FA Alpha Daily

Credit Rating Agencies Fail to Recognize the Strength of Sovos Brands Despite Strong Cash Flows and Market Demand

Even though more people still prefer to eat at home in the past years, convenience remains a priority for many, thus increasing the demand for pre-made sauces and frozen foods. Despite this, credit rating agencies think that Sovos Brands (SOVO), a food company with a wide range of packaged food brands covering breakfast, lunch, and dinner, has a 25% chance of defaulting. Today’s FA Alpha Daily will examine the company’s actual credit risk through Uniform Accounting.

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Wednesday Credit
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Although we do not talk about it as much, obesity has become a global problem.

1.9 billion adults were overweight and 650 million of them were obese in 2016, nearly tripling since 1975.

As obesity becomes more frequent, so are the services that help battle it.

One company that provides such services is WW International (WW). Formerly known as Weight Watchers, the company offers weight management services such as its comprehensive diet program.

The core of its business model is a subscription-based program of support, but customers have access to a variety of purchasable products as well.

As WW International markets itself as a health and wellness brand rather than a weight-loss brand, its target audience is not only people with obesity but also those trying to live healthier.

Ironically, the company’s stock has not been the healthiest. It has been incredibly volatile as its valuation swings wildly from quarter to quarter.

This is due to the irrational behavior of its investors.

People tend to think any change in the company’s subscriptions is an indication of its permanent outlook going forward, but this is not the case.

Investors do not recognize the strong brand image and the impressive power the company has in the healthy living and weight management world.

As a result of impressive brand and demand, WW International has enjoyed remarkable profitability.

Its Uniform return on assets (“ROA”) has been above 50% every year for the past 15 years and a long time before.

Like many investors, the rating agencies are having a hard time understanding the business as well.

They rate a company with robust returns like WW International B+, thinking there is a 25% chance it will go bankrupt in the next five years.

Given high profitability and the company’s strong position in the industry, this rating makes no sense.

We can figure out if there is a real risk for this company by leveraging the Credit Cash Flow Prime (CCFP) to understand the company’s obligations matched against its cash and cash flows.

In the chart below, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand available at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).

The following chart proves that WW International has a much safer credit profile than what the credit agencies have been suggesting.

Sovos has no debt maturities until 2026, when they have a significant debt headwall. Despite this headwall, there is little need for concern.

Sovos has strong cash flows which may get even stronger with improving demand and healthy cash balances. Furthermore, with so much time left to refinance, Sovos will be able to spread out this debt obligation into multiple years.

This is also a company that only recently went public and it will continue to improve, so it is unlikely that this headwall will pose a significant issue.

Because of these factors, Sovos gets an IG3- rating from Valens. This corresponds to a default risk of less than 2%. 

The CCFP shows that credit investors should be far less worried about this name than the rating agencies would lead you to believe.

With the power of Uniform Accounting, we hope to highlight the true creditworthiness of companies that are wrongfully judged.

To see Credit Cash Flow Prime ratings for thousands of companies, click here to learn more about the various subscription options now available for the full Valens Database.

SUMMARY and Sovos Brands, Inc. Tearsheet

As the Uniform Accounting tearsheet for Sovos Brands, Inc. (SOVO:USA) highlights, the Uniform P/E trades at 32.9x, which is above the global corporate average of 19.3x and its historical P/E of 18.1x.

High P/Es require moderate high growth to sustain them. In the case of Sovos, the company has recently shown a 61% Uniform EPS decline.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Sovos’ Wall Street analyst-driven forecast is for a 68% EPS shrinkage in 2022 and a 679% EPS growth in 2023.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Sovos’ $14 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to grow by 18% annually over the next three years. What Wall Street analysts expect for Sovos’ earnings growth is below what the current stock market valuation requires in 2022 but above in 2023.

Furthermore, the company’s earning power in 2021 is 5x the long-run corporate average. Also, cash flows and cash on hand are almost 4x its total obligations—including debt maturities and capex maintenance.

Overall, this signals a low credit and dividend risk.

Lastly, Sovos’ Uniform earnings growth is well below its peer averages, but the company is trading in line with its average peer valuations.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research 
at Valens Research

This analysis of Sovos Brands (SOVO) credit outlook is the same type of analysis that powers our macro research detailed in the member-exclusive FA Alpha Pulse.

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