Vital Farms Q3 23’ Investment Thesis Update

Executive Summary

Thesis I: Vital Farms Continues to Take Share in the Massive Egg Industry

• Q2 2023 Growth: Substantial increase in prices and volume, indicating robust consumer demand.

• Market Share Expansion: Overcame industry challenges to grow market share by approximately 150 basis points.

• Optimism for Fall Season: Anticipating growth with upcoming retail shelf resets.

• Product Range and Retail Presence: Aiming to increase SKU count and market presence.

• Maintaining Market Leadership: Vital Farms remains confident despite emerging competition.

Thesis II: Vital Farms has Immense Potential from Continued Network Expansion

• Retail Expansion: Added 2,500 stores, reflecting growing demand for ethical and sustainable products.

• Premium Pricing Strategy: Offers higher margins to retailers, differentiating from industry norms.

• Market Expansion Potential: Opportunity to increase store count and revenues in untapped grocery markets.

Thesis III- Massive and Expanding Specialty-Egg Market

• Consumer Shift: Rising preference for specialty eggs, driven by health, wellness, and ethical considerations.

• Specialty Egg Sector Growth: Outpacing overall market growth with significant CAGR projections.

• Economic Indicators: Retail sales growth and consumer spending power favor specialty eggs.

• Industry and Retail Impact: Influencing traditional egg producers and retail strategies.

Vital Farms’ strategic expansion, combined with the growing market for specialty eggs, underscores its potential for substantial growth. The company's approach to premium pricing, expansion into new retail channels, and adaptation to evolving consumer preferences position it for sustained success. The increasing consumer inclination towards ethically produced, high-quality eggs further bolsters Vital Farms' market position, making its stock an undervalued asset in light of its business potential.

Thesis I: Vital Farms Continues to Take Share in the Massive Egg Industry

Thesis Summary

1. Exceptional Growth in Q2 2023:

   • Vital Farms reported notable growth with a 21% price/mix increase and a 6% volume growth.

   • The ability to raise prices while expanding volume reflects strong consumer demand and a perception of Vital Farms' products as superior to conventional eggs.

   • This growth demonstrates the brand's disruption in the egg industry and suggests potential for further market expansion.

2. Market Share Expansion Amid Industry Challenges:

   • Despite challenges like bird flu impacting the industry, Vital Farms increased its market share by about 150 basis points to approximately 7%.

   • The company successfully navigated supply constraints and volatile retail order patterns, reflecting its resilience and strong market position.

3. Optimism for Fall Season and Retail Shelf Resets:

   • Vital Farms anticipates growth opportunities with upcoming retail shelf resets in the fall.

   • The company plans to introduce more products during this period, aiming to capitalize on seasonal retail changes to boost sales.

4. Expanding Product Range and Retail Presence:

   • Vital Farms aims to increase its average of 2.5 SKUs per store, leveraging its high-performing core SKUs to persuade retailers to add more products.

   • This strategy could significantly enhance the brand's market presence and sales.

5. Maintaining Market Leadership Amidst Rising Competition:

   • Vital Farms remains confident in its market leadership despite emerging competition.

   • The brand's focus on quality, ethical sourcing, and transparency continues to resonate with consumers, maintaining its distinct market position.

Exceptional Growth in Q2 2023

Vital Farms exhibited a remarkable performance in Q2 23, underscored by a unique combination of growth drivers: a significant price/mix increase of 21% coupled with a volume growth of 6%. This outcome has profound economic implications, particularly highlighting the robust demand for Vital Farm's offerings. The ability of the company to substantially raise prices, especially considering its products are already positioned at a premium, strongly indicates that consumers don't perceive Vital Farm's products as mere conventional eggs. The company emerges as a disruptor in the otherwise mature egg industry.

An illustrative scenario that underscores this point might involve consumers at a grocery store. Faced with a choice between conventional eggs and Vital Farms' higher-priced, pasture-raised eggs, more customers are opting for the latter, despite the price difference. This choice is driven by their recognition of the visibly superior quality and taste of Vital Farms' eggs, which some attribute to the company's commitment to natural, ethical farming practices.

