Sowing Good: A Promising Growth Story, With Risks to Consider (NASDAQ:SOWG)

Investment thesis

Sowing good (NASDAQ:SOWG) is a story of strong growth, being one of the first brands to bet on the sale of freeze-dried candies, which, according to management, have a high demand that the company is failing to keep up and is reflected in its very strong sales growth (and its potential for continued growth).

If the company can establish its products and not remain a mere fad, it could be a very profitable investment.

Another type of candy

Freeze-dried candy can be considered healthier than traditional candy in some ways. For example, because it has a very low water content, it often contains fewer additives such as artificial colors, flavors, and preservatives, compared to traditional candy. And it’s also important to consider that the crunchy texture and concentrated flavor helps satisfy the craving for something sweet in a smaller portion, thus contributing to eating less candy.

This doesn’t mean it’s a “healthy” product. In fact, when I read the nutritional information, I realized that 28 grams of the product contains 40% of the daily value of sugar to consume, while some traditional Nerds treats contain 42% of the daily value in 30 grams.

In short, it may have fewer additives and generally make you feel fuller faster, but nutritionally it’s not much better. I think this is a relevant point for the thesis and for assessing the target consumer.

Explosive growth, but to what extent sustainable?

Between Q1 2023 and Q1 2024, SOWG experienced extraordinary growth, going from $200,000 in sales in one quarter to over $11 million a year later. Additionally, in Q3 2023, it began to turn profitable and currently has an EBIT margin of around 8%, making this year set to be the first profitable year in the company’s short life.

Thanks to profitability and the issuance of shares, the company has reached a balance of almost $7 million, while total debt is around $12 million. This translates into a net debt of $5 million, compared to the $2 million of EBITDA that the company generated over the last twelve months.

This is controllable debt and SOWG could issue more shares to raise cash (I wouldn’t like that very much) or this profitable growth generates more free cash flow to pay off the debt.

This strong growth appears to be attributed to a strong demand for freeze-dried candy, according to the CEO’s recent comments:

Brendan (CFO) has been instrumental in helping us advance our strategic growth initiatives in support of the strong market demand for freeze-dried candies… Our first and foremost priority remains to increase our production capacity customer demand support.

Claudia Goldfarb – Co-Founder and CEO. Excerpt from Q1 2024 Earnings Conference Call.

Currently, 48% of production is done in the company’s two plants, located in Irving and Dallas, Texas. The remaining 52% is manufactured in Colombia and China, which allows for rapid production scaling and reduced capital costs. I wouldn’t be surprised if, in the future, the company sought to own close to 100% of its production capacity, but in the short term, this seems to be an effective measure to meet demand.

Sow Good product exposure used to be at smaller candy distributors like Redstone Foods or Nassau Candy, but with the arrival of Five Below as a client in 2023, the brand exposure has increased significantly. In fact, I first tried Sow Good candy while shopping at Five Below, specifically, when you’re in line to pay, there are about 8 SKUs (stock keeping units) of Sow Good products and although next to it there is another brand of freeze-dried candy (I can’t remember the name), the Sow Good packaging definitely stood out, but I have to admit I was a little biased knowing the company’s stock.

Five Below has been joined by other retailers that I consider to be top-tier, such as Albertsons, Ross, Target or Circle K. This should be helpful for Sow Good’s growth and all this without taking into account the possibility of e-commerce as a distribution channel, which currently represents only 2% of sales and is an interesting channel to exploit.

One point that I consider a risk to be taken into account is the fashion factor and the extent to which freeze-dried candies can be implemented as candies for everyday consumption. Due to their price, a first barrier is already set for this, for example, taking Target prices to make a fairer comparison, we obtain the following price per ounce results:

• Jolly Rancher: $0.25 per ounce.
• Nerds: $0.52 per ounce.
• Skittles: $0.64 per ounce.
• Tru Fru (freeze-dried strawberries): $1.28 per ounce.
• Sowing good (freeze-dried candy): $1.43 to $3.99 per ounce.
• Crazy candy (freeze-dried candy): $1.54 to $2.50 per ounce.

