[00:02:47] Shawn O’Malley: Maybe you’ve had a similar experience yourself, and if you have, you might know that I’m talking about none other than Vital Farms. A company of egg cellent quality. Puns aside, Vital Farms has taken what is supposed to be a commodity product with correspondingly fierce competition and turned it into a massively profitable and fast growing business.

[00:03:07] Shawn O’Malley: As crazy as it sounds to some people who probably cannot fathom paying a premium for something as common as eggs, Others are more than happy to pay a few extra bucks for the small luxury of eating eggs that transparently celebrate family farming, ethical animal treatment, sustainable practices, and importantly, just taste better, thanks to a healthier lifestyle and more well rounded diet from the chickens laying the eggs.

[00:03:30] Shawn O’Malley: Again, I know that might sound like maybe hippie nonsense to some people, but speaking from experience, those things matter to people in a world of factory farming, pesticides, and environmental degradation from commercial agriculture. Being able to read on the carton about exactly where your eggs came from, the name of the farm, and to see a picture of it too, while also being able to learn about how they were humanely raised, is a major differentiating factor that helps support why so many people are willing to splurge on so called premium eggs.

[00:03:57] Shawn O’Malley: I’ll just say that the marketing for these eggs is fantastic, a real masterclass. I never thought so much personality and folksy flair could be communicated on the outside of a carton of eggs, but Vital Farms does it pretty dang well. So today, I’m evidently digging into Vital Farms to see if there’s any substance behind these flashy eggs that I’ve purchased more than a few times myself.

[00:04:19] Shawn O’Malley: With average returns on invested capital of 16 percent and 35 percent average revenue growth in the last 5 years, this is anything but a commodity business. I want to know though, whether this is just the latest ephemeral trend in healthy eating, or evidence of a surprisingly durable moat cultivated over nearly 2 decades.

[00:04:37] Shawn O’Malley: Let’s start with Vital Farms mission. On their website, they write, We are on a mission to bring ethically produced food to the table, and our purpose as a business is to improve the lives of people, animals, and the planet through food. Correspondingly, the company claims to operate with a stakeholder focus, rather than just a shareholder focus.

[00:04:55] Shawn O’Malley: It would, in theory, cast a wider net of consideration for the decisions they make. A lot of companies say things like that in the spirit of ESG, but Vital Farms seemingly walks the walk. They’re a certified B corporation, meaning the company has undergone a comprehensive B impact assessment, which evaluates its practices across its governance, worker relations, communities, environment, and customers.

[00:05:18] Shawn O’Malley: To achieve B Corp certification, it must score at least 80 out of 200 points on an assessment, and the process is repeated every three years to ensure continuous improvement. So B Corp status is a legitimate certification, and a real sign that they live by their good old fashioned values. True to their mission and B Corp status, this stakeholder focus includes minimizing environmental impacts, which is why vital farmers do not use pesticides or herbicides on their pastures.

[00:05:44] Shawn O’Malley: Similarly, they claim to compensate farmers fairly since they’re the backbone of the company’s operations. This fair treatment of the environment, animals, farmers, and customers all combined together to form an enduring business model that rewards shareholders, too. This can mean, though, that other stakeholders are prioritized at the expense of shareholders.

[00:06:03] Shawn O’Malley: For example, the company may choose to build state of the art facilities with quality control processes that well exceed the requirements of the USDA or FDA. That extra cost would be shouldered by shareholders to ensure the company’s eggs are safely packaged and distributed. Here’s a line directly from the company on this.

[00:06:20] Shawn O’Malley: Quote, We may choose to revise our policies in ways that we believe will be beneficial to stakeholders other than our stockholders, including farmers, suppliers, crew members, and local communities, even though the changes may be costly. Warren Buffett frequently talks about how treating people well is, in many cases, simply good business, and I think there’s probably no better example of that than Vital Farms, where treating people as they’d like to be treated at every touchpoint is foundational to their identity.

[00:06:47] Shawn O’Malley: Don’t get me wrong. There are plenty of instances where I think companies get distracted by this kind of ambitious jargon But ultimately fall short of their goals, especially these kinds of ESG focus values don’t directly matter for their brand You probably don’t put that much thought into whether Lego is a good steward of relations with local communities or the environment I mean in theory, yes, you might but in practice if your kid wants a new Lego Star Wars set You’re probably going to just buy it for them regardless of your perceptions of Lego as a corporate entity But with Vital Farms, being sustainable and ethical is a core part of their brand.

[00:07:20] Shawn O’Malley: So whether you believe that they actually succeed in achieving some of these claims is an important part of their value proposition. And I do think the Vital Farms brand is very strong, though it could be vulnerable to scandal. Bad press surrounding how farmers are treated, or the practices they actually follow could materially hurt how the brand is perceived.

[00:07:36] Shawn O’Malley: I do think Vettel Farms is the responsible operator they claim to be, but all I’m saying is that when you build your brand around this sense of responsibility, any reports that leak out suggesting something otherwise could really be detrimental to whether people are still willing to pay a premium for those eggs.

[00:07:50] Shawn O’Malley: My feeling is that people pay 9 for a carton of eggs because it’s a small luxury where they either think the quality and taste are better or they take pleasure in knowing that they’re contributing to more humane or environmentally friendly food production practices. And if their perception of Vital Farms is tainted at all, it becomes harder to justify that greater expense, or they’ll just turn to other brands that they think more highly of.

[00:08:13] Shawn O’Malley: To this point, there was a lawsuit in 2021 that threatened to do just this, accusing the company of effectively greenwashing its branding and in private, following practices that were far less humane and ethical than what they publicly espouse. And that put Vital Farms at the center of a number of viral videos on TikTok about the controversy.

[00:08:31] Shawn O’Malley: So, there was a real risk that the tide of favorable narratives about the company could have changed quickly, but they responded very effectively in videos showing the accusations being hurled at them, like the suggestion that their chickens don’t actually roam free, with a response from an actual farmer standing in a pasture amongst their vital farm’s hens.

[00:08:48] Shawn O’Malley: With 120, 000 plus followers on TikTok, it’s a pretty dang good following for an egg brand and positions them well to respond to viral trends. Vital Farms appears to have come out victorious on the other side of greenwashing accusations for the most part and based on how fast the company is growing, I would not say in any way that this has hindered their finances.

[00:09:08] Shawn O’Malley: PETA was affiliated with one of these lawsuits against them, accusing them of a few different practices they find unethical, like doling chicken speaks so they can’t peck each other. I’m sure not everything about Vital Farms operations are as rosy as they make it out to look, but I also don’t think PETA is the ethical standard bearer that most consumers identify with either.

[00:09:27] Shawn O’Malley: I’d imagine most people see Vital Farms as a major ethical upgrade to more common options, even if their operations aren’t perfectly ethical, which is, of course, an arbitrary thing anyway. There are always going to be differing perceptions of what’s ethical, or some people think eating eggs at all is unethical.

[00:09:43] Shawn O’Malley: The lawsuit outlines practices at Vital Farms that are common at other egg producers, but it says are not ethical. The company, the suit claims, cuts the beaks of chickens so they don’t peck at one another, obtains chicks from hatcheries that kill male chicks that aren’t edible and don’t lay eggs, and sells its hens for slaughter when they’re 18 months old once their egg production slows down.