Moreover, the increase in sales volume, alongside a steep price rise, further cements the notion that customers find substantial value in the company's products. Many customers regard Vital Farms' eggs as distinctly higher quality, directly contributing to a better taste profile for this staple food. The transparency of their "farm to table" approach also resonates with a growing consumer segment that values ethical and sustainable food sources.

The manner in which Vital Farms has achieved its revenue growth is particularly telling. It's not merely the growth itself but how the growth has been achieved that points to a strong, enduring demand. This dynamic positions Vital Farms favorably for sustained expansion in a market that still offers considerable untapped potential, or "white space." Hence, the company's recent performance isn't just a temporary upswing but a sign of its strategic positioning and the evolving preferences of health-conscious and ethically-minded consumers.

Market Share Expansion Amid Industry Challenges

During a particularly challenging quarter for the egg industry, Vital Farms demonstrated exceptional resilience and competitive strength. While the overall egg category experienced a modest 1% increase in retail dollar growth, Vital Farms stood out by significantly increasing its market share. This achievement becomes even more notable considering the broader market faced supply constraints, primarily due to a bird flu outbreak.

Despite these industry-wide challenges, Vital Farms not only effectively navigated through the adversities but also achieved a remarkable expansion in its dollar share — increasing by approximately 150 basis points. This growth signifies that Vital Farms now represents about 7% of the total egg category in tracked retail channels. The company's ability to grow its market share under such difficult circumstances is a testament to its strategic resilience, operational efficiency, and perhaps most importantly, the strong consumer trust and loyalty it has cultivated. This growth amidst a challenging backdrop highlights Vital Farms' robust position in the market and sets a precedent for its potential to thrive even in the face of industry disruptions.

Vital Farms' volume increase, driven by both new and existing retail customers, illustrates a widening customer base and strong market penetration. The company achieved an impressive 26% volume growth in Q1, a figure that, while notable, was partly influenced by a one-time boost due to avian influenza impacting the overall market supply. When this exceptional factor is set aside, Vital Farms still exhibited robust underlying volume growth in the high teens, indicating significant organic growth.

In Q2, the market conditions altered as egg supply returned to normal. However, retail order patterns continued to be volatile. This volatility stemmed partly from retailers who were readjusting their ordering strategies to align with the normalized supply. They had to recalibrate their ordering algorithms, which were previously disrupted by the supply shortages and inconsistent baseline data resulting from the avian flu outbreak. As a result of these shifting dynamics, there were occurrences of empty shelves in the egg aisles of retail stores, and a consequential dip in customer demand for Vital Farms' products, estimated to be in the mid-single-digit percentage range. This circumstance led to a more moderated volume growth of 6%, a rate considerably lower than usual.

An illustrative scenario could involve a supermarket chain that, during the peak of the avian flu outbreak, had increased their orders of Vital Farms' eggs due to shortages from other suppliers. However, once the overall egg supply normalized, the supermarket reduced its orders, attempting to balance the overstock from the previous quarters. This reduction in orders, coupled with the stores' efforts to recalibrate their stock based on new demand forecasts, occasionally led to gaps on shelves where Vital Farms' eggs usually sat. Consequently, this contributed to a temporary decline in customer demand for their eggs.

Despite these challenges, with the supply stabilizing and exceeding what had been typical pre-crisis levels, Vital Farms started witnessing a return to more regular order volumes. This resilience reflects the company’s adaptability and the inherent strength of its customer relationships and supply chain management. Vital Farms' ability to navigate these complex market dynamics and maintain growth, albeit at a more moderate pace, underscores its solid market presence and potential for sustained growth as conditions stabilize.

Optimism for Fall Season and Retail Shelf Resets

Vital Farms exhibits optimism regarding its growth prospects, especially with the anticipated retail shelf resets in the fall. These resets are seen as an opportunity to introduce more products, aiming to boost volume sales. This expectation to leverage seasonal retail shifts demonstrates a strategic and proactive approach by Vital Farms. Expanding the product range and increasing visibility during such times can tap into new customer demand that typically accompanies retail refreshes.

