Beyond Meat Looks Rich

Beyond Meat BYND is a pioneer in the plant-based meat industry. It offered the first burger to look and taste like meat, targeted to omnivores and sold in the meat case. Beyond was soon followed by Impossible Foods and several others. Maple Leaf Foods’ Lightlife brand and Smithfield Foods’ Pure Farmland brand have already launched similar products, with many more expected in the next year: Kellogg’s K MorningStar Farms Incogmeato, Conagra’s CAG Gardein Ultimate Burger, Nestle’s NSRGY Sweet Earth Awesome Burger, Hormel’s HRL Happy Little Plants, Kroger’s KR Simple Truth, and Tyson’s TSN Raised & Rooted burger, which blends beef and plant-based protein. Given the rapidly changing marketplace, we think it is too early to tell if Beyond’s first-mover advantage will result in a sustained market leadership position or if the onslaught of competitive products will challenge Beyond’s position. Until we have better visibility on the strength and durability of Beyond’s brand, we assign the company a no-moat rating.

We are optimistic on the prospects for the meatlike plant-based meat market, which provides a great option for omnivores seeking to increase their consumption of vegetables. We expect the primary growth driver to be the 20% of consumers willing to adjust their daily habits in order to benefit the environment. We assume these consumers will shift one fourth of their meat consumption, converting 5 points of ground meat market share to plant-based meats. We also assume a modest amount of ground meat share shifts to plant-based meats for health reasons. While Beyond Burger (70% of 2018 sales) has the same amount of calories and saturated fat as an 85% lean beef burger (and 5 times more sodium), the health benefits of Beyond Sausage are more evident, with lower fat, calories, sodium, and cholesterol than the pork equivalent. We expect the global plant-based meat market to grow to $48 billion by 2028 from $5 billion in 2018. We model Beyond’s market share increasing from 1.9% in 2018 to 6.5% in 2028, as meatlike plant-based meats gain a larger share of the overall category, and as Beyond’s brand continues to win with consumers, given its strong performance in taste tests and ongoing research and development investments.

Current First-Mover Advantage Beyond Meat launched the Beyond Burger, the first vegetarian burger designed to look and taste like meat, during the second quarter of 2016, shortly followed by privately held Impossible Foods' Impossible Burger, launched in July 2016. While MorningStar Farms has been on the market since 1975, Beyond Burger revolutionized the category by targeting omnivores (95% of U.S. consumers) and first merchandised the products in the meat case in 2016. Also, unlike its predecessors, Beyond Meat seeks to make its products indistinguishable from their animal protein equivalents in terms of appearance, taste, texture, and cookability. Legacy players (MorningStar Farms, Gardein, and Kraft Heinz's KHC Boca Burger) have sought to produce a vegetable-based product that tastes good but does not mimic meat, which would not appeal to the products' largely vegetarian customer base. However, given the strong demand for meatlike plant-based meats from omnivores, several similar meatlike products are slated to launch over the next year. It took Beyond Meat seven years and Impossible Foods five years to develop a plant-based meat that tastes, looks, and even bleeds like real meat. As the industry is in its infancy, and most competitive products are scheduled to launch over the next year, it is too early to know if Beyond's first-mover advantage will prove prohibitive to overcome, or if the new entrants will be able to quickly develop products that resonate with consumers. As such, we don't believe Beyond Meat has carved out a sustainable brand intangible asset at present, and we lack confidence that it is poised to generate economic profits for more than 10 years.

Beyond Meat was founded in 2009 by Ethan Brown, who thought since the primary components of meat (amino acids, lipids, trace minerals, vitamins, and water) are also readily available in plants, the architecture of meat could be replicated with plant-based materials. Brown worked with scientists at the University of Missouri to develop a process that combines proteins from plants into a basic structure that resembles animal muscle. Beyond currently licenses this process from the university as the initial foundation for its products. Over the past decade, Beyond’s R&D team has delivered several plant-based meat breakthroughs as well as continuous improvements to existing products. The company also relies on unpatented proprietary expertise, recipes, and formulations (some with copyright protection, some developed with comanufacturers). In the past three fiscal years, Beyond spent 36%, 18%, and 11% of revenue on R&D, significantly higher than the 1%-2% average for packaged food companies. We expect this ratio to fall over time but to remain well above the industry average, given the company’s commitment to close the gap between its products and animal protein.

We think the most relevant competitors are those that make plant-based meats targeted at omnivores, which is Beyond’s target market. In addition to Beyond Meat and Impossible Foods, Smithfield Foods has launched a similar product under the Pure Farmland brand, and Maple Leaf Foods has a line of meat-like plant-based burgers and sausages under the Lightlife brand. We are impressed by how quickly these two companies have been able to launch competitive products, although in taste tests, these products have generally not fared as well as the Beyond Burger and Impossible Burger (Impossible is consistently favored and Beyond is a close second). Several other meatlike plant-based meat products are expected to launch in 2020, including Incogmeato, Gardein Ultimate Burger (freezer only), Sweet Earth Awesome Burger, and Happy Little Plants, a new line.

