Investment Note: MGP Ingredients - GuruFocus.com

The conservatively run company is now selling at a decent valuation

MGP Ingredients Inc. (NASDAQ:MGPI) is a small-cap industrial alcohol and food ingredient producer that has greatly expanded its presence in liquor (bourbon whiskey, vodka, etc). The company started in Atchison, Kansas as Midwest Grain Products in 1941. For many decades, it was a small town grain company. Then it moved into producing food ingredients and industrial alcohol.

In October 2011, MGP Ingredients bought the Lawrenceburg, Indiana-based distillery (formerly owned Seagrams and Pernod Ricard) from the bankruptcy of CL Financial, a Caribbean-based company that went bust in the last recession. This was a brilliant move as it transformed MGP from a commodity producer to something better. MGP then began “white-labeling” liquor for marketers, meaning that it did the actual distilling but the alcohol was sold by others under their own brand names, somewhat misleadingly as craft distillery products. This strategy caught the fancy of the market and MGP's stock took off.

While the company's operating margin improved following this "white label" strategy, the real growth was generated by the price-earnings expansion driven by investor enthusiasm. At the height of investors' infatuation, the stock was selling at an earnings multiple of 40, up from the low teens previously. This has since dissipated and is back in the low teens now. However, the company's strategy of premiumization of its offering has legs.

What is attractive about MGP Ingredients in the current coronavirus crisis is that it is in good financial shape. Current assets are more than total liabilities, though it should be pointed out that most of the current assets are in the form of inventories; i.e., barrels of whiskey being aged in its warehouses. One-third of the market cap is inventory. Liquor inventory is valued at lower of cost or selling price "on a first-in, first-out" basis. As illustrated in the chart below, MGP has been building substantial barrelled inventory in its warehouses over the last five years. While this adds to assets of the company, if it is unable to get a good price for the aged liquor in the future, there is risk that the value of the inventory may have to written down.

The debt-to-Ebitda ratio is quite low with long-term debt of $40 million and Ebitda of $58 million. The company is well positioned to withstand an extended period of adverse conditions.

While cash flow is a bit erratic, earnings per share have grown consistently over the last five years.

MGP is a family-controlled company

Karen Seaberg, chairman of the board of directors and daughter of the founder, owns about 20% of the common stock but controls all of the preferred stock. The preferred stock gets preferential voting rights. Preferred shareholders are entitled to elect five of the nine directors and only holders of our preferred stock are entitled to vote with respect to major decisions like a merger, dissolution, lease, exchange or sale of assets.

Insider purchases

As the stock has fallen, insiders have been buying stock. This is a good sign that they are recognizing value.

Valuation

I think the stock has come down closer to fair value now after a wild ride over the last five years. The company's reliance on aged whiskey, where it can get three times the value of fresh distillate from marketers, may be too optimistic in the short run but appears viable in the medium run as the economy recovers. Its also developing some of its own brands to avoid excessive dependence on marketers. Overall, I like this company given its long history, conservative balance sheet and simple, understandable strategy. I plan to wait for a bigger margin of safety than what is at the offer. A per-share price below $20 would be of interest.

Disclosure: The author has no position in the stock, but may initiate a long position in the future.