Over the past year, the company’s expansion, adding about 2,500 new retail points of distribution, significantly broadens its market reach. This growth isn't just a numerical increase but symbolizes new opportunities for both volume sales and enhanced brand exposure. As these new retail locations begin to contribute to sales, Vital Farms expects a noticeable impact on its volume, highlighting not just an expansion of distribution networks but also a strategic shift towards optimizing sales and revenue through these added channels.

Vital Farms' strategy to use its expanded distribution network for driving volume sales showcases an alignment between market expansion and operational effectiveness. The key lies in converting the growth in distribution points into real revenue enhancements and market share growth. Aligning product expansions with the timing of retail shelf resets, and maximizing the benefits from newly established distribution points, positions the company for an improved market presence and a stronger competitive stance.

This strategic maneuvering indicates Vital Farms' foresight and ability to execute plans that contribute to its growth. By proactively expanding their product offerings and efficiently using new distribution channels, the company is demonstrating its capacity for forward-thinking planning and growth execution. This strategy could not only increase sales but also fortify Vital Farms' position in a competitive market, reinforcing the company’s reputation for innovation and adaptability in a dynamic retail environment.

Expanding Product Range and Retail Presence

Vital Farms' strategic outlook and optimism about growth through expanded product offerings exhibit a confident and forward-looking approach in the competitive market. The management's bullish attitude towards increasing the number of stock-keeping units (SKUs) with current retail partners serves as a promising pathway for boosting net revenue. Presently, with an average of only 2.5 SKUs per store, in stark contrast to around six from their largest branded competitor, Vital Farms has a significant opportunity to expand its product range within existing retail channels. This discrepancy highlights a substantial potential for the brand to enhance its market presence and capture more shelf space.

Most of Vital Farms' SKUs are outperforming the category average, which is a testament to the strong consumer demand and acceptance of their products. The company's core SKUs are notable high performers, especially when compared to some legacy SKUs in the assortments of retailers. This demonstrates the strength and appeal of the Vital Farms brand in the market. The company’s strategy to persuade retailers to add more Vital Farms SKUs, leveraging their superior category performance, is sound and pragmatic. This approach benefits not only Vital Farms in terms of increased sales but also helps retailers in boosting their overall category performance.

An example illustrating this strategy might involve a popular grocery chain, where Vital Farms' pasture-raised eggs and butter are already well-received by customers. Recognizing the high performance of these SKUs, the management of Vital Farms proposes the introduction of new products like ready-to-eat egg bites or new flavored butters. By presenting data showing how their existing products outperform others in the same category, Vital Farms convinces the grocery chain to add these new SKUs. This addition is anticipated to not only increase sales for Vital Farms but also attract more customers and enhance sales in the grocery chain's dairy and egg categories.

The expected outcome is a mutually beneficial situation — where increased shelf space for Vital Farms leads to higher sales and greater customer satisfaction in retail stores. If this strategy proves successful, it could initiate a virtuous cycle of growth for both Vital Farms and its retail partners. By continuously proving the market appeal and performance of their products, Vital Farms can solidify its position as a leading brand in the industry, while also driving category growth for its retail partners.

Maintaining Market Leadership Amidst Rising Competition

Vital Farms' management displays a confident stance in light of other companies attempting to replicate their successful business model. This confidence stems not just from their competitive pricing, but more so from the brand's core values – encompassing quality, ethical sourcing, and transparency. These attributes resonate strongly with both consumers and retailers, helping to solidify Vital Farms' unique position in the market. Despite observing other brands entering similar market segments, Vital Farms' leadership notes that these competitors have not significantly affected their performance or presence on the shelves, reflecting a robust brand loyalty and a differentiated value proposition.

This isn't the first time Vital Farms has faced competition attempting to mirror their approach. Since their market entry, they have consistently faced and overcome similar challenges. This history demonstrates Vital Farms' ability to develop and refine strategies that sustain and enhance their market leadership, showing adaptability and resilience. Their ongoing success, even in the face of competition, underlines a deep understanding of the market, consumer preferences, and the importance of maintaining strong brand positioning.

An example illustrating Vital Farms' distinctiveness and strength could be their response to a competitor introducing a similar product line of ethically sourced, free-range eggs. Despite the competitor's efforts, Vital Farms might continue to thrive due to their established reputation for transparency and ethical practices, elements deeply valued by their consumer base. Their approach might involve reinforcing brand messaging around the authenticity and integrity of their farming practices or highlighting specific aspects of their supply chain that showcase genuine sustainability efforts – factors that emerging competitors may not replicate easily.

