Colabor: A Small Canadian Distributor
Colabor faced significant challenges before the appointment of CEO Louis Frenette in 2019 and the subsequent rightsizing of its operations. Prior to joining the company he was the CEO of Lactalis Canada a dairy company, he has good expertise in the distribution sector. Now let’s talk about the CFO Pierre Blanchette who joined in May 2021 has been a great addition with experience at Fierra Capital an asset management company, being in diverse senior finance role I think he brings credibility to the group. I will talk later about their compensation and incentive.
At its peak, Colabor was a company with over $1 billion in revenue, but that figure mean nothing when the business is not profitable. Since its IPO, Colabor's stock has declined by 92%. It’s baffling how previous leadership focused on expansion without prioritizing the bottom line. If the former CEO wants to call me and explain the rationale behind those poor decisions particularly the lack of a coherent capital allocation strategy (my phone is open).
Now let’s pass on the speculation front of what I’m predicting in the future. I expect free cash flow to increase in 2024 due to the end of the Saint-Bruno warehouse capex. The capex for 2023 was something in the ballpark of 15 million. We also saw a lot of company making wrong decision when building new headquarters in Quebec. Jean Coutu 190 million warehouse and Agropur 100 million head office was poor capital allocation decision and made their debt situation way worse. Once again, they didn’t provide a lot of information on their new warehouse lease’s term. With the low vacancy on industrial property in the GMA, they will probably pay at least $12-$13 per square foot for the new lease. I think overall the increase in reach from the Saint Bruno facility will be a plus and increase potential new clients to compete against it main competitor SYSCO Canada and Gordon food.
The 2021-2023 year were pretty good for Colabor with adjusted EBITDA margin growing each year as the economic condition and restaurant sales returned to pre-pandemic level. Gross margin also improved to 18.7% or an improvement of 240 basis points in three year which prove that the current strategy is clearly working. If they can keep those margin or improve them slightly when the economy start picking up again the company will be clearly undervalued or more than now.
The year 2024 has been challenging for the group so far due to macroeconomic issues in Quebec. In Q3 2024, restaurant sales declined by 0.8% after adjusting for inflation. However, Colabor has increased its market share from 10.3% to 11.0%, a positive indication that the new warehouse is beginning to deliver results. The main challenge right now is the wholesale operation, which is more sensitive to consumer spending and has experienced a 10.1% reduction in revenue. On a positive note, revenue is now more balanced, with restaurants accounting for 40% of sales, reducing the overall risk profile.
The new warehouse will incur higher costs initially, as it will not immediately achieve the volume needed for optimal operational efficiency. The management has already brought in more sale representative to service the greater Montreal area to win contract. During Q3 2024, cash generation at Colabor was strong, with $9.9 million generated during the quarter an increase of nearly $2 million which has helped reduce debt. One concern I see is the potential to accept contracts at lower margins to retain business. For example, a recently renewed contract representing 11% of sales was taken at a lower margin. Management said they have the situation in control and are putting effort in improving the product mix with more private label that should help recoup some margin lost, but we still need to monitor this situation. When it is an institution margin are less good versus an independent chain because they don’t have big leverage to get prices down.
On June 22, 2023, the Company also made a 13% investment in 9374-1502 Québec inc. ("Maturin"), which exclusively offers food from more than 600 farms in Quebec. This is a good partnership to propose more Quebec product to restaurant and is a differentiator versus the big players like Sysco or Gordon Food that has not the same product offering that make it possible to win key contract. Over the last few years we saw a lot of demand from consumer on locally sources fruits and vegetable in their plate as they tend to be more environmentally friendly restaurant seek them. (I don’t get it, but I hope they make money). Their meat and fish division is a good margin product that can bring diversity and quality to their clients this would be an area I would look to bolster with M&A.