To-date, Impossible represents the most significant competition for Beyond, in our view. An important distinction between the two companies is that Impossible uses two genetically modified organisms, heme and soy protein, while Beyond is GMO-free. We think this is an important distinction because GMOs (and therefore the Impossible Burger) are banned in Europe, and according to a survey conducted by the International Food Information Council, 46% of American consumers avoid GMOs, which have been linked with various diseases. Impossible developed heme, an ingredient that makes the Impossible Burger appear to “bleed.” Heme is a molecule found in all plant and animal life. In animals, it gives meat its flavor and red color. Impossible found a way to engineer a type of yeast to produce soy leghemoglobin, which provides the company with a sufficient supply of heme to produce its burgers. Impossible also uses soybeans genetically engineered to include Roundup, which as a herbicide protects the soybean plants, but it’s also a suspected carcinogen. The use of heme also prevented Impossible Burger from being sold in U.S. grocery stores until the Food and Drug Administration approved the ingredient in September. (The same rule did not apply in the food-service channel, as the product was not sold raw.)

There has been substantial interest in Beyond Burger, which we think could signal modest initial brand strength, although the sustainability is far from a guarantee. The brand has been successfully used to drive traffic into restaurants. In the summer of 2018, A&W Canada, the country’s second-largest burger chain, ran an advertising campaign promoting the Beyond Burger. The campaign drove a material increase in guest counts, leading to record same-store sales growth in the quarters following the launch, and the restaurant reported that it was the fastest new-product launch in the history of the chain. When Beyond Burger launched at TGI Fridays, it was the fastest new product launch in the chain’s history. Consumers flocked to KFC in Atlanta for a test of Beyond Chicken, causing the store to sell out of the product in under five hours. That day, the restaurant sold as many Beyond Chicken boneless wings and nuggets as it would normally sell of its popcorn chicken in a week. We don’t expect this frenzy to continue (especially once supply is able to keep up with demand), but we think the strong interest bodes well for the brand’s potential market opportunity.

While we acknowledge intense interest in the product itself, we think the Beyond brand is a large part of the draw. Beyond has received significant media attention, which rapidly improved brand awareness to 34% of consumers in July, up from 23% just two months earlier. Food retailers and restaurants that sell and serve the product often display brand signage in store windows to draw customers inside, further evidence of the brand’s strength. In the retail channel, Beyond provides customers with new products in the meat case, where innovation rarely occurs, driving higher retail velocities (units sold per month per store), as well as repeat purchases. The Beyond Burger 1.0 (launched in 2016) reported 40%-50% repeat purchase rates, significantly higher than typical quick-turning consumer goods products, which we believe average around 20%. The company expects a similarly strong repeat rate for the Beyond Burger 2.0, which was launched in 2019, although data is not yet available.

The demand for Beyond Burger has accelerated in the restaurants that first launched the products, which in our view provides evidence of the brand’s increasing demand. Carl’s Jr., a chain of nearly 1,500 restaurants across the United States and Canada, launched the Beyond Burger nationwide on Jan. 2. In October, the restaurant announced that due to the strong performance of the Beyond Famous Star burger (the chain had sold 4.5 million to date), it was adding another product to the menu, the Beyond BBQ cheeseburger, and said it envisioned launching more Beyond products in the future. Similarly, A&W Canada announced in March that it added the Beyond Sausage and Egger breakfast sandwich to its menu. However, we don’t think these products are a good fit for all restaurant chains. Tim Hortons, Canada’s largest chain of quick-serve restaurants, primarily known for coffee and doughnuts, tested the Beyond Burger and Beyond Sausage patty in breakfast sandwiches and wraps. However, after the tests, the chain decided to permanently add the menu items only in restaurants in Ontario and British Columbia. Similar to McDonald’s failed launch of the McPizza in the 1980s and 1990s, we think Beyond’s products must be a good fit with the restaurant chain in order to be successful.

We also think it’s important to assess how Beyond Meat stacks up against animal protein. Claims that Beyond’s products are healthier are not ubiquitously true (to date, at least). However, benefits for the environment and animal welfare are evident, which we think will result in continued demand for the products, particularly over time, as the environment is exceedingly important to the younger generation. Beyond Burger has roughly the same amount of calories, fat, and saturated fat as an 85% lean beef burger. While Beyond Burger has no cholesterol (versus 75 milligrams for beef), the plant-based burger contains more sodium (390 milligrams versus 75 for beef) and carbohydrates (3 grams compared with none for beef). For consumers concerned about calories and fat, a turkey burger contains 40% fewer calories and half of the fat and saturated fat as Beyond Burger. However, the more recently launched Beyond Sausage does appear to have superior health benefits, with 79% of the calories, 67% of the fat, 83% of the saturated fat, 66% of the sodium, and none of the cholesterol of the pork equivalent.

