. Something New – Tick, two great recent acquisitions for cash and more to come.
7. Small Market Capitalisation (a small cap stock - anything in the FTSE250 or above is out) - Tick
8. Relative Strength (as in the share price movement compared to the FTSE All Share Index) - Tick

DESIREABLE

9. Dividend Yield - Tick
10. Reasonable Asset Position - Tick
11. Management Shareholding – Tick

2022 financial year only benefitted nothing from WesCountry Foods acquisition. 2023 will benefit from 10 months of sales and earnings. MJ Baker produced 8 months earnings for Kitwave in 2022, in 2023 they get a full year or an extra 4 months over 2022. Like for like sales grew 27% over the prior year, total sale up 32%. EBITDA of £29.5m came in 40% ahead of Canacord’s £21.0m forecast initially set at IPO. Gross margins rose 240bps to 20.4% Canacord’s FY23E adj. EBITDA forecast is now circa 70% higher than at the time of IPO in May 2021, due to stronger than expected trading and the acquisitions of M.J. Baker and WestCountry. It should be noted that for 2022, 6p eps was achieved in H1 and 14p eps in H2. The company said at year end results that the strong performance had continued into Q1

Zulu stocks with strong growth tend to see earnings rise strongly and PE expansion, this is what attracted Slater to them. With the founding CEO still running the business and highly invested that feels a good place to be investing with someone who has a reason to care about the company. With both acquired growth and organic growth, I hope and expect the recent re-rating and sharp rise in the share price signifies the start of market awaking to the value here and the growth potential.

Risks: There’s over £40m of debt which could be an issue if interest rates continued a lot higher but they could just stop doing acquisitions to pay it down if they needed. Cashflow could clear the debt in 2 years. A large rise in fuel costs wouldn’t be good for margins. The market is fragmented so competition could eat into margins. A recession might see customers focus more on price than service. Most other retail risks would likely be similar for Kitwave too imo.

Kitwave’s H1 period ends on April 30^th, The next trading update is due around May 4^th

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