[00:10:04] Shawn O’Malley: In response, Vital Farms said in a statement, quote, We are transparent about what happens to male chicks, as well as what happens once hens reach their post laying life. As for the industry standard practice of doling the tips of hen’s beaks, that is not done to harm the birds, but to protect them. The company added, We are pleased to offer products that value animals, including by providing hens, a meaningfully better life than the confinement they would face in the industrialized food system.

[00:10:29] Shawn O’Malley: David Kirkpatrick was an early stage investor in vital farms. And he told the New York times that it’s ironic because there are massive aid companies out there that are doing things that are awful. When you buy vital farms, you can put in a code and see where those hens are. It’s a little bit like attacking a solar company instead of Exxon because they’re doing something you don’t like.

[00:10:47] Shawn O’Malley: And I tend to agree with that. There’s been a lot of legal back and forth and some settlements and dismissed cases. But in the aftermath of these accusations, the company has avoided any lasting damage to the brand. From what I can tell directionally, the consensus feeling is that vital farms does mostly live true to its branding, even if unsurprisingly, it’s not perfect.

[00:11:07] Shawn O’Malley: I already mentioned this, but just to make the point again, because it’s important. One of the strongest indicators of this to me as a customer is that on the side of every panel of their eggs, they include the name of the farm that the eggs came from, which you can look up on their website and learn more about.

[00:11:22] Shawn O’Malley: That traceability is just super impressive and honestly gives a step further than not only any other egg brand I’ve ever seen, but also further than really any healthy food brand I’ve ever encountered. Plenty of brands tell you generally about how their products are ethically sourced or what region they’re from, but to have a vast network of different family farms and spotlight them in this way immediately creates trust with customers, at least it did with me as a shopper.

[00:11:45] Shawn O’Malley: I remember being blown away at the idea of knowing where the eggs I was eating were sourced from, which really, as you think about it more, shouldn’t be such a unique thing. It is weird in a way that we effectively have no idea where most of the food we eat comes from and got to us. And I can only imagine the level of effort and organization that goes into offering that degree of traceability.

[00:12:05] Shawn O’Malley: Just to clarify, a carton of eggs may not be 100 percent from the same farm, but the farm they spotlight will be guaranteed to have contributed a portion of the eggs in that carton. And the rest of the eggs in your carton will come from similar farms. And again, that is good enough for me. But so I wanted to basically test this out myself, and I walked down to my local grocery store and picked up some Vital Farms eggs, and I’ll say too, if you’re imagining these are only sold at Whole Foods, be wrong.

[00:12:30] Shawn O’Malley: From Publix to Food Lion, Vital Farms has gained distribution across a pretty diverse set of retailers. We’ll get to distribution later, but now back to my carton of eggs. With my carton in hand, it was pretty easy to find the name on the side and then go to vitalfarms. com slash farm. There I input the name of the farm, which in my case was called Blue Ridge Farms, and it directed me to a page with a four minute long dynamic video.

[00:12:54] Shawn O’Malley: Where I could virtually interact with the farm and spin around with a 360 degree view of all the operations. I just think that’s super cool and something that is so valuable to the type of people who are really mindful about the food they eat and how it’s produced. In the video, the viewpoint is from the middle of the pasture, so it’s as if you’re standing alongside all the chickens, just sort of watching them stumble around and eat worms, which stands in pretty sharp contrast to the footage I’ve seen of how most eggs are produced in factory farms.

[00:13:22] Shawn O’Malley: And again, I want to hammer in the message that this isn’t entirely marketing fluff or crunchy nonsense. Even if this kind of traceability or more humane lifestyle isn’t something 90 percent of the population cares about, especially if it means eggs that are twice as expensive, the 10 percent of the population that does care about that stuff, it really matters to them.

[00:13:40] Shawn O’Malley: I’m just making up percentages there, but, you know, you get the idea. They’ll take it even further to letting you message your farmer with feedback, concerns, or, you know, whatever you want to say to them, which is so unique. It’s almost like a digital farmer’s market. One of the main draws of farmer’s markets is that you can meet the farmer who produced your food, support your local community, and get some stuff that is maybe healthier or fresher than what you can get at your average grocery store.

[00:14:04] Shawn O’Malley: And Vital Farms has embraced people’s love of farmers markets, allowing you to see the local farms in your area that are part of the Vital Farms network and sharing feedback with them if you’d like. I did leave a note for the farm that my eggs apparently came from just to say thanks and not like you can DM back and forth with them, but still appreciate the sentiment behind the ability to share a message with a farmer.

[00:14:25] Shawn O’Malley: I have no idea whether Vital Farms actually relays the message to them and whether farmers care at all to read these types of notes. My guess is they probably don’t see them, but branding is all about perception. I think these little wrinkles all go a long way toward building up the Vital Farms brand and the trust people have in it.

[00:14:41] Shawn O’Malley: And I also have to say, I just received in the mail today, right before I filmed this episode, some discounts and coupons for free eggs and butter from Vital Farms, just because I reached out and messaged a farmer. So they do give you a little perk for having done that. But we’re going to be a critic of Vital Farms or skeptical about potential greenwashing.

[00:15:00] Shawn O’Malley: I’d point out that it would be far more effective if you could see a live stream of their hens running around to truly verify how they’re treated rather than some pre recorded video, and even though I do appreciate the ability to leave farmer’s feedback, it is largely symbolic. To take a step back, the company’s story begins as a single family farm in Austin, Texas, which explains the funky flair to their branding.

[00:15:23] Shawn O’Malley: As they grew, they didn’t make their farm bigger, instead they found more like minded farmers who put the welfare of animals first. Today, over 375 small family farms commit to Vital Farms exacting standards and the farming practices that they believe are the best for hens and the land. For example, pasture rotation allows the girls, as Vital Farms likes to call them, to forage on a new section of healthy greens about every 21 days.

[00:15:48] Shawn O’Malley: Which lets the section behind them recover until they come back around again. But raising hens in this way can only be done in some geographies, since other places are too rainy, cold, or too hot to allow them to spend the recommended amount of time outside. Accordingly, Vital Farms has what it calls the Pasture Belt, the perfect region in the US for raising pastured hens.

[00:16:09] Shawn O’Malley: This area goes from roughly Kentucky to parts of Kansas, Missouri, Illinois, and Texas. It’s important to note that the term pasture raised isn’t regulated in the U. S., so it can be used loosely and unevenly, but the company does have the certified humane label on its eggs too, verifying that each of its hens has access to at least 108 square feet of land, alongside requirements relating to the quality of food and living space that must be available to them.

[00:16:35] Shawn O’Malley: One of the key words there to focus on and that label is access certified humane pasture raised hens simply need to have access to green space that is available to them, but it doesn’t mean that they spend the bulk of their time on it or that they can easily use it. Free range claims by egg brands in the United States operating nationally, even if they have a certified humane logo or similar third party verifications are likely to be deceptive to a lot of consumers who are inclined to dig into their meaning.

[00:17:04] Shawn O’Malley: And that’s because when you put thousands of hens into a barn with limited space, many of those hens are never actually going to fight through and reach the outdoor space that is technically available to them, no matter how much outdoor space there is. So while a large pasture is required for these hens, large amount of indoor space is not, and they might be so packed together indoors that they can’t reach the outdoor area.

