The virtues of a founder led company are often extolled. Research shows that founder led companies invest more aggressively than their peers in research and development, capital expenditure, and mergers and acquisition. As a result they grow revenues at a faster pace and, to quote Peter Lynch, “corporate earnings drive stock prices”.
I try as much as possible to factor this into my stock selection process. I don’t just buy founder led companies, but if a company fulfils enough of my criteria, I ideally want the management to have plenty of skin in the game. One such stock that ticked both such criteria is AIM listed Supreme PLC.
High CEO ownership
Supreme manufactures, distributes and licenses consumer staples in the form of lighting, batteries, vaping products and sports nutrition and wellness products (think multi-vitamins, protein bars and emal replacement shakes). Supreme CEO Sandeep Chadha started working in what was then his father’s business after leaving school. He bought his father out in 2003 and still holds over half of the company following its listing on AIM in 2021. Supreme also boasts some significant institutional holdings for a sub-£250m market cap, including a near 5% holding by Mark Slater, the heir of GARP investing.
Supreme major shareholders
Growth at a Reasonable Price?
Supreme looks on paper to offer investors a potential growth at a reasonable price investment. At the time of writing SharePad had Supreme on a forecast PE of 15 and a forecast PEG of 1, both of which appear to be fair especially when compared to some AIM listed small cap darlings. Both revenues and profits have been growing with revenue showing a CAGR of 14% and EBITDA a CAGR of 26% between 2018 and 2021. Both the top and bottom-lines are forecast to continue growing.
Supreme revenue/profit growth and forecasts
However, this doesn’t tell the whole story. Not all elements of the business are driving this growth equally. The more mature battery and lighting parts of the business are growing slower (or not much at all in the case of batteries), with revenue from branded household goods actually reducing. The vast majority of the growth is coming from the well-established vape business and increasingly from the newer sports nutrition and wellness lines.
Performance of Vaping (Red) and Sports Nutrition (yellow) business lines
Fortunately there are tailwinds for Supreme in that the market for both categories is growing. Supreme has strong relationships with the discount retailers, who stock lines in both of these categories. The increasing growth of the discounters has a corresponding benefit to Supreme, who now have product lines in more stores as a result of this expansion. Supreme are also now seeing their vaping and nutrition products stocked in main supermarkets, including Sainsbury’s and Asda, exposing them to a different customer base.
Vaping has been a strong performer for Supreme and now represents half of the gross profit. Although regulatory concerns have long been raised for vaping, Public Health England and the NHS have endorsed vaping as a method for people to quit smoking that is much less harmful than smoking cigarettes. Supreme have managed to grow their customer base further by securing a contract to provide vapes to prisons (the very definition of a captive audience!), along with vitamin D and protein bars, which has further grown revenues and profits. However, despite the impressive domestic growth, the CEO has freely admitted that growing the vaping business in Europe will be difficult, which places a potential limit on just how much this business line can grow by.
With the maturity of the batteries and lighting division, sports nutrition has been critical for providing growth beyond the vaping business. Supreme are aiming to become a cut price Holland and Barrett and claim that their scale and virtual integration model allow them to do this. It is a strategy that the CEO has successfully executed in other business lines and he looks to be repeating the trick again here, with their Sealions vitamins range offering a year’s supply for just £5 and proving popular on Trustpilot. Investors will be aware that being the lowest price operator, even in a low margin area such as consumer staples, can become a powerful moat.
Cost Control & Dividend Dilemma
One aspect that comes across clearly in all of his communications is the CEO’s laser like focus on cost control. This has included examples such as:
- Buying ‘last minute’ advertising slots when agencies become desperate to fill them, making the marketing budget deliver more bang for buck.
- Acquiring brands/businesses when they are in distress or management are looking for an exit, allowing a favourable price to be negotiated that limits the downside risk to Supreme.
- Introducing the Supreme lean management model to those acquired businesses, retaining only key staff that are adding value (this strategy is detailed in this interesting podcast with CEO Sandeep Chadha).
- Bringing as much manufacturing in-house as possible, such as producing their own vaping bottles and making their own vitamin pills.
This commitment to cost control is commendable and just what I like to see. This is likely a key contributor as to why Supreme have demonstrated good returns on capital for a business of this nature. The issue for Supreme will be that cost management can only contribute so much to the bottom line and the key question if for how long growth can continue organically.
Supreme has had an impressive Return on Capital Employed of over 20% & EBIT margin of over 10%
Supreme have acquired businesses recently to supplement the sports nutrition division and the CEO has made noises that he would like to do the same again. Whilst the CEO has a good track record on acquisitions can he continue to do so in a manner that adds shareholder value in the form of returns on capital and improved margins rather than destructive acquisitions that grow revenues at the expense of shareholder value?
There’s also the issue of the dividend policy. At IPO Supreme committed to a dividend policy of paying out 50% of net profits, largely to entice income focused institutional investors. This limits funds available for extra growth and is a policy the CEO has admitting to having regrets about. The risk to investors is that further growth is financed by debt, which needs to be serviced, or equity, which will dilute existing shareholders.
Supreme debt has begun to be reduced in recent years as the business has generated more cash
Unfortunately a management incentive which provides a hefty annual bonus is based largely on the ridiculous measure of ‘adjusted’ EBITDA. Such a measure does nothing to discourage acquisitions financed by either debt or dilution or prevent value destruction through reducing returns on capital and margins. At this stage it would be better for Supreme to reengage on it’s 50% dividend policy to target a sustainable way of funding further growth, a measure most shareholders would surely support.
Despite the bonus incentive, the CEO would benefit more than anyone in Supreme continuing to grow and add value to shareholders so he should be aligned with shareholder interests. Supreme offers ownership of a growing business that is supplying growth markets at a reasonable valuation and could be considered for a long term, appropriately sized investment that also offers some income.
- CEO has plenty of skin in the game and a good track record.
- Strong growth in vaping and sports and nutrition product lines that are themselves in a growing market.
- Wide customer base including discounters, traditional retailers, government and direct to consumer.
- Vertical integration model increases margins and limits supply side risk.
- Lean management model led by a long serving team with a focus on cost reduction.
- Vaping business could appeal to big tobacco as a potential takeover target.
- Institutional ownership by managers with a good track record.
- Transparency – the CEO and CFO appear to be very upfront and clear in their communications and are very happy to answer shareholder questions.
- Performance appears to be heavily dependent on the CEO.
- Illiquid. Over half of the stock is held by the CEO who is currently in a lock up period.
- A risk that the vaping product, which now accounts for half of gross profit, could be subject to regulatory pressures.
- Further growth appears to be somewhat dependent on continued acquisitions.
- 50% dividend policy limits the use of reinvesting profits for growth, increasing the risk of the business taking on further debt or equity raises to facilitate growth.
- Retailers tend to force suppliers, rather than their own customers, to absorb cost increases and these are a significant part of Supremes’ customer base.