Hot Oven , Hot Stock ?? ( Barrons )

Food for thought for Middleby bears: As the company's ovens change the way we eat, its earnings show no sign of growing cold.
SOMETIMES IT SEEMS AS IF THE penalty for success is to become the darling of Wall Street's shorts. Just look at Middleby , the Elgin, Ill.-based oven maker, which has a record of rising earnings and impressive cash flow from products that have changed the way we eat.
Middleby sells cooking equipment to hotels, hospitals and restaurants, including Dominos, Subway and McDonald's. Analyst Anton Brenner of Roth Capital Partners notes that Middleby's quick conveyer oven "allowed Domino's and Pizza Hut to offer short-term guarantees on delivery."
Courtesy of Middleby
The Blodgett oven, which will cook KFC's new low-fat chicken.
The company, which has a history of surprising analysts, recently delivered it 26th consecutive year-over-year gain in quarterly earnings, handily beating the Street's expectations. In the second quarter, net income rose 36% to $17.1 million from $12.6 million, or 99 cents a share, up 32% from 75 cents a share a year earlier.
But this performance isn't reflected in Middleby's stock (ticker: MIDD). From $78 at the end of the year, it had plunged to a low in the upper 30s in July, before recovering to about 55. As of Sept. 10, shorts made up nearly 35% of the 16-million-share float. And that's for a stock that trades only about 300,000 shares a day. Bears say that growing debt and rising costs, coupled with a slowing U.S. economy, will cool Middleby's earnings.
Indeed, customer traffic at casual-dining restaurants is sluggish, but that segment accounts for only 9% of Middleby's revenue. The company also supplies the quick-serve pizza and sandwich markets, which are holding up well. And a hard look at Middleby's numbers suggests that the downdraft in the stock price is overdone.
The company has a history of rising cash flow. Over the past five years, annual sales growth has averaged 22%, beating the industry's 15%. Middleby's gross margins in the high 30s have been stable, despite soaring steel prices -- steel purchases alone eat up 12% of sales revenue -- and acquisitions with lower margins. Return on invested capital in 2008's first half ran a healthy 14.7%.
More than a third of Middleby's revenue comes from replacing equipment it has installed in 850,000 establishments. The equipment's average life is less than eight years, and some newer products are so efficient that they pay for themselves in two years, a big incentive for restaurants to upgrade. New products that save energy, labor and food account for more than 25% of sales.
A third of sales comes from menu changes for more healthful diets. Brenner of Roth Capital notes that KFC will introduce a low-fat grilled chicken using Middleby's new Blodgett convection oven, which "can grill a batch of chicken in just over 20 minutes." He considers the stock a Buy and has a target price of $95 a share.
The rest of its revenue comes from store openings, and it should get a lift from the new restaurants in Asia and elsewhere operated by Middleby customers. "There is a great love affair with American eateries around the world," says Middleby CEO Selim A. Bassoul, 51.
A Threat to Debt: Acquisitions, though ballooning Middleby's debt, have also helped its cash flow, which management says can pay off the IOUs.
BEARS POINT TO MIDDLEBY'S debt -- $274.6 million, or 1.37 times equity, up from $96.2 million at the end of last year -- amassed for a host of recent acquisitions.
There is no question that Middleby has been on a takeover tear; sales are up more than 50% because of seven companies it has bought since the start of 2007. The stock fell 8% on last month's announcement that Middleby would buy oven maker TurboChef for $6.47 a share in cash and stock. But Bassoul thinks Middleby has more than enough cash flow to pay down that debt.
"We minimize our working capital and have very low capital expenditure," says Bassoul. Acquisitions-related goodwill and other amortization keep a lid on taxes. Depreciation and amortization ran $3.3 million in the second quarter, up from $1.4 million a year earlier. And the TurboChef purchase will produce $120 million in net tax-loss carry forwards, making the deal's effective price "lower than the headline price," says Robert Willens, who heads a New York-based tax-advisory firm bearing his name.
The Bottom Line:
Sales growth for Middleby has averaged 22% annually over the past five years, versus 15% for the industry. A positive surprise could send the shares above 80.
Analyst Peter Lisnic of Robert W. Baird rates Middleby No. 1 or No. 2 in nearly all of its product categories. Lisnic, who has a target price of 81 for the stock, thinks Middleby will be able to revamp TurboChef's residential business and raise margins on the commercial side.
In view of the large short position, any positive surprises, such as lower steel prices, could push the stock higher. Since Middleby doesn't depend on any one customer category or geographic region, that surprise could come from anywhere.