[00:17:27] Shawn O’Malley: There is also no mandated amount of time for the chickens to be outdoors. I’m not sure if the nuances of pasture raise and organic certifications are interesting to most investors who look at the company, but I’ve enjoyed going down the rabbit hole and I do think it’s important to understand how the brand is positioned and whether they live up to that positioning.

[00:17:46] Shawn O’Malley: If from your own research of the company, you don’t believe that they do live up to this positioning, that would be a real risk that could ripple back to customers and future lawsuits or journalistic reports. Let’s get more into the business of Vital Farms though, since we’re here to try and understand the company’s intrinsic value to shareholders.

[00:18:04] Shawn O’Malley: Vital Farms works with a trusted network of around 375 farms, of which they have built up relationships with over nearly two decades. This network of farms provides them with a meaningful scale that could not be easily replicable by competitors and is a cornerstone of their branding. A subtle advantage of this is that Vital Farms is less vulnerable to the effects of bird flu.

[00:18:24] Shawn O’Malley: Which is a major obstacle to factory farming operations. Bird flu has only gotten more common as chickens are stuffed into less and less space on factory farms and because it can spread so rapidly, entire flocks must be culled as soon as a case is detected. That would clearly be a major opportunity cost for egg producers that suddenly lose out on all that supply.

[00:18:45] Shawn O’Malley: On a factory farm, responses to bird flu could mean culling an order of magnitude more chickens than on a smaller pasture raised farm. And as such, due to its wider network of smaller farms, Vital Farms has fewer choke points since they’re not dependent on one or two massive farms to supply their eggs, where a single outbreak could bring down a disproportionate amount of their supply.

[00:19:07] Shawn O’Malley: A wave of bird flu outbreaks in 2022 saw millions of chickens cold, contributing to a 40 percent rise in chicken and egg prices. Besides the risk of an illness outbreak, another variable cost for a business like Vital Farms is feed costs. Corn and soybeans in particular are most often relied upon as feed and falling prices for these two commodities have been a tailwind for profitability after peaking in response to disruptions stemming from Russia’s invasion of Ukraine in 2022.

[00:19:36] Shawn O’Malley: Distributing its products is an even bigger network of retailers, well over 24, 000, and that number is fast growing too. Creating more and more opportunities for a wider set of customers to purchase the company’s products nationwide by 2027 vital farms hopes to add another 8000 retailers to its distribution network, 250 additional farms and a new processing and packing facility to boost its supply chain and increase the number of product types on average sold at retailers.

[00:20:02] Shawn O’Malley: All in service of driving the company to a target of 1 billion in sales with a 35 percent gross margin. Just as an FYI, gross margin is the profit margin that subtracts out only the cost of goods sold. For context, in the last 12 months, the company has done about 580 million in revenue, well on its way to that 1 billion goal with two years still to go.

[00:20:23] Shawn O’Malley: That’s more than double their 2020 revenues of 214 million, so growth has been pretty impressive at around 30 percent per year. With all that growth, by the end of 2023, Vital Farms had an 85 percent market share over the U. S. pasture raised egg industry. Behind all this is not just one product, though.

[00:20:42] Shawn O’Malley: SKU, spelled S K U, is a common acronym in the consumer packaged goods industry. It’s an acronym for Stock Keeping Unit, tracking all the different variations of products a company sells, from different sizes to different flavors. Vital Farms has a handful of different SKUs, including medium, large, and extra large pasture raised eggs.

[00:21:01] Shawn O’Malley: Organic pasture raised eggs available in all three sizes. Restorative eggs, which are held to an even higher standard of ethical and sustainable practices. True blue heirloom eggs, which are actually blue and come from a specific type of hen known as the azure chicken. Various sized packs of boiled eggs.

[00:21:18] Shawn O’Malley: 16 ounce cartons of liquid pasture raised eggs. And then these egg carton options also come in packs of 6, 12, 18, and 24. And that’s just the range of options for egg products. The company’s other product line is a set of butter products held to similar ethical standards, but this only reflects between five and 8 percent of the company’s overall revenues.

[00:21:39] Shawn O’Malley: The company did dramatically scale down its butter production though, after bumping into issues with farmers who couldn’t meet the company’s quality standards. But in the last quarterly earnings call, management said that they had found a new supplier in Ireland who didn’t meet their standards for grass fed pasture raised butter.

[00:21:53] Shawn O’Malley: The variety for butter is much narrower, with just 8 and 16 oz versions of salted and unsalted butter. I think the Vital Farms brand reputation has definitely carried over to butter, where people probably discover their eggs first, are impressed by the quality, and then notice that they sell butter too and try it.

[00:22:10] Shawn O’Malley: Based on the rapid success they’ve had with just eggs and butter, there’s some pretty obvious subsequent areas for them to explore to widen the brand even further, like yogurt and cheese. So we’ll see. But according to the company’s CEO at their last investor day, the next big thing for them will be something that is disruptive to a large and existing category anchored in the company’s values.

[00:22:29] Shawn O’Malley: And it’s something that can be delivered at scale where there is demand for products specifically from vital farms. Who knows? I’d imagine if they’re going to truly maintain their standards across new product categories, it takes a ton of planning, even if just jumping to something like pasture raised, grass fed cheese.

[00:22:45] Shawn O’Malley: The farmers they work with to produce ethical butter, for example, may not be equipped to produce cheese at scale. I’m not going to pretend to know the nuances of cheese production versus butter production, but I’m sure there are some major differences that make leaping across categories tricky when you have such a high bar for quality.

[00:23:02] Shawn O’Malley: I’d also say though that new product categories are not critical to the growth story for this company. There’s something to keep in mind, but there are many more households that can reach with their range of egg and butter skews before they need to worry about embracing new categories to keep growing.

[00:23:16] Shawn O’Malley: In terms of who their target customer is, in a 2023 presentation to shareholders, Vital Farms outlined that there are roughly 11 million households in the U. S. They classify as current customers, while a broader group of 72 million households in the U. S. purchase premium eggs. These people are more inclined to care about eating organic and natural food, as well as environmental sustainability, and they’re categorized as such for having intentionally purchased cage free eggs, suggesting that animal welfare is at least a factor in their decision making.

[00:23:46] Shawn O’Malley: Naturally, Vital Farms believes these households are great targets to essentially upsell on pasture raised brands that take another step or two toward higher ethical standards. In particular, they narrow in on a subset of 34 million households in that set of premium egg purchasers, which they believe are the most prime to respond to vital farms branding.

[00:24:05] Shawn O’Malley: And basically the company’s primary growth and marketing plans are premised around tripling its customer base from 11 million to capture that cohort of Roughly 34 million households who are especially sympathetic to various ethical standards for their food. Since 2015, the company has grown from a customer base of 800, 000 to about 11 million households, as mentioned.

[00:24:25] Shawn O’Malley: So tripling from here is ambitious, but not unprecedented. At the same time, as they’ve become a staple of more and more households grocery spending, Vital Farms has also become a larger share of wallet, as they call it, meaning existing customers are spending a growing portion of their overall budget for eggs on Vital Farms products.

[00:24:43] Shawn O’Malley: Share of wallet in this context refers to the percentage of a customer’s total spending on a specific product category, like eggs. That is allocated to a particular brand within that category, such as Vital Farms, essentially showing how much of a customer’s spending on that type of product goes to a single company relative to its competitors.

