Deal To Watch: Creamy Hot Sauces

Key Stats:

Summary

The Blue Top Brand team has been selected as a “Deal to Watch” by KingsCrowd. This distinction is reserved for deals selected into the top 10%-20% of our due diligence funnel. If you have questions regarding our deal diligence and selection methodology, please reach out to hello@kingscrowd.com.

Hot sauce is old. Very old. The earliest evidence of humans adding chili peppers into their food goes back at least 2,400 years. Commercially, the space is old as well. The first known hot sauce, a brand made up of cayenne pepper, dates back to 1807.  In addition, the company that brought the world Tabasco Sauce is still around despite having been founded in 1868. To put this in perspective, tomato-based ketchup as we know it today wasn’t developed until between 1812 and 1824. Anchovies, however, remained in it until sometime in the 1850s. Given how old the hot space is, it might be expected for it to dominate the condiment world, but this couldn’t be further from the truth. Until recently, hot sauce was a minor niche space, but over the past several years strong growth has propelled it into the spotlight. Recognizing this opportunity, Chris West and his team founded Blue Top Brand.  The company’s goal is to make the next hot iteration in the industry: street sauces.

Problem

Demand for hot sauce has been rising at a far greater pace than other condiments in recent years. One particular piece of the hot sauce industry driving this demand is what’s called street sauce. As younger generations seek out street food or at least food with the street theme involved, street sauces have benefited. The problem, though, is that no dominant players have really come out of the mix.  The hope is, until now.

Solution

Recognizing this opportunity, Blue Top Brand has stepped up to the plate. Literally. In 2015, Chris West and his family, all located in West Texas, created the first Blue Top Brand product: Original Creamy Street Sauce. Within six months of its founding, the company was shipping products. In 2016, sales totaled $218,000, and the growth didn’t stop there. In 2017, sales were $317,963. Last year was even more impressive, with net sales totaling $1.06 million. By August of this year, sales had hit $1.70 million for the year. Sales in the second quarter of 2019 alone were $600,000.

Today, Blue Top Brand has 12 different sauces to its name, all street-oriented, and all with one thing in common: they are hot. The firm sells DTC (direct-to-consumer) through its website, as well as through other online channels like Amazon. In order to continue its expansion, the company is looking to place its products in retail establishments. The company claims to have purchase orders in place from Walmart, H-E-B, Kroger, Albertsons, Safeway, Tom Thumb, Randall’s, Brookshire Grocery, Target, Meijer, Sobeys, Stop & Shop Supermarket, Giant Foods, Topp’s, and Heinens. The company also has agreements in place with nine food brokers. Management’s ambitions don’t stop there though. They hope to sell directly to restaurants, and they want to provide their product in packages suitable for prepared foods as well. 

Blue Top Brand’s goal is to create a large and viable company that can be acquired by a major food business in the next three to six years. They are currently anticipating revenue of $6.67 million in 2020, and by 2023 the company believes it can achieve sales of $27.98 million. This story isn’t just about growth though. The company has also put significant thought into developing a product that appeals to health-conscious consumers. They claim all of their sauces are vegetarian, gluten-free, and MSG-free. They also do not contain GMOs or high-fructose corn syrup in them. With younger generations picky about their food choices, this places the company in a good strategic position. 

While Blue Top Brand has done well to establish and grow their business over the past few years, not everything has been stellar. Last year, the company generated a net loss of $639,044. The year before that, their loss was $1.23 million. Operating cash flows have seen a similar trend. In 2017, the company’s operating cash flow was -$804,390. This figure did improve considerably last year, but at -$560,203, that’s still a significant hit to the business. Moving forward, losses are likely to continue too. Next year, management is forecasting EBITDA of -$1.09 million. If all goes according to plan, the business will not generate positive EBITDA until 2021.  Because EBITDA typically trails earnings, actual positive earnings may not occur until the year after.

This is not to say that the books are horrible though. While losses and cash outflows have been significant, the company has managed to keep its debt picture under control. Short-term loans and notes payable (those due by the end of this year) totaled $331,897 at the end of 2018. The company had a further $338,560 in long-term debt, bringing total debt to $670,457. With this current capital raise, management has said that it may allocate up to $300,000 toward paying this debt lower. 

A Niche Industry

The overall condiments, sauces, and dressings industry today is large. Globally, this market was estimated to total $124.6 billion in 2017. The hot sauce segment of this market, by comparison, is remarkably small. Estimates vary as to its actual size. One source identified estimated the global hot sauce market to be about $2.29 billion in size last year. However, what is undisputed is the fact that this niche is growing rapidly. That same source stated that the industry should grow at a CAGR of 6.5% through at least 2026. This means that by 2026 the global hot sauce market could be $3.77 billion in size. Another source indicated that the global market today could be as large as $4.1 billion. According to that estimate, the industry is growing at a rate of 5.4% per annum, and by 2024 it’s expected to reach $5.5 billion. 