Environmental benefits of plant-based meat products are far more evident. The global livestock industry generates a material amount of greenhouse gas emissions (estimated to be between 18% and 51%, depending on the methodology used). According to the United Nations’ Food and Agriculture Organization, livestock occupies 30% of the planet’s land surface (although a material portion of the land has no other productive use), and the World Resources Institute reports that 29% of water in agriculture is used for animal production. A study conducted by the University of Michigan shows that compared with a beef burger, the Beyond Burger generates 90% less greenhouse gas emissions, requires 46% less energy, has 99% less impact on water scarcity, and has 93% less impact on land use. Although beef industry greenhouse gas emissions can be dramatically reduced by using grass-fed cattle, this approach does not improve environmental concerns related to water use or downstream pollution, while it exacerbates the land use concern and could result in accelerated deforestation and species extinction. As such, we think plant-based meats offer an attractive option for consumers concerned about the environmental consequences of beef production. According to the Pew Research Center, 20% of Americans actively adjust their behavior in order to benefit the environment. As Beyond seeks to price its products on par with beef over time, we think it’s reasonable to assume that 20% of the population will convert a portion of their meat consumption to plant-based meats due to environmental benefits. We do not expect animal welfare concerns to drive incremental demand for plant-based meats. In our view, consumers concerned about animal welfare enough to adjust their behavior have already eliminated meat from their diets. We don’t expect the Beyond Burger, which looks, tastes, and even bleeds like real meat (using beet juice instead of heme), to appeal to these consumers.

No Cost Advantage Yet We do not believe Beyond Meat currently possesses a cost advantage, either. To conserve capital for high-priority R&D investments, Beyond Meat outsources a significant amount of manufacturing and distribution. To protect its intellectual property, the company produces all of the woven protein product, which serves as the basis for all finished products. The woven protein is then converted into the final packaged product according to formulas and specifications, typically by one of the company's comanufacturers, although a small portion is finished in-house. Over time, when capital is more plentiful, Beyond plans to bring a higher portion of finished product production in-house, which should improve margins. Also, as the company continues to scale, it is likely to in-source distribution, which should also improve margins. But for the time being, the company is not cost-advantaged, particularly in comparison with well-established competitors like wide-moat Kellogg (MorningStar Farms), wide-moat Nestle (Sweet Earth), Smithfield Foods, a division of narrow-moat WH Group (Pure Farmland), narrow-moat Hormel (Happy Little Plants), no-moat Conagra (Gardein), no-moat Tyson (Raised & Rooted), no-moat Kraft Heinz (Boca Burger), Maple Leaf Foods (Lightlife), and narrow-moat Kroger (Simple Truth).

As Beyond Meat is still in the early investment stage, it has not yet reported a profit or positive return on invested capital on an annual basis. As the business has been rapidly scaling, margins have been improving markedly. We expect the company to be profitable in 2019 and beyond, with ROIC of 14%, climbing to 33% by the end of our 10-year explicit forecast, above our estimate of the company’s 7% cost of capital. Over the long term, we expect Beyond to report 35% gross margins, in line with the packaged food average, not far from the 33% reported for the first nine months of 2019 and generally in line with management’s guidance of mid- to high 30s. We expect high teens operating margins, also in line with the packaged food average. To date, a lack of scale has resulted in a very high portion of revenue being invested in selling, general, and administrative costs and R&D. As this business scales, we expect SG&A to improve from 2018’s 39% of sales to 8% over the next decade, in line with packaged food peers. We expect R&D to decrease from 11% of sales in 2018 to 3% over the same horizon, still above the industry’s 1%-2% average, given the company’s commitment to making the products increasingly indistinguishable from their animal protein equivalents. As a partial offset, we expect marketing investments to increase from less than 1% of sales to over 5% long term, more in line with the packaged food industry.

Future Demand Uncertain One of the biggest uncertainties facing Beyond Meat is the difficulty in predicting the demand of the product, which could be skewed by whether consumers continue to shift away from products with long ingredient lists and/or become increasingly focused on health benefits, as Beyond's beef products have the same amount of calories and saturated fat as 85% lean beef and 5 times more sodium. Further, Beyond's ability to supply any uptick in demand could be challenged if a deal is secured with McDonald's. For one, Beyond may not be able to obtain sufficient pea protein supply or ramp capacity quickly enough, given the tight labor market and six-month lead times for additional extruders used in production. If Beyond is unable to meet demand, it could lose business to competitors, particularly large, established companies entering the space.

Another significant risk is the onslaught of new competition. In September, the Impossible Burger began to launch in the retail channel. The retail rollout will be gradual, but we expect the product to become increasingly available in stores across the U.S. over the next year. Lightlife and Pure Farmland have already launched plant-based meat-like burgers that sell in the meat case alongside Beyond Burger. Several other competitive products are expected to launch in 2020.

Beyond Meat has very little debt leverage, and we don’t surmise that it will need to assume any meaningful level of debt as it seeks to expand its share and reach in the growing plant-based meat market. We think the $255 million cash inflow from the May initial public offering should provide the company with sufficient cash to fund the business until cash flow from operations turns positive in 2020. We do not expect the company will initiate a dividend over the next 10 years, but we do expect there will be sufficient cash on hand for moderate share repurchases. We view this as a prudent use of cash when shares trade below our assessment of its intrinsic value.