[00:25:02] Shawn O’Malley: In other words, it indicates the level of customer loyalty a brand holds within a specific product category. And the share of wallet has only been growing in recent years, which is pretty rare to have both more households purchasing your products and customers becoming more loyal to them too. I was amazed when I heard the company’s chief marketing officer say this, but according to their in house research and surveys, they believe 36 percent of their customers will leave the store without eggs if they don’t find a Vital Farms product.

[00:25:31] Shawn O’Malley: I mean, that is just unheard of for a staple product like eggs. I mean, seriously, this is supposed to be a commodity, but Vital Farms customers could not feel more differently about that. At least a third of them see Vital Farms as the only worthwhile producer of eggs, and they’d rather go without than switch.

[00:25:47] Shawn O’Malley: I think this is emblematic of a bigger trend behind vital farms. Consumer demand has shifted so much toward organic and natural food, and ethically produced food as well, that it is driving legislative changes. So far, 10 states, including California and Michigan, have banned caged eggs, and legislation to do so is pending in Hawaii, New York, and New Mexico.

[00:26:08] Shawn O’Malley: An important part of the business and brand of Heidel Farms is that they conduct extensive quality checks on their products to maintain their defining quality. And it may sound crazy if you’ve never tried pasture raised eggs, but there is a real difference beyond just the considerably higher price.

[00:26:21] Shawn O’Malley: Sometimes if you buy organic or pasture raised products at the store, it’s not clear what’s different besides the fact that they’re more expensive. But with eggs, especially with vital farms, the difference is very clear, in my opinion. Generic, cheaply priced eggs from factory farms look sickly in comparison because, well, they come from unhealthy animals living in unnatural conditions.

[00:26:41] Shawn O’Malley: Your typical factory farmed eggs have pale white and yellow yolks, whereas legitimately pasture raised eggs like those sourced by Vital Farms have deep orange and red colorings in the yolk, have more nutrients, and honestly just taste better in terms of flavor and consistency. Not everybody thinks it’s worthwhile to pay 8 or 9 dollars for a carton of eggs, but it’s a small luxury that is clearly quite popular, especially as consuming more sustainable farming products has become trendier, and as the public becomes increasingly aware of how unhealthy many of the products most of us have consumed for years can actually be.

[00:27:12] Shawn O’Malley: So Vital Farms very much has a signature coloring to its eggs, driven in part by the supplemental feed they give hence, which includes marigolds and paprika, contributing to the orange and red colors so common in its yolks. The orange and red yolks of Vital Farms in a way are the Nike swish of the egg industry, beloved and widely recognized among consumers of premium eggs.

[00:27:33] Shawn O’Malley: And all of this goes toward why Vital Farms is able to charge such a massive premium for its products. Her carton in 2023, it charged around 5 more than conventional eggs, and even compared to other so called premium egg brands that offer cage free and patch erased products, Vital Farms eggs still cost nearly 2.

[00:27:50] Shawn O’Malley: 50 more per carton. And from 2020 to 2023 at least, those spreads increased, reflecting that Vital Farms actually has growing pricing power. So yes, their eggs are really expensive, but customers evidently think they’re worthwhile, and that sort of pricing power and brand value is really attractive from an investment perspective.

[00:28:10] Shawn O’Malley: Loyalty to Vital Farms products is impressive, and clearly customers are willing to pay a premium for their eggs, and as mentioned, may forsake purchasing eggs at all if Vital Farms is out of stock. But whether there is room for continued growth is the key question investors today would want to know.

[00:28:26] Shawn O’Malley: And on that front, there is some room for optimism. There are thousands of grocery stores that don’t sell any Vital Farms products at all for the company to expand into, and the company hopes to triple its customer base, as we mentioned, but there are other ways for the company to grow, too. For example, stores that already carry at least one Vital Farms SKU could increase the number they carry.

[00:28:46] Shawn O’Malley: Perhaps they start offering organic options or want to offer cartons of 18 or 6 eggs to complement the 12 egg cartons they already sell. Whatever it is, more shelf space devoted to Vital Farms is a good thing for the company. That is of course true for any consumer packaged goods brand, though with Vital Farms, there’s a particularly strong case for why retailers are incentivized to increase the amount of shelf space they devote to Vital Farms.

[00:29:08] Shawn O’Malley: The company’s best selling item, its 12 count egg cartons, are the number 3 best selling product in the entire category of eggs, and yet 25 percent of retailers who do carry premium eggs have still not added Vital Farm’s best performing products yet. Retailers not offering 12 count egg cartons from Vital Farms are missing out on the third most popular egg product nationwide.

[00:29:29] Shawn O’Malley: So they are certainly going to try and correct that eventually. Retailers want to devote their limited shelf space to proven and profitable products. And this is about as proven and profitable as it gets in the world of consumer packaged goods. There’s a very clear draw for the grocery stores that do not offer at least one Vital Farms product to change that.

[00:29:46] Shawn O’Malley: And at natural food stores, where there’s a more concentrated selection of more ethical and healthier food options, the top four best selling egg products are all from Vital Farms. That’s a really special thing for a brand to not only dominate the niche of natural food stores, where customers are enthusiasts about healthy eating, but also to have best selling products nationwide at more mass market grocery stores.

[00:30:08] Shawn O’Malley: Where the average customer is not historically as motivated by organic and pasture raised food labels. In the world of fashion, you might expect some luxury brand to dominate an exclusive niche when it’s available only at boutique stores, but once it goes mass market and is available at Target or Macy’s, brands are effectively sacrificing their luxury status and hiring buyers to reach a wider audience at lower prices.

[00:30:30] Shawn O’Malley: But with Vital Farms, no such thing has happened because people don’t eat premium eggs for the sake of exclusivity. To a natural foods connoisseur who frequents farmers markets twice a week and only bikes to work, they aren’t offended at all if their favorite brand of eggs is now available at Kroger and Walmart, they’ll still buy Vital Farms at their local natural foods store or at a traditional grocery store, and more mass market points of distribution for Vital Farms probably doesn’t dilute the brand for them at all, if anything it just makes it easier for them to find their favorite brand of premium eggs.

[00:31:01] Shawn O’Malley: If there were some reason to think that more points of distribution were hurting the quality or sustainability of the eggs, it definitely could be a turn off to purists who shop at natural food stores and spend the most on premium eggs, but everything else being equal, my point is simply that there is a real, almost luxury quality to the eggs that Vital Farms sells that doesn’t necessarily get diluted with more scale in the way that exclusive fashion products can lose their appeal when they’re suddenly available to a wider audience.

[00:31:25] Shawn O’Malley: And that’s because first and foremost, people are buying premium eggs from brands like Vital Farms because they like to know they’re supporting small farmers, funding more sustainable and ethical agricultural practices, and also consuming food that they believe is either better tasting or healthier in some way.

[00:31:41] Shawn O’Malley: It’s not entirely based on exclusivity, which is what underpins many other types of premium and luxury products and can be a limiting factor. Maintaining that premium status and pricing power while going mainstream has supercharged the brand. Driving much of its sales growth in the past few years, even as conventional egg prices have fluctuated a bunch in the past few years and dropped off more recently, increasing the spread between premium egg prices and regular egg prices, demand for Vital Farms remains firm.

