Armanino Foods of Distinction: Risk/Reward Not Attractive, So Continue To ‘Hold’ (AMNF)

gorchittza2012/iStock via Getty Images Intro We wrote about Armanino Foods of Distinction, Inc. (OTCPK:AMNF) (US frozen food production company) in January of this year when we stated that shares of the company would most likely continue to rise over the near term. This prediction came to pass as strong momentum resulted in shares rallying from $4.66 a share at the time of writing our January commentary to eventually surpassing $6.20 a share in early April of this year. Since those April highs, shares have come back down to the $5.40 level meaning the stock has gained almost 18% over the past 20+ weeks alone. This has been a strong showing for the pesto-derived US company considering the S&P500 has returned just north of 12% over the same period. Although we envisaged momentum in the share price over the near term, we stamped a ‘Hold’ rating on the stock back in January which we continue to maintain. As we see from Armanino’s technicals below, there is every possibility (due to the newly established trend of lower highs & lower lows) that shares come back down to test their 200-day moving average below $5 a share. We state this because of a potential descending triangle in play depicted by a descending upper trendline coupled with a flat lower counterpart. These patterns usually result in lower prices over the near term due to sellers in the stock being more aggressive than buyers. Suffice it to say, this newly formed bearish trend ties in with our previous ‘Hold’ rating in Armanino Foods of Distinction. Therefore, let’s go through the company’s latest quarterly numbers to see how fundamental trends tie in with what we are seeing on the technical chart. AMNF Technical Chart (Stockcharts.com) Q1 Demonstrated Continued Gross Margin Expansion In Armanino’s most recent quarter (Q1 earnings – For the Period Ending March 31st, 2023), the company reported $15.72 million in net sales & $2.318 million in net income. Although net sales dropped some $631 million in the quarter, net income rose by 21% over the same period of 12 months prior. Margin expansion is a trend we highlighted in our January commentary so it is encouraging that this trend continues in earnest. For example, if supply-chain challenges were to gain traction in the quarters ahead, given how margins have been improving in the company, you feel that Armanino would continue to make strong inroads concerning its cost-cutting initiatives on the income statement no more so in the key ‘Cost Of Goods Sold’ line item. In Q1, gross margin hit 38.36%, dwarfing the comparable 29.42% in the same period of 12 months prior. An elevated gross margin can both protect bottom-line profitability & drive the income statement forward so it will be interesting to see if management can continue to lower its ‘cost of goods sold’ over time. Valuation Continues To Rise From A Sales Standpoint However, Top-line growth remains absent although management stated in the Q1 earnings report that growth has been affected by temporary ‘forward shipping’ challenges of its customers. Lower quarterly sales and a higher share-price invariable means that the company’s sales multiple has risen as we see from the exercise below. Given the absence of forward-looking sales projections for Armanino, if we were to average out the Q1 top-line tally of $15.72 million, we would get adjusted forward 12-month sales of $62.88 million. Dividing this number into Armanino’s present market cap of $173.15 million would then result in an adjusted forward sales multiple of 2.75. This is the first trend that investors should watch given the Consumer Staple sector as a whole trades with a forward sales multiple of only a mere 1.19. Therefore, not only are Armanino’s sales twice as expensive as the sector but they are also undergoing a negative growth trend as discussed earlier. Assets Also Remain Overvalued Cash & cash equivalents rose to $22.45 million at the end of Q1 due to strong working capital trends in the quarter. However, the increase in account receivables ($9.089 million) & the decision to take cash out of the company by declaring a special dividend ($0.10 per share) alongside the regular cash dividend ($0.363 per share) resulted in a sizable reduction in shareholder equity ($28.453 million). This trend also adversely impacted the stock’s valuation in Q1 in the following way. When we divide shareholder equity of $28.453 million into the present market cap of $173.15 million, we get a trailing book multiple of 6.09. The sector trades with a book multiple of 2.41. The separation here between the two multiples also highlights how much Armanino assets trade above the averages. Remember, although the company continues to make strong inroads regarding its gross margin gains, it is very difficult to see this trend continuing indefinitely at its current clip. Strong earnings power MUST be accompanied by an attractive valuation to ensure sustained share-price gains. This is why we believe share price consolidation is more likely over the near term to let Armanino’s respect valuation multiples retract somewhat to more traditional levels. Significant Customer Concentration Remains At the end of Q1, 66% of Armanino’s receivables & 55% of the company’s top-line sales came from one sole distributor. Although this distributor services a significant number of accounts (which benefits Armanino from an accounting standpoint), this strong concentration does bring risk to Armanino’s business especially if the fundamentals of this distributor were to weaken in any considerable way. Furthermore, the below-average trading volume in Armanino means that shares can move meaningfully in either direction when aggressive buyers or sellers take positions in the stock. Suffice it to say, that this risk given our concerns regarding the stock’s valuation discussed above is enough for us to remain on the sidelines at present. Conclusion To sum up, although Armanino Foods of Distinction made solid net profit gains in Q1, the sustained absence of top-line growth, an overextended valuation & significant customer concentration risk lead us to believe that the right course of action here is to wait for a better entry. The risk simply doesn’t justify the potential reward here at present. We look forward to continued coverage. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.