Given their established market presence, robust brand identity, and a loyal customer base, Vital Farms is likely well-positioned to maintain its leadership in the sector. This ongoing dominance, in the face of emerging competitors, accentuates Vital Farms' resilience and strategic depth. It illustrates how the company not only navigates market challenges effectively but also sustains its unique appeal amidst a landscape of evolving competition.

Thesis II: Vital Farms has immense Potential from Continued Network Expansion

Thesis Summary

1. Aggressive Retail Expansion:

   • Vital Farms has significantly expanded its retail presence by adding 2,500 stores, bringing its total to approximately 24,000 locations.

   • This expansion likely reflects growing consumer demand for ethical and sustainable products, and Vital Farms' successful strategy in meeting this demand.

2. Premium Pricing Strategy's Appeal to Retailers:

   • The company’s premium pricing model offers higher margins to retailers, making Vital Farms' products financially attractive for retail partners.

   • This strategy contrasts with the industry norm of discounting, emphasizing the added economic value Vital Farms provides in the retail category.

3. Potential for Market Expansion in Untapped Grocery Stores:

   • With Vital Farms' products in nearly 25,000 stores and the U.S. having over 60,000 grocery stores, there's a substantial opportunity for market expansion.

   • The company's ability to replicate its success in these new markets could significantly increase its store count and revenues.

Aggressive Retail Expansion and Market Penetration

Vital Farms' significant expansion, marked by an increase of 2,500 stores in its retail presence, showcases an aggressive strategy aimed at growth and market penetration. This expansion could be driven by strong retailer demand for Vital Farms' products or a successful push strategy by the company, indicating the brand's growing appeal. With products now available in approximately 24,000 locations, Vital Farms boasts a robust distribution network, enhancing brand visibility and accessibility, which are key factors for consumer goods success.

The expanded retail footprint substantially increases customer accessibility to Vital Farms' products, potentially attracting new customers and meeting previously unmet demands in regions where these products were unavailable. This increased reach may also reflect or influence shifts in consumer behavior towards more ethical, sustainable, and high-quality food options.

Premium Pricing Strategy's Appeal to Retailers

Vital Farms' strategy around premium pricing reveals a significant insight into their business approach and retail relationships. The company points out that its premium pricing isn't a deterrent for retailers; in fact, it's quite the opposite. The higher price point of their products offers a healthy margin, making them an appealing and profitable option for retailers. This approach is particularly important in an industry where discounting and promotional strategies are frequently employed for other products. By offering a high-margin alternative, Vital Farms provides a lucrative counterbalance for retailers.

This strategy not only bolsters the brand's attractiveness to retailers but also aids in upholding its premium pricing model. It emphasizes the added value Vital Farms brings to the retail category, not just in terms of product quality but also in economic terms. Retailers, grappling with thin margins on many conventional and promotional items, might find the profitability of Vital Farms' products enticing. For example, a grocery store typically runs frequent promotions on standard egg brands to drive foot traffic, often at lower margins. In contrast, Vital Farms' eggs, positioned at a higher price point, could offer the retailer a more substantial margin per unit, contributing positively to their bottom line even without resorting to volume-driven strategies.

Such a pricing and positioning strategy not only reinforces the premium nature of Vital Farms' products in the eyes of consumers but also makes a compelling case to retailers about the financial benefits of stocking these products. It's a clear indication of how Vital Farms leverages its premium quality to create value for both its end consumers and retail partners, distinguishing itself in a competitive marketplace.

Potential for Market Expansion in Untapped Grocery Stores

Vital Farms' presence in nearly 25,000 grocery stores, while impressive, is juxtaposed against the backdrop of more than 60,000 grocery stores across the U.S., highlighting a significant opportunity for market expansion. This disparity illustrates that the company has currently tapped into less than half of its potential retail market. If Vital Farms can replicate its success from existing stores in these untapped markets, it stands to substantially increase its store count and thereby amplify its revenues.