[00:32:07] Shawn O’Malley: Going back to what I was saying about why retailers have strong incentives to increase their shelf space for Vital Farms, the company has some compelling data on how their products sell better when there are more types of Vital Farms products being offered. Across 1, 200 plus retailers, Each time a new SKU from Vital Farms was added to the product mix on store shelves, each product individually ended up having even greater sales volumes after 5 years.

[00:32:30] Shawn O’Malley: To have no net cannibalization and actually have the opposite effect is again just really impressive and showcases how, after discovering the Vital Farms brand, It resonates with shoppers who become increasingly loyal to it over time. Even at more quote unquote mature stores, like smaller natural food stores where Vital Farms has sold their products through for longer, a 4 year review of the same 250 mature stores that offer 7 or 8 SKUs from Vital Farms shows there is very little cannibalization and still growing total sales volumes.

[00:33:01] Shawn O’Malley: In other words, in retailers where Vital Farms has already been distributed for at least 5 years, total eggs sold per store continued to increase at the 8 year mark with minimal friction, even as more types of Vital Farms eggs products were offered on the shelves. Just from more people buying each individual type of Vital Farms product, and also retailers offering a wider assortment of Vital Farms products generally, That is all incremental revenue that goes both to Vital Farms and retailers, encouraging retailers to continue adding shelf space for Vital Farms.

[00:33:33] Shawn O’Malley: A few retailers sell as many as 11 different egg products from Vital Farms, so I’d have to imagine almost the entire egg section in their store is just different items from Vital Farms. Ranging from 6 count cartons to 18 count cartons, conventional pasture raised, pasture raised and organic, storative eggs, as well as the true blue eggs from Azure Hens.

[00:33:53] Shawn O’Malley: As I mentioned, Vital Farms best selling product of the 12 count conventional pasture raised eggs is only in 80 percent of grocery stores, and the company’s number 2 and 3 best selling products are in less than 50 percent of grocery stores. So there are a lot of retailers out there who could probably knock off some lower volume and less profitable egg products in place of Vital Farms offerings, and doing so would be a massive tailwind for the company’s growth.

[00:34:17] Shawn O’Malley: And honestly, counting on a chunk of retailers to offer a wider variety of Vital Farms products, even if it’s just going from one SKU to two or three, doesn’t seem that unrealistic or even that speculative to me at all. The results speak for themselves, and all the momentum is pointing toward more and more stores offering Vital Farms for the first time, or expanding their selection of Vital Farms products.

[00:34:37] Shawn O’Malley: Vital Farms products are distributed through a broker distributor retailer network, whereby brokers represent their products to customers, and retailers, in turn, sell the products to consumers. Correspondingly, let me also mention that Vital Farms breaks out the retailers it works with into three categories labeled as food, mass, and natural.

[00:34:57] Shawn O’Malley: Mass retailers are just traditional grocery stores, and retailers are stores like Walmart and Target, and natural retailers are specialty food stores devoted to organic and natural foods like whole foods or sprouts. Whole Foods in particular is where around 20 percent of the company’s sales come from, so there is a lot of dependence on them in particular.

[00:35:16] Shawn O’Malley: About half of Vital Farms sales come from the food channel at regular grocery stores, roughly 40 percent from natural retailers, including Whole Foods, and a bit less than 10 percent at mass retailers. It also does some distribution to commercial restaurants, like the chain True Foods Kitchen, which recently partnered with Vital Farms.

[00:35:33] Shawn O’Malley: The company’s focus right now is on traditional grocery stores, because even though half of their revenues come from there, that’s actually low compared to the broader premium egg industry, where 60 percent of revenues come from the so called food channel at conventional grocers. Meaning the company sees an opportunity to focus on places like FoodLine, Publix, Kroger, and Harris Teeter as the drivers behind much of its incremental growth in the next few years, which, if they can close that gap in where their revenues come in versus the broader premium egg industry, then that would be worth about 115 million in additional revenue.

[00:36:05] Shawn O’Malley: If Vital Farms can get on average half of the number of their items sold on shelves at Whole Foods at traditional grocery stores, the company will comfortably hit its growth ambitions according to their CFO in a 2023 presentation. As of that time, the average grocery store offered 2.5 different Vital Farms products, but the company thinks they can potentially double that average number of products to as much as five or more.

[00:36:27] Shawn O’Malley: All that potential to scale into new stores or expand the number of products offered at other stores is promising. But none of that matters if expanding the company’s supply chain can’t be done without compromising the company’s quality and ethics, or without absorbing exorbitant costs. For Vital Farms to truly become the universal go to premium egg brand, they have to have universal distribution, which they are well on their way to, but also an equally robust supply chain underpinning the increase in production necessary to sell more eggs.

[00:36:58] Shawn O’Malley: Impressively, the company can already process roughly 6 million eggs per day, but that will need to scale up even further. The process of bringing on new farmers to support Vital Farms can easily entail an 8 month onboarding period, where the company works closely with these farmers after signing deals with them to help get them up and running with an operation that aligns with the company’s ethical standards.

[00:37:21] Shawn O’Malley: The team at Vital Farms helps them plan things like how they’ll set up their barn, which financing partners to work with, how to manage the whole process, and what to expect once they’ve got their birds in place laying eggs. Vital Farms has already demonstrated an ability to work with their suppliers to scale up production as needed during the pandemic, which is when the brand really began to take off and enter a new phase of growth.

[00:37:44] Shawn O’Malley: The company’s network of farms has grown from 50 in 2015 to almost 400 today, while the average flock size at these farms has grown from around 3, 500 birds to closer to 20, 000. In terms of selecting farmers to work with, the company has a devoted selection team that vets their operations and they mostly try to go off referrals from the approved farmers they already work with.

[00:38:07] Shawn O’Malley: They look for owner operated farms to work with, particularly ones with an existing operation that they’re hoping to better monetize. For example, imagine a dairy farmer who has some unused woodland acreage at the edge of their property. They could work with Vital Farms to set up a barn for hens to profit off that vacant land.

[00:38:24] Shawn O’Malley: The contracts they sign with these farms tend to be for raising three flocks of birds, which is about the equivalent of five years, with the opportunity for one year extensions and consistent payment terms over the period, with variable adjustments quarterly to compensate farmers for fluctuations and things like feed costs.

[00:38:41] Shawn O’Malley: The hope is to renew contracts with these farmers if both parties are happy, but if not, the contracts are short enough that vital farms can get out of them fairly quickly if the economics of a certain farm just aren’t working out. What’s interesting is that as part of the arrangement with farmers, Vital Farms commits to exclusively purchase all of their supply for the duration of the contract, even if for some reason Vital Farms couldn’t sell all of the eggs due to some backlog or decline in customer demand.

[00:39:05] Shawn O’Malley: Given that there seems to be more demand than supply for Vital Farms products, it’s not something I’m terribly concerned about now, but if they maintain these kinds of commitments as they scale, it could become a bigger risk that they’re stuck in contracts to purchase eggs that they’re unable to process or sell for a period of time.

[00:39:21] Shawn O’Malley: Under the terms of the company’s contracts with their network of family farms, they don’t actually own their egg laying hens, but are generally responsible for coordinating the acquisition and delivery of hens to the farmers. To meet these obligations, they place orders for chicks directly with hatcheries that are intended to supply egg production at least a year in advance.

