Tattooed Chef Stock: Why I’m Not Buying the Dip (NASDAQ: TTCF)

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Investment thesis

The tattooed cook (NASDAQ: TTCF) the hype is fading fast. The company recently announced an abyssal quarter. It missed both revenue and profit estimates and gross margins fell to just 1.3% in the quarter.

At this point, the firm’s strong earnings growth is the company’s main bullish argument. But with poor profitability prospects and a fragile balance sheet, it is a risky prospect. I recommend avoiding this company at this time.

Is the revenue growth sufficient?

The most notable positive about Tattooed Chef is the company’s strong revenue growth. The company grew its revenue by 44% in 2021 and again by 37% in the first quarter. Growth has slowed with an increase in turnover of only 15% in the last quarter. But the company still reaffirmed its guidance, calling for revenue of $280 million to $285 million for this fiscal year.

2022 Tattooed Chef Prospects and Drivers

Tattooed Chef May 2022 Investor Presentation

But that doesn’t tell the whole story. According to the company’s 10-Q filing, only a fraction of that growth was organic. Of the $7.8 million increase in net sales, only $1.1 million of growth came from the company’s core brand. $3.8 million was generated from private label products and $2.9 million from other revenue. The company attributes most of this revenue growth to its acquisitions of New Mexico Food Distributors, Karsten Tortilla Factory and Belmont Confections.

Organic revenue growth for the Tattooed Chef brand was up just 3.4% year-over-year. That’s a bad sign for a company valued almost entirely on revenue expansion.

However, these results could improve later in the year. The company reaffirmed its revenue forecast of $280 million to $285 million. This implies a slight acceleration in the second half.

So far, the company has grown mainly by launching new products and expanding the distribution of these products. Management recently announced that it was also raising prices in the fourth quarter. This could help increase revenue and profitability. It could also reduce the number of units sold.

Tattooed Chef SKU Growth Chart

Tattooed Chef May 2022 Investor Presentation

Grocery stores have reported a downward trade effect, where consumers buy products at a lower cost to save money. This can lead to pressure on high-end, low-margin products like Tattooed Chef.

I think Tattooed Chef could be more resilient to these headwinds. The company said half of its customers have incomes above $100,000.

It remains to be seen how the company will weather the current economic headwinds. But I don’t think the company’s revenue growth is as strong as it looks. The current environment could dampen the strong growth on which the company relies.

Profitability at the center of concerns

The main problem that Tattooed Chef faces is the profitability of the business. In the last quarter, the company posted abysmal gross margins of just 1.3%. The company loosely blamed inflation and shipping costs for the drop. Management then reduced its gross margin forecast for the full year from a range of 10% to 12% to a range of 8% to 10%.

The company described its profitability model as being based on operating leverage. The company plans to offset its fixed costs with volume.

Management hasn’t focused much on profitability in the past. Their previous advice and benefits have focused on revenue growth. But now they’ve guided Adjusted EBITDA to breakeven by the end of 2023. Management outlined that plan on its last earnings call.

It’s very, we’re very unique. This is why our model seems so important to us compared to what most other companies are. We are therefore vertical. We have our price increases. We have our robotics going, and then we have our revenue growth coming. So you add all of those things together and we’re really confident by the end of 23 we’re going to be profitable. So absolutely by doing all of these things, our workforce numbers by introducing this robotics are also going to drop significantly… And it’s like, because we’re this new company that we just introduced all of these products, we have inefficiencies. The more products we make, the more we streamline our operations, the more we will be able to be profitable.

I am cautious on this orientation. The company repeatedly praises its fixed-cost models, but its operating expenses are up nearly 50% year-over-year. That’s faster than revenue growth. It may also be difficult to capitalize on operating leverage with declining organic growth rates. I think the company can benefit from its existing distribution strategy. The latest distribution deal with Walmart might be a tailwind, but I think increased competition and inflation could easily offset the gains. The company has very low margins for a high-end food product.

High cash burn makes valuation expensive

Even after an 80% drop, Tattooed Chef is trading at a higher valuation. The shares are quoted at a forward P/S of approximately 1.7 times. The company is trading at 18.5 times its full-year gross profit forecast. I think it’s expensive for a company with this profile. I recognize that the company might be able to continue to grow revenue for some time, but the company is unlikely to be able to achieve the profit margins that this type of valuation entails.

This investment seems quite risky considering its dwindling cash reserves. The company has less than $28 million in cash on its balance sheet. This is down from $140 million in the prior year quarter. Compare that to the company’s free cash flow burn rate of over $20 million in recent quarters.

Management has taken steps to improve their situation. They plan to cut spending in the second half of the year. The capital expenditure forecast is less than $5 million for the remainder of the year, down from $15.6 million year-to-date. The company also added a $40 million asset-backed line of credit. This should provide immediate cash.

The company’s low debt and declining enterprise value could make it a potential strategic acquisition. A large company could use its infrastructure to improve profitability and distribution. But I don’t think that speculation is a good reason to buy.

final verdict

Tattooed Chef’s valuation has returned to reality, but profitability issues continue to plague the company. While the company may recover, I see no compelling reason to buy the stock. Growth prospects are not strong enough to compensate for weak profitability. The valuation isn’t cheap enough to make this a flipping game. For these reasons, I recommend avoiding the stock at this time.

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