The basis for this expansion potential relies on the assumption that the appeal and competitiveness of Vital Farms' products in their current retail environments will be mirrored in new locations. This expansion isn't just about the attractiveness of the products; it also hinges on the company's ability to penetrate these markets effectively and expand its distribution reach. If Vital Farms can successfully enter these new markets while upholding its high product standards and strong brand identity, the impact of potentially tripling its store presence could dramatically transform its revenue profile.

This scenario implies a strategic need for Vital Farms to diversify its focus: continuing to deepen market penetration where it currently operates, while also actively seeking to break into and capture new retail spaces. The vast segment of untapped markets represents a rich opportunity for growth. Moving forward, Vital Farms' strategy will likely encompass not just aggressive expansion but also targeted marketing and scalable distribution efforts to encompass a more comprehensive national presence. This approach will not only enhance the brand's visibility but also cement its position as a leading player in the grocery and egg market, taking full advantage of the extensive network of grocery stores across the United States.

Thesis III- Massive and Expanding Specialty-Egg Market

Thesis Summary

1. Shift from Traditional to Specialty Eggs:

   • Consumer focus on health, wellness, and animal welfare drives preference for specialty eggs like organic, free-range, or pasture-raised.

   • Industry advancements make specialty eggs more accessible and affordable, challenging traditional egg producers to adapt.

2. Growth Dynamics in the Specialty Egg Sector:

   • Specialty eggs are outpacing the overall egg market growth, with an expected 12% CAGR from 2023 to 2033.

   • Cage-free eggs show significant growth, with organic and pasture-raised eggs leading the category in growth rates and premium pricing.

3. Economic Indicators Supporting the Specialty Egg Market:

   • Retail sales growth and rising consumer spending power indicate a favorable environment for specialty eggs.

   • Increased disposable income and moderating inflation support consumer willingness to pay more for higher-quality, ethically produced eggs.

4. Impact on the Agricultural Industry and Retail Strategies:

   • The growth of the specialty egg market influences traditional egg producers to transition toward specialty products.

   • Retailers are adjusting offerings to meet rising demand, allocating more shelf space to specialty eggs.

Specialty Egg Ecosystem

The shift in market share from traditional to specialty eggs is driven by a convergence of consumer trends and industry responses. From a consumer standpoint, there's a growing emphasis on health and wellness, with specialty eggs often perceived as more nutritious and safer due to organic and non-GMO standards. Additionally, ethical considerations around animal welfare have become more influential, with many consumers opting for eggs that guarantee humane treatment of hens, such as free-range or pasture-raised options.

On the industry side, advancements in production and distribution have made specialty eggs more available and affordable, contributing to their rising popularity. Producers have been able to scale up operations while maintaining the quality and ethical standards that attract consumers, reducing the price premium that specialty eggs once commanded. Retailers, noting the shift in consumer preferences, have increased shelf space for specialty eggs, further supporting the growth in market share.

The resulting dynamic is a significant challenge for producers of traditional eggs, who are now compelled to adapt to these market changes. This may involve adopting some of the practices of the specialty egg market or finding ways to compete on price and convenience. Meanwhile, the specialty egg sector continues to innovate, capitalizing on consumer loyalty and the willingness to pay a premium for products that align with their values.

Growth Dynamics in the Specialty Egg Sector

The analysis of the specialty egg sector within the global egg market reveals a pattern of rapid growth and an increasing shift in consumer preferences towards more specialized products. While the entire egg market is projected to grow steadily, specialty eggs are outpacing this growth significantly, with an expected compound annual growth rate (CAGR) of 12% from 2023 to 2033, compared to the overall market's CAGR of 5.40% in the same period. This disparity in growth rates underscores a robust consumer appetite for specialty egg products.

As the specialty egg market burgeons, it's essential to dissect the factors propelling its expansion. Cage-free eggs are witnessing an upsurge, driven by heightened concerns for animal welfare and the perceived health benefits of such products. The market for these eggs is expected to reach USD 6.89 billion by 2028, growing at a CAGR of 4.70%. This growth trajectory suggests that ethical considerations are becoming increasingly influential in consumer buying decisions.