[00:39:39] Shawn O’Malley: Once the chicks are hatched, they are delivered to a network of pullet farms, who rear the chicks to approximately 16 to 18 weeks of age. And then at that point, they are delivered to the vital farms network of family farms to begin laying eggs. It’s kind of funny but Vital Farms actually puts all of its new farmers through what they call egg school, which is just a one day course on the company’s expectations around stuff like egg quality, bird health, water management, and accounting financials.

[00:40:03] Shawn O’Malley: The Vital Farms support team apparently has weekly contact with farmers, visits all of their farms monthly, performs internal audits of their operations, sends out quarterly newsletters and hosts annual meetings with them, and is on call 24/7 to assist as needed. With other big food brands, I know these relationships and monitoring of farmers can get toxic since brands like Tyson’s Chicken or Vital Farms essentially have most of the leverage, especially after farmers have revamped their operations to accommodate a specific buyer.

[00:40:31] Shawn O’Malley: I’ve heard horror stories from the industry generally, and I’m not sure every farmer who has ever worked with Vital Farms walked away happy about it. But all in all, my impression is that Vital Farms has a better reputation than most other food brands when it comes to how they treat their suppliers. If some sort of exposé to the contrary comes out, I wouldn’t be shocked because this is the food industry after all, and the food industry does not have a stellar record in treating its suppliers well historically, but everything I’ve seen points to Vital Farms mostly being the sort of responsible operator you’d hope they are, which is obviously a big part of their brand and the flywheel management is trying to build.

[00:41:06] Shawn O’Malley: I don’t want to sit here and just regurgitate all the company’s claims about ethics and sustainability though, from the hens they raise to the farmers they partner with. They paint a rosy picture and even if I do think they operate more honestly than most big ag companies, they are a big ag company operating at scale now themselves.

[00:41:22] Shawn O’Malley: They have gone from being a small fish in a big pond to being one of the biggest fish in their pond, and there are real trade offs that have to be made to do that. Plenty of people are quick to accuse the company of greenwashing, even if they did largely come out on the right side of allegations back in 2021 in most consumers eyes.

[00:41:38] Shawn O’Malley: And I’m sure there are legitimate points coming from the critics of Vital Farms. For example, I found a letter submitted to the FDA by Vital Farms where the company argues against regulation that would specifically define the term pasture raised, laying more ground rules for how the phrase can be used in marketing efforts.

[00:41:55] Shawn O’Malley: That’s something I don’t think you would do unless you were worried about some of your farms not meeting a new legal standard for being called pasture raised. This line from the letter is pretty telling, quote, The 300 plus family farms that we work with have already invested in building their operations to the highest scalable standard for ethically produced eggs.

[00:42:15] Shawn O’Malley: The highest scalable standard is the key part there, where implicitly there’s some recognition that ethical compromises are made to scale operations. My guess is that a legal standard for slapping pasture raised branding onto eggs would be a fairly low bar compared to what they claim to be doing. So I’m not sure how much I buy the company’s argument that a defined standard would discriminate against farmers who take different approaches to raising their hens on pastures.

[00:42:39] Shawn O’Malley: And I take it to be a bit of a red flag that they’re opposing these probably low bar regulations because again, to me, that suggests that maybe they’re not meeting those standards across all of their operations. But I keep coming back to greenwashing because as someone who does make the extra effort typically to try and eat in a way that I understand to be more environmentally mindful and humane, these details matter to me on a personal level, but I also continue to mention it throughout the episode because I think it’s fundamental to the thesis for Vital Farms.

[00:43:08] Shawn O’Malley: Branding and perception is everything, and if evidence leaks out that they’re not the responsible operator they appear to be on paper, there could easily be a consumer revolt. Their pricing power exists thanks to their stellar reputation in consumers minds, but that stellar reputation can disappear quickly.

[00:43:24] Shawn O’Malley: So it is genuinely important that Vital Farms conducts itself in the way they claim to, otherwise shareholders are taking a serious risk that the brand could be impaired down the road, and that’s probably my biggest concern with the company at this point. I don’t doubt that their products are growing in popularity quickly, or that retailers will end up devoting more shelf space to the brand, and I don’t even worry as much about competition being able to craft an even more trusted brand.

[00:43:46] Shawn O’Malley: For now, Vital Farms enjoys an unrivaled degree of trust, but there’s really only one direction that trust can go in. I can’t imagine people trusting them even more than they already do, as the company continues to scale its operations, but I could certainly imagine a PR nightmare that ruins the brand’s trust and crushes its momentum.

[00:44:03] Shawn O’Malley: I do find it reassuring that the company’s original founder, Matt O’Hare, is still significantly involved with the company as the chairman of the board of directors, and he still owns 16 percent of the stock. This is someone who built the company to what it is today, and he really did start as a small individual farmer focused on doing things ethically.

[00:44:20] Shawn O’Malley: So the odds strike me as being higher that the company operates in practice as they claim to in marketing, with O’Hare still being closely affiliated with Vital Farms. In an interview with CNBC, O’Hare outlines how, in 2007, he started Vital Farms with 20 Rhode Island red hens on a 27 acre farm near Austin.

[00:44:38] Shawn O’Malley: His goal was twofold, raise egg laying hens in a more humane environment than was typical in the U. S. and teach other farmers to do the same. After two years of unprofitability, O’Hare frequently donated his eggs to food banks because he had no one to sell them to until he landed his first big customer with Whole Foods.

[00:44:55] Shawn O’Malley: That relationship with Whole Foods has continued to this day, not only as a sales distribution point, but as an investor. Whole Foods first invested in Vital Farms years ago, and then when it was acquired by Amazon, Amazon held onto that stake and now owns 3. 5 percent of Vital Farms. If O’Hare had totally left the company and sold all of his stock, I’d be far more skeptical that the company had gone completely corporate.

[00:45:18] Shawn O’Malley: But he’s still around, and I’m not sure he would be if he felt the company no longer resembled the mission oriented organization he started in its focus on treating animals, farmers, and the environment as well as possible. As part of its efforts to shore up its supply chain longer term, Vital Farms has been opening what they call Accelerator Farms, where they directly operate them and basically learn first hand what challenges the farmers in their network face.

[00:45:41] Shawn O’Malley: The idea is similar to a company that uses a franchising model, choosing to open and run a few stores of their own directly, so they can better understand the nuances of what their franchises do, as opposed to actually aiming to vertically integrate and operate all of their farms themselves. This should hopefully increase management’s insights into the industry they compete in and also make them a better partner with the farmers they buy eggs from.

[00:46:04] Shawn O’Malley: Since the company will have an even more intimate idea of the more subtle kinds of problems that can arise on a daily basis. But roughly, the supply chain goes as follows. Family farms supply the eggs, and then the eggs are sent to cold storage centers provided by a partner company called ColdZone, and then from there, they’re sent to a central egg station where the eggs are washed and packed.

[00:46:24] Shawn O’Malley: Then, distributors come in and ensure the eggs are delivered to retailers and restaurants, who then are the ones to sell Vital Farms eggs to consumers. Looking at the financials for Vital Farms, this is a company that has earned a solid 16 percent return on invested capital in the last 5 years, while earnings per share have grown around 30 percent per year over that period.