A big slice of this market is in the US. This is a good thing, because at this time all of Blue Top Brand’s sales come from the US and Canada. Between 2000 and 2017, hot sauce consumption in the US soared by 150%. By 2017, the market in the US had hit $1.37 billion. This same forecast puts the market at about $1.50 billion this year, implying a global market share of between 31.4% and 61.5%. By 2022, the hot sauce market in the US should rise to $1.65 billion, which comes out to an annualized growth rate of 3.8%. To see how the hot sauce market has done compared to other condiments in recent years, we need only look at the image below.

A considerable part of this growth in the US is driven by today’s youth: Millennials and Generation Z.  Last year, Generation Z had $29 billion of spending power (at the low end). They used a significant portion of this eating out. In fact, the group made a collective 14.6 billion restaurant visits in 2018, accounting for roughly one-fourth of all people going out to eat last year. When looking for what to eat, 42% have said they want street food on their menus. 

Millennials have been no laggard in promoting hot sauce’s rise either. In 2017, half of Millennials identified themselves as ‘foodies’.  Their love of eating out and trying new types and venues of food, fueled tremendous growth in the street food category. Between 2012 and 2015, food truck revenues doubled from $600 million to $1.2 billion. Another source, the US Chamber of Commerce Foundation, found the industry to be even larger.  In 2017, they estimated it to be worth $2.7 billion, with annualized growth in the preceding six years averaging 7.9%. Either way, this is explosive upside and the theme corresponds perfectly to Blue Top Brand’s collection of street sauces. 

Another contributor to upside has been the health impact associated with certain hot foods. A chili pepper, for instance, has more vitamin C in it than an orange does. It also carries more vitamin A than an equal weighting of carrots, and chili peppers are known for being low in calories. 

An Eye on Management

At the center of Blue Top Brand is its founder, CEO and President: Chris West. Chris began his career in the food industry in 1991 at Cajun Injector Company. 10 years and $15 million in sales later, Chris brought his talents to Tony Chachere’s. His time there corresponded with North American sales quadrupling between 2001 and 2008. From 2008 to 2015, Chris worked with Stubb’s Legendary Kitchen as the Executive Vice President of Sales.  There, he managed a team of 15 brokers and four regional directors. In 2015, after Stubbs was bought by McCormick for $100 million, Chris decided to start his own family business: Blue Top Brand. Chris’ wife, Brock West, serves as the company’s Vice President. She handles the office responsibilities and accounting functions for the firm. The company also employs a supply chain consultant and a marketing director. 

Terms of the Deal

The transaction management is looking to close is fairly straightforward. According to the firm’s filing documents, it is trying to raise between $750,000 and $3 million. The company is doing so at a pre-money valuation of $9.985 million. Investors can buy into the firm’s preferred equity units at a price of $7 apiece, but the required minimum is $252 per participant. At this time, the company has $77,357 committed to its raise, but its window for closing the deal is still more than 140 days away. The preferred equity has no special voting rights, nor do they entitle their holders to a dividend unless management declares one. They do rank senior, however, to the firm’s Class A and Class B common stockholders in the event of a liquidation though. Shareholders may elect to convert their preferred shares into common at any time.

The Rating: Deal To Watch

After a careful evaluation of the details surrounding this transaction and this company, we have rated Blue Top Brand a “Deal to Watch”. This rating was decided based on the strong growth the company has achieved over time, the relatively low debt that’s on its books, and the strong growth this niche space in the broader (and very large) condiments industry has experienced. These all point to an attractive outlook for the business.  If it does achieve the sales growth it is forecasting, the upside for shareholders could be significant over time. 

This is not to say that everything is perfect though. Certain risks do exist. The large (but narrowing) net losses are disconcerting, but not wholly unexpected given where in its lifecycle the company is at. The firm must achieve cash flow neutrality, or the end result will be further dilution for investors or perhaps worse. Another negative that investors need to keep in mind is the pre-money valuation of the firm. A pre-money valuation of $9.985 million on a non-technology business is high.  This is especially true when you consider that it will likely be generating between $2 million and $2.5 million in sales this year. To compound this issue is the fact that the business is losing money. If management is correct and sales approach $7 million in 2020, this valuation could be justified. But one thing you can know about any projection is that it will always be wrong to some degree. The question is by how much. 

In all, these issues are important, and investors should not participate in this deal before weighing them on a risk/reward basis. That said, the good points about the firm are enough to suggest to us that it’s a solid prospect worthy of further thought. If management can keep this hot streak up, Blue Top Brand could someday see an excellent exit.  Along the way, investors should anticipate further dilution. Even with that, though, if the stars align, the opportunity could be worth it.