The organic egg sector is also experiencing a significant uptick, with projections estimating growth from USD 4.2 billion in 2023 to USD 10.7 billion by 2032. The substantial CAGR of 12.50% for organic eggs is indicative of a broader trend toward organic food consumption, bolstered by rising health consciousness and concerns over environmental impact and animal welfare. Organic eggs' promise of being free from synthetic additives and the guarantee of outdoor access for chickens is resonating with consumers, who are showing a willingness to invest in products that align with their health and ethical standards.

Notably, the pasture-raised egg segment is not just growing but leading the category growth rates across measured channels. This segment's performance is particularly impressive, combining volume growth with premium pricing, which is a clear indicator of market readiness to pay more for added value in ethical and quality terms. Retail sales data reflects this trend, with a remarkable 24 percent increase in a 12-week period for pasture-raised eggs, outpacing the growth of other specialty categories such as free-range eggs.

These growth patterns within the specialty egg market have significant implications. Firstly, they demand a reorientation of production practices to meet the ethical and quality standards expected by consumers. Producers who can adapt to these standards are likely to capture more market share and realize higher profit margins due to premium pricing.

Secondly, the specialty egg market's growth is not happening in isolation but is influencing the broader agricultural industry. Traditional egg producers may feel the pressure to transition towards specialty products or risk losing relevance as consumer preferences evolve.

Lastly, the growth of the specialty egg market is shaping retail strategies. Grocery stores and other retailers are reconfiguring their offerings to accommodate the rising demand for specialty eggs, which may include dedicating more shelf space to these products and engaging in marketing efforts that highlight their unique selling propositions.

Economic Indicators Supporting the Specialty Egg Market

The recent economic indicators present a positive backdrop for the specialty egg ecosystem. An increase of 3% in Q1 and 6% in Q2 for overall retail sales, as reported by the Fed, is indicative of a robust consumer spending environment. This uptick in retail activity suggests that consumers are not only willing to spend but may also be increasingly directing their expenditure towards higher-value goods, which include specialty egg products known for their health and ethical attributes.

Job growth exceeding 2% annually provides a broader base of consumers with employment stability, potentially increasing the number of individuals with discretionary income. This economic stability is likely to fuel consumer confidence and spending power, which bodes well for specialty egg producers. As more consumers find themselves in a secure financial position, the likelihood of them opting for premium products, such as organic or pasture-raised eggs, over conventional alternatives could increase.

The annual wage growth of over 4% further strengthens this narrative. With higher wages, consumers are better positioned to prioritize quality and ethical considerations in their purchasing decisions, potentially leading to a greater market share for specialty eggs. This trend is especially relevant as specialty eggs are often priced higher than traditional eggs, and a population with growing disposable income is more capable of affording such premium products.

Moreover, the growth in disposable income, surpassing 3% from an already high base, directly impacts consumer purchasing behavior. With more disposable income, the threshold for premium pricing becomes less of a barrier, and the value proposition of specialty eggs becomes more appealing. The correlation between disposable income growth and the propensity to purchase higher-quality food products can be particularly strong in markets that emphasize health and sustainability.

Finally, the moderating inflation plays a critical role in preserving the purchasing power of consumers. As inflationary pressures ease, the real value of increased wages and disposable income is maintained, if not enhanced. This economic breathing room may lead consumers to make more conscious choices, favoring products that meet higher standards of production and nutrition, which are central to the specialty egg market.

Forecast and Valuation

Vital Farms exhibits significant potential that is not fully reflected in its current stock valuation. The company's significant growth in Q2 2023, marked by a 21% price/mix increase and a 6% volume growth, indicates a strong consumer demand for its products. This growth trend, combined with strategic retail expansion, premium pricing strategies, and the immense potential of the specialty egg market, positions Vital Farms favorably for future growth.

Despite the industry challenges such as bird flu, Vital Farms has effectively increased its market share, reflecting its resilience and adaptability. The anticipated expansion during the fall season and further growth in untapped grocery markets highlight the company's potential to significantly amplify its retail presence and revenues. Additionally, the specialty egg market, driven by consumer focus on health, wellness, and ethical standards, is expanding rapidly, offering vast opportunities for Vital Farms to capitalize on shifting consumer preferences and retail trends.