Grupo Bimbos (OTCPK:BMBOY) (BIMBOA.MX) mascot Osito may finally be coming out of hibernation, at least in the U.S., as recent market trends indicate that the company has regained some pretty meaningful share in the last couple of quarters. Whether that lasts, though, and allows the company to drive long-awaited margin leverage in North America is still a big question, and theres still a lot of work for management to do to improve its Latin American business outside of Mexico, to say nothing of driving enough share growth and volume in other geographies to justify the investments made there.

These shares havent done much since my last write-up, which is basically what I expected, and they have lagged the likes of Gruma (OTC:GMKKY), Flowers (FLO), and Mondelez (MDLZ) over that time. I still have pretty mixed feelings about the company. Although the ROIC has been pretty reliably in the double-digits, the companys growth by M&A strategy has produced mixed results at best, and progress on various self-improvement initiatives has been slow. If management can get FCF margins back into the mid-single-digits on a reliable basis, I think theres value here, but thats still a work in progress.

The changes in consumer patterns that have accompanied COVID-19 have benefited Grupo Bimbo, as consumers stay at home and eat and load up their shelves with comfort foods.

Revenue growth has accelerated from a 2% contraction in the fourth quarter to 7% growth in the first quarter, and 20% growth in the second quarter, with U.S./Canada the main driving force (with revenue up 36% in the second quarter). Granted, currency has played a significant role there, but sales were still up more than 11% in the second quarter in local currency, with the company seeing high single-digit volume growth in the first half of the year.

What I find encouraging is that the Bimbo seems to be benefiting from more than just an overall shift in consumer spending. Nielsen data has shown significant share growth, with Bimbo basically doubling the growth of the underlying bread, baked goods, and cakes in the second quarter. That outperformance has slowed since, but Bimbo is still gaining share. Ive seen some speculation that when people feel nervous they stick to (or go back to) brands they recognize and have long personal histories with, and I suppose the data support that. The big question, though, is whether Bimbo can hold that share growth after COVID-19 fades the companys market share had been weakening through 2019, and Bimbos core products arent exactly in keeping with the healthy eating and low-carb trends that are supposedly still popular.

In the near term, at least, Bimbo is leveraging this improved volume into better margins. There were still some opportunities left for Bimbo to optimize its supply chain and logistics, as well as introduce more automation into its plants, but as you might imagine, COVID-19 has put those plans on the back burner for the time being. Still, the added volume leverage did boost gross margin by three points in the second quarter, helping to drive better than 50% EBITDA growth and a 150bp improvement in EBITDA margin. The U.S. business is still far less profitable than Mexico in terms of operating margin and EBITDA margin, but better is still better.

While Bimbo seems to be benefiting from a shift toward comfort food in the U.S. and Canada, the business has faced greater challenges in Mexico (where the company still generates almost 30% of its revenue). Revenue in Mexico rose 4% in the fourth quarter of 2019 and 6% in the first quarter of 2020 before declining 1% in the second quarter, and EBITDA margin has fallen from 19% to 17% over that time.

Although they dont help, I question whether new labeling laws (which highlight the elevated calories, sugar, salt, and fat content of many of Bimbos products) in Mexico are making much of a difference. Instead, I think the weakness in channels like foodservice, vending, and convenience stores (FEMSAs (FMX) same-store traffic was down 24% in the second quarter) is likely the bigger driver. The Mexican business is far more leveraged towards sweets and snacks than the North American business, and I think Mexican consumers behave more or less the same as Americans do we may exercise discipline in the grocery store, but our self-control fades when its late afternoon and we pass a vending machine or a rack at the gas station.

I also believe there could be a modest economic impact here. Bimbos products are more luxuries than staples, and Mexicos economy is struggling, which may create some demand destruction at the margin. Still, Im not concerned about this business on any sort of long-term basis, and I expect volumes to start recovering as movement restrictions in Mexico have meaningfully eased.

Outside North America, theres a lot more work to do. Margins are still weak in Latin America (ex-Mexico) and Europe, with operating scale and operating leverage an issue in both regions. Bimbo still has fairly weak SKU breadth in Latin America and its distribution/logistics remains quite inefficient as a result. In Europe, the company just doesnt have all that much traction the company has a couple of brands that have some value here and there, but its still more of a hodgepodge business, and one that doesnt generate attractive margins at this scale.

I think the companys real problem areas are likely to remain so for a while. The company has given no indication that theyre seriously considering pulling out of any markets (or not to a meaningful extent), and its going to take time to build brand value. Along those same lines, I dont rule out the possibility (or risk, depending upon your point of view) of the company doing more deals to acquire more brands and improving operating scale/leverage in Europe.

Im looking for Bimbo to generate revenue growth on the lower end of the mid-single-digits. I do still see share growth opportunities in Latin America and Europe, as well as some incremental growth opportunities in North America, though product development/innovation will be essential to generating real organic growth above underlying volumes in the U.S.. I do expect Bimbo to generate better margins over time, but Im not going to give the company full credit for whats possible at this point until I see sustained improvement. Even so, mid-single-digit FCF margins can drive double-digit FCF growth.

With mid-single-digit revenue growth and mid-single-digit FCF margins (a roughly 150bp improvement over the trailing decades average) Bimbo looks priced for mid-to-high single-digit annualized total returns, and the shares look more undervalued on an EV/EBITDA basis, even with a lower multiple than I use for Gruma. I dont really love Bimbo, but I do think theres a fair price for almost any going concern, and with Bimbos market share growth and long-term FCF growth opportunity not fully reflected in the share price, there could still be some opportunity in this relatively defensive name.

Disclosure: I am/we are long FMX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Grupo Bimbo May Be Coming Out Of Hibernation, As Improving Market Share Can Drive Better Margins And Stock Multiples - Seeking Alpha