It seems clear that if you’re looking for candy, traditional ones are more affordable than freeze-dried ones, so unless the crunchy texture is something of a non-negotiable for you, you’d probably go with the traditional option since Sow Good currently offers flavors similar to traditional candies such as Skittles, Peach Rings, or Gummy Bears.

A choice skin in the game

The company is founded and run by Ira and Claudia Goldfarb, a husband and wife team who own 17% of the shares. In addition, brothers Lyle and Bradley Berman together own 15% of the shares and are independent directors, meaning that over 30% of the shares are controlled by two families.

This creates a somewhat curious situation, because on the one hand it assures us that there are a lot of stakeholders and that the founders and management will always try to do good for the company. But on the other hand it is also subject to family drama. Let’s say the Goldfarbs get divorced (I don’t wish that on them), that could destabilize the company and I don’t know how much that would hamper decision-making. Given that the company is currently growing and still very small, these kinds of problems have a greater potential impact than if they happened to, say, Microsoft, which can almost run itself.

I think it’s a good sign that SOWG insiders have been buying heavily and there has been no selling over the last year. This indicates that the people working on the day-to-day operational decisions see a positive path forward and believe they will achieve their goals.

It’s not totally decisive in my decision making, but it’s good to see it in a company.

Assessment

It is not easy to predict the growth of a company that has grown 90% and 20% quarter-on-quarter in the last two quarters, to say the least. So I will take into account the expectations of the 3 analysts currently covering the company.

By fiscal 2024, SOWG is expected to generate nearly $65 million in revenue, and that number will reach $100 million in fiscal 2025. While this is very high growth, the company has shown that it is indeed growing at this rate and there is demand to continue doing so. Additionally, expansion to new stores is expected to drive this growth.

Subsequently, I noticed that companies like Tootsie Roll (TR) and Mondelez (MDLZ) have similar margins to SOWG and their profit margins are typically around 12%. If the company is doing things right, that is the profitability target I would have in mind.

That said, to be more conservative, I estimate that by 2025, revenue would reach $70 million (versus $100 million expected by analysts) and that from there, growth should naturally slow down a bit. At the same time, net margin would reach the 12% I mentioned earlier within 5 years (over the last three quarters, it has averaged 8%, not unrealistic), so SOWG would generate $19 million in earnings or $3.45 in EPS if we consider the 5.5 million shares outstanding currently.

Assuming a 20x P/E, the price per share would be about $70, or 3x the current price and a 25% annualized yield. This P/E seems reasonable considering that in five years the company would hypothetically continue to grow and that currently TR’s P/E is 23x, MDLZ’s is 21x, Nestle’s is 20x and HSY’s is 19x, all with single-digit growth. So 20x would seem to be the average.

It goes without saying that for this to happen, the product must continue to enjoy the success it has demonstrated so far; otherwise, growth would be lower and, therefore, the potential return as well.

The essential

I see a lot lights and the shadows in the thesis.

• On the one handI like that the product has proven itself at Five Below and that big brands like Albertsons and Circle K are joining the brand. Plus, the e-commerce opportunity would allow the product to be moved to more places. Also, being one of the first serious competitors in the freeze-dried candy segment gives it a first-mover advantage, and I think the branding is enough to become a standout in the industry.
• On the other handI worry about the strong competition it will face from traditional candy companies. From price and consumer preferences to the potential risk that big brands will decide to enter the freeze-dried market, as Hershey already does. All this without mentioning the risk that 30% of the company will be controlled by two families who could experience internal problems at any time.

In conclusion, this is a company with the potential for tremendous internal profitability and growth, but one that will require trust in management and belief in the quality of the product. If so, it looks like an obvious buying opportunity, if not, it’s probably best to stay away.