[00:46:45] Shawn O’Malley: The company is in a fairly healthy financial position too, with basically no net debt. After netting out debt from cash, they have around 140 million in cash left over still. Compared to CalMain Foods, ticker C A L M, which is a company behind brands like Agland’s Best and Lando Lake, Vital Farms has a gross profit margin that is 9 percentage points higher, a result that I think largely stems from the brand power associated with Vital Farms that allows them to charge higher prices than other premium egg brands.

[00:47:14] Shawn O’Malley: The overhead costs of ensuring the additional traceability and sustainability of its products combined with the extra marketing spend to build the Vital Farms brand results in Vital Farms actually having a much lower net income margin than CalMain, despite starting with a higher gross profit margin.

[00:47:30] Shawn O’Malley: Put differently, for every dollar of revenue that CalMain earns, Twice as much becomes a net income versus Vital Farms. I was pretty surprised to see this, honestly, as I was expecting Vital Farms to be considerably more profitable than other egg brands. Even if Vital Farms is at a younger stage than a more mature company like CalMain.

[00:47:48] Shawn O’Malley: When it comes to free cash flows, about 10. 5 percent of Vital Farms revenue converts to free cash flow compared with over 16 percent for CalMain. So again, on a slightly different measure of profitability, CalMain wins out. I’m sure investments in new production facilities are weighing on the company’s profitability, but still, I was a bit disappointed that with such premium pricing, the company didn’t have more favorable margins compared to what I’d consider inferior brands.

[00:48:12] Shawn O’Malley: The company also isn’t super aggressively reinvesting in itself, either. Only a little more than 2 cents of every dollar it earns goes toward capital expenditures. CalMain, on the other hand, invests almost 6 percent of all of its revenues into CapEx, so really, it’s hard to make the argument that Vital Farms is like any other young, fast growing company that will become more profitable when they mature.

[00:48:32] Shawn O’Malley: On a percentage basis, to make the comparison apples to apples, CalMain as a mature company is spending more than twice as much on reinvestment into new facilities and maintaining its existing facilities than Vital Farms. With a price to earnings ratio of well over 30 compared with just 12. 5 for CalMain, I actually became very curious about CalMain as an alternative investment in the food industry.

[00:48:53] Shawn O’Malley: Typically, when you see that sort of disparity in valuation ratios, where investors pay a much higher premium for one company than the other, you might expect that the more mature business, which in this case is Cal main would have effectively no growth. But in fact, Cal main has grown revenues by 24 percent per year in the last three years and 16 percent per year.

[00:49:10] Shawn O’Malley: And the last five years, let me emphasize again, that those figures are per year growing by more than 15 to 20 percent per year over a multi year period is great stuff. I’m being a bit misleading here because analysts are expecting a dramatic slowdown in CalMain’s growth over the next few years, which is definitely why the PE ratio is so much lower, but the point remains that with a handful of these metrics from a 30, 000 foot view, I found myself feeling less satisfied with the results for Vital Farms and the company’s valuation, and was surprised by some pretty impressive results and a seemingly attractive valuation for CalMain.

[00:49:42] Shawn O’Malley: If folks are interested, maybe I’ll dig into CalMain in a future episode, but for now, I’m mostly just going to stick with referencing surface level summary statistics at CalMain rather than trying to really comprehensively understand these subtle differences in what they do. The other thing I want to note in CalMain’s favor is that over the last decade or so, their share count hasn’t increased at all.

[00:50:02] Shawn O’Malley: That’s a sign that management isn’t recklessly issuing stock to compensate themselves or other employees to the detriment of shareholders, because if you create more shares of stock than they are to pay people with, all existing shareholders now own a smaller slice of the same company. Meanwhile, at Vital Farms, the total share count has grown from 25.

[00:50:19] Shawn O’Malley: 8 million in 2017 to about 44 million today. That’s a growth rate of nearly 8 percent per year, and that’s a major headwind for shareholders. This sort of thing isn’t uncommon at fast growing companies, but is more typical in the tech industry than elsewhere. So it was a negative surprise once again, to see that vital farms has been so aggressive about issuing new stock.

[00:50:39] Shawn O’Malley: If the company were to stop growing today, but keep expanding its share count at 8 percent per year, then earnings per share would also decline by 8 percent per year. As I said, that’s an 8 percent headwind to any returns you earn as a shareholder. Perhaps in that scenario, given some unforeseen obstacles that dramatically stopped growth in its tracks, it’d also stop issuing so many shares, but perhaps they wouldn’t either.

[00:51:00] Shawn O’Malley: I wouldn’t get my hopes up that they will, because share issuance seems to be fundamental to their employee compensation. Here’s a line from the company’s annual report. Quote, All full time crew members are eligible for health insurance, paid parental leave, retirement contributions, employee stock purchase plan participation, equity grants, and complimentary Vital Farms products.

[00:51:20] Shawn O’Malley: Healthcare and retirement contributions are normal, but the structural existence of an employee’s stock purchase plan and equity grants for all employees, not just management, is probably why the share count keeps growing and growing. To me, there are a few things more damaging to shareholders than excessive stock based compensation, and once companies have set that precedent, I do not want to give them the benefit of the doubt.

[00:51:41] Shawn O’Malley: It can feel as though issuing stock is just free money for management to make use of, and that temptation is very alluring. So I prefer companies that have proven they can resist this temptation over long periods of time, and even better, if they demonstrate a commitment to actually reducing the shares outstanding through buybacks.

[00:51:57] Shawn O’Malley: With that said, I still want to go through the process of trying to value the company before I make any final decisions. There are some wonderful things about the company I don’t want to overlook, even if I have mixed feelings after comparing its profitability with Calmain and looking at its share dilution.

[00:52:12] Shawn O’Malley: Comparing Vital Farms with other fast growing pure play consumer packaged goods companies like Monster, Celsius, and the pet food company Fresh Pet provides a more favorable comparison, at least in terms of valuation. The energy drink company Monster Beverage has grown its revenues at a fraction of what Vital Farms has in the past few years, and yet, Monster is more richly valued, Monster’s equity is valued at about 7 times its sales revenues in the past 12 months compared with just 3 times for Vital Farms.

[00:52:40] Shawn O’Malley: It’s a similar story with Celsius and Fresh Pet, where investors are valuing these companies at much higher multiples of sales, 5 times for Celsius and almost 8 times for Fresh Pet. What I’m doing here is using what you might call a pricing approach to valuation rather than trying to reconstruct a company’s finances from scratch and build out a model of its expected future cash flows to get an exact estimate of what the company is worth per share.

[00:53:04] Shawn O’Malley: Basically, the idea is to try and find similar companies to Vital Farms, look at how the market has valued them, and decide whether the company is comparatively being fairly valued. Like any approach to valuation, this is flawed because picking peer companies to benchmark against is imperfect, and it can be easy to overlook small differences between the companies.

[00:53:23] Shawn O’Malley: Celcius and Monster both have cult followings in the energy drink market, and Fresh Pet is a well renowned brand for healthier pet food, and that strong brand awareness around a single type of consumer product is similar to Vital Farms and the premium egg industry. Fresh Pet in particular is interesting because they’ve grown at roughly the same pace in the past two years as Vital Farms, with similar profit margins too, and yet, Investors are willing to pay five times as much to own a share of Fresh Pet per dollar of earnings as they are for Vital Farms, which is a fancy way to say that Fresh Pet’s price to earnings ratio is five times higher.