Net debt has decreased to $51 million from $60 million, demonstrating Colabor's ability to generate free cash flow. Optimizing working capital could also be a tailwind for the company. Let’s try to forecast the free cash flow they could generate this year. Cash from operations will likely be around $30 million I always try to be conservative when forecasting. You can subtract $2 million in planned capex, and I would include the warehouse leases, which are currently running at $12 million per year, there is also a small payment of 800 000 dollar in Q4 2024 from the GRA acquisition. That should result in an estimated free cash flow of approximately $15 million. This should position the company to reward its shareholders. A potential option should be repurchasing 5% of the market cap for only $5 million a strategy they should explore instead of pursuing M&A. Since 2019, under the new management, Colabor has completed three M&A deals totaling $8 million. We don’t have much data to prove they were good unless the management comment but take it with a grain of salt. Don’t forget that the two main player (Sysco, Gordon Food) got 53% of the market and Colabor has 11%, so the rest of the industry is pretty fragmented and there is a ton of M&A possibilities in the Quebec market pretty cheaply for 3-6 time EBITDA, Colabor big size could create interesting synergy. At the end the only metric management should focus is how to increase free cash flow per share on the next 5 years. A lot of management think the only way to increase EPS is through M&A, but buyback are a powerful tool to increase shareholder ownership in the company, but there is still a lot of pedagogy to do. Otherwise, there would be no alpha in the stock market. For that I recommend to every CEO or board member to read the book The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success.
Let’s now look at the incentive and what senior management are paid. The CEO is paid a base salary of 640 000 dollar pretty stable and total compensation is 1.7 million for 2023 which I think it's fair. The CEO got 1 million unit in option at a price of $0.47 when he joined the company in 2019, he also got option at 1.14 and 1.00, so I think a sale at 150 million would be accepted by the board. The target that they need to hit is consolidated EBITDA and EBT targets is 75%, but the board has not specified what the target is, so nice for them not disclosing us this. Same thing with the executive ownership rule they don’t have a timeline to get to 1.5/1.0 time their base salary they should 100% change this rule so that the management is accountable to us the shareholder. The CFO pay structure is almost the same as the CEO, so I won’t talk about it.
I can see a mid double-digit CAGR return for the next 3 years without much margin expansion and modest M&A acquisition. Free cash flow should continue to increase each year as they ramp up of the Saint-Bruno warehouse, and they will probably keep increasing their market share in that period. I’m pretty confident that a liquidity event is possible like a buyout as the Board own almost 25% of the company they could decide to monetized their asset. Buyback should also be an option on the table if they can't surface value on the stock market to signal their intention that the company is cheap I could even see a SIB since the trading volume on Calabor is pretty low. They should also have 15 million in FCF to allocate at a market of 100 million it a 15% free cash flow yield right now not a bad deal if you don’t even account for the future growth.
My 2 scenarios possible for the value creation of Colabor to increase the share price.
Acquiring the company for $130–170 million (LOW BALL) would be relatively easy to achieve in Quebec with the backing of Investissement Québec, CPDQ, FTQ, BDC, and considering Colabor's current low leverage of $51 million (excluding leases), which places it at 2.6x EBITDA. We could add another $130 million in debt to execute an LBO at 6.0x debt-to-EBITDA if you prefer almost 0 equity into the deal. However, you would likely need to provide around $30-40 million in equity to secure good lender term. A management buyout would be my preferred option, as the board holds nearly 25% of the shares and could roll their equity into the new Colabor structure. The IRR would be highly attractive, given the strong free cash flow generation that allows for rapid debt repayment. My DM are always open to any private equity firm.
An activist investor purchasing a 10% stake in Colabor, securing a board seat, and nominating a well-qualified candidate to improve the company's capital allocation to boost share price. He could also try to tell the board to sell the company. That would be tough since the stock is not liquid enough to buy a big stake in the company without moving the stock too much.
Increasing disclosure for the shareholders:
The increase of disclosure should include free cash flow, ROIC, target leverage for the company, organic growth, volume vs. price growth chart. (yes I’m lazy) This has been done great until July 2024 which we have nothing new information for Q3 2024
They should have a clear plan to deliver increase margin and drive productivity.
Having clarity in the capital allocation framework, so investor can look at the priority of the management when using the excess free cash flow to provide great return on investment,
The new lease for St-Bruno is for 20 years (exp. Sept. 30, 20244)