[00:53:56] Shawn O’Malley: I made a basic spreadsheet comparing Vital Farms against five peer companies, including a company called Mama’s Creations and the parent company for the beverage brand LaCroix. My simplified approach was to compare how fast these companies had grown in the past 12 months, how fast analysts expected them to grow in 2025, their operating profit margins, and relatedly how these companies were valued at a multiple of their expected revenues.

[00:54:18] Shawn O’Malley: In short, only one of these peer companies had recently grown faster than Vital Farms, and only one company was expected to grow faster than it in the next year, while Vital Farms was roughly in the middle of the pack in terms of operating profitability, and yet the company’s enterprise value to sales ratio was by far the lowest.

[00:54:35] Shawn O’Malley: Normally, you’d expect companies with the fastest growth to have the highest enterprise value to sales ratio, unless they were dramatically less profitable than their peers, which isn’t the case with Vital Farms. So something very much does seem off where Wall Street either thinks the company won’t sustain its growth or can’t sustain its profitability as Vital Farms tries to expand its business in the coming years.

[00:54:55] Shawn O’Malley: Otherwise, it’s difficult to explain why Vital Farms would be valued as if it were a much more mature or less profitable company. This is super oversimplified, but to just sort of directionally paint a picture of the range of outcomes for Vital Farms valuation relative to a cohort of peer companies, I calculated what its stock would be worth if its enterprise value to sales ratio converge closer toward these other companies.

[00:55:17] Shawn O’Malley: If Vital Farms enterprise value to sales ratio rose from 2. 3 at the time of recording today to 3. 5 in line with LaCroix’s parent company, a business that is only expected to grow 2 percent in the next year, that would imply roughly 50 percent upside for the stock. And if it converges with fresh pet, a premium consumer brand that is growing at approximately the same rate, and that would imply that the stock should rise by more than 160%.

[00:55:41] Shawn O’Malley: To see the model I’m referencing here and all the assumptions, make sure you’re subscribed to our intrinsic value newsletter, where I show all of this in more detail that is easier to follow. If you’re not subscribed already in the description below this episode, there should be a link to sign up with.

[00:55:54] Shawn O’Malley: I will be the first to tell you, as I’ve already said, that taking this kind of pricing approach to valuation is a messy process, so don’t put a ton of weight into any one approach to valuation, but still, it is informative to go through this exercise and reflect on how a company like Vital Farms compares to its peers, especially when there is such a large gap in how they’re valued.

[00:56:13] Shawn O’Malley: In part, the less favorable valuation for Vital Farms could be related to the fact that more than 30 percent of the company’s outstanding stock has been sold short by investors who are betting against its share price. That is a considerable amount, and from what I’ve seen, this mostly stems from the fact that over the last two years, conventional egg prices got so expensive thanks to bird flu outbreaks that they were almost the same price as more premium pasture raised eggs.

[00:56:37] Shawn O’Malley: There was a lot of concern on Wall Street that people were simply buying pasture raised eggs because they were only modestly more expensive than regular eggs for a period of time. But as regular egg prices have fallen, Many thought people would become more aware of the price gap and switch down to egg brands that were becoming comparatively cheaper.

[00:56:54] Shawn O’Malley: So, you know, 6 or 9 months ago, I would have totally understood that thesis. If all the eggs at the store were selling for 5 or 6, you might as well pay a dollar more for the highest end stuff. But when regular eggs are 3 again and Vital Farms is selling cartons for 9, it becomes more compelling to opt for the cheaper alternatives.

[00:57:11] Shawn O’Malley: But we’ve made it through to a period of more normalized egg prices and demand for vital farms didn’t fall off, but in fact has only risen. So I see that as a very powerful illustration of just how much customers love this brand, which is also why I’m surprised to see it remain so heavily shorted. I mean, yes, I do get it from an outsider perspective, I totally understand why someone would look at this company and conclude that this is just some sort of fad like beyond meat and people will eventually abandon the brand once they come to their senses and realize they don’t want to be paying two digit prices for a carton of eggs.

[00:57:41] Shawn O’Malley: And if after listening to this episode, you still feel that way, then fair enough. But I do think vital farms is at least relatively undervalued compared to similar consumer packaged goods companies. And for some, that is all they need to know to want to buy. For me, I’m not sure I’m ready to invest in this company yet, but I want to see in 6 months or a year from now how they’re able to maintain profitability as they scale up.

[00:58:02] Shawn O’Malley: With the extra quality and transparency of their products comes structurally higher overhead, production, and marketing costs, and as such, they probably won’t benefit as much from economies of scale in the same way that other packaged good companies might. I also want to see whether they continue to issue shares with reckless abandon because I don’t want to own stock in companies that treat shareholders that way.

[00:58:20] Shawn O’Malley: Maybe it’s not surprising that Vital Farms doesn’t hesitate to issue stock aggressively considering that it is, after all, a B Corp, meaning management is supposed to prioritize other stakeholders in the business and not just run the company in a way that’s in shareholders best interest. I do think a fair price for Vital Farms given its track record, customer loyalty, and further runway for growth could easily be 58 per share or higher, which would imply a decent bit of upside from today’s prices, but I want safer investments where I can sleep comfortably at night knowing there’s little in the way of me earning at least a low double digit return on an investment, and I’m not quite sure I’m there yet with Vital Farms.

[00:58:56] Shawn O’Malley: Honestly, in a blind test, I don’t think I can differentiate Vital Farm’s egg taste from other pasture raised or even just cage free eggs. To me, that’s a bad sign for the company. In a blind taste test, I definitely could not tell the difference. I can certainly tell the difference between premium eggs and conventional eggs generally, but unless you’re strongly biased by Vital Farm’s marketing and the storytelling around their eggs, I’m not sure there’s a meaningful difference between their eggs and other premium eggs, except among a more narrower demographic of customers who shop first and foremost with animal welfare at the top of their mind.

[00:59:26] Shawn O’Malley: You might say that in the long run, this is a brand that might be similar to, say, Driscoll Strawberries. There’s some name recognition there, and perhaps some perceptions of better quality versus other strawberry brands, but ultimately the branding only commands a modest price premium. As more competition looks to market themselves similarly to Vital Farms, I could easily imagine a similar outcome in a decade from now, where Vital Farms is still a common and premium product, but they can no longer charge a massive premium to other premium egg brands, which already charge considerably more than regular eggs.

[00:59:56] Shawn O’Malley: If true, that would not be conducive to long term compounding for shareholders. For better or worse, I’m passing on Vital Farms for now and won’t be adding it to the Intrinsic Value Portfolio. If you disagree with my decision, feel free to email me at shawn@theinvestorspodcast.com. That’s S-H-A-W-N @theinvestorspodcast.com.

[01:00:15] Shawn O’Malley: Before I let you go today, I want to share a quote that has been on my mind this week as I dug into Vital Farms. This line comes from the imitable Seth Klarman. Quote, Investing is the intersection of economics and psychology. I can’t think of a better company to illustrate the intersection of economics and psychology than Vital Farms. For all of the consumer psychology working in the brand’s favor, the market is more skeptical of the company than you might expect for such a hot brand. Next week, I’ll be back here digging into another fascinating business looking for the next edition to the portfolio. See y’all then.

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