Topic: Dividend Stocks

Food Producers Offer Value & Growth

August 1, 2006|by Pat McKeough

Many investors see the food industry as stable and slow-moving. However, food is in the news every day. Consumers worry about the risk of common foods from transfats and other ingredients. New scientific studies link health with the presence of vitamins, minerals and other food components. Obesity is a growing concern as it becomes more common and its risk becomes better understood.

This volatile situation creates opportunities for well-managed food producers like these three. All are improving their market share with new products, and cutting costs. They are also enhancing their longterm potential with new projects outside of Canada.

CANADA BREAD COMPANY, LTD. $61 (Toronto symbol CBY; Conservative Growth Portfolio, Consumer sector; SI Rating: Above average) is a leading supplier of fresh and frozen baked goods to supermarkets and restaurants. It also makes pastas and sauces. Its main brands include “Dempster’s”, “Tenderflake” and “Olivieri”.

Canada Bread’s revenue rose from $678 million in 2001 to $1.35 billion in 2005, mainly due to its $262.3 million acquisition of the U.S. and UK bakery operations of Maple Leaf Foods Inc. (see below). Maple Leaf now owns 87.5% of Canada Bread.

Earnings before restructuring costs jumped from $0.97 a share (total $36 million) in 2001 to $1.80 a share ($64 million) in 2002. Income fell to $1.61 a share ($63 million) in 2003, but grew to $2.62 a share ($99 million) in 2004, and to $3.07 a share ($111 million) in 2005.

Maple Leaf has steadily increased its ownership of Canada Bread in the past few years. This high level of control has hurt Canada Bread’s liquidity.

Rumors that Maple Leaf would bid for the rest of Canada Bread helped drive the stock to a recent peak of $66 in July 2006. However, the stock is still reasonably priced at 17.4 times its likely 2006 earnings of $3.50 a share. The $0.24 dividend yields 0.4%.

Canada Bread continues to do a good job responding to changing consumer tastes. It has improved the taste of its products while emphasizing healthier ingredients, such as whole grains instead of refined flour. Strong demand and effective marketing let the company charge premium prices for these products, which helps it cope with rising prices for fuel, grain and other costs.

Foreign operations now provide 20% of Canada Bread’s revenue, and it continues to expand internationally. It just paid $1.9 million for a UK bakery which should increase Canada Bread’s annual revenue by $40 million. More important, this acquisition broadens the company’s UK product line, which should help it expand sales elsewhere in Europe.

Canada Bread is a buy.

MAPLE LEAF FOODS INC. $13 (Toronto symbol MFI; Conservative Growth Portfolio, Consumer sector; SI Rating: Average) is one of Canada’s largest food processing companies. It makes fresh and frozen meat products under the “Maple Leaf” and “Schneiders” brand names. It also supplies animal feeds and other agricultural services to farmers, and owns 87.5% of Canada Bread.

The company’s revenue rose from $4.8 billion in 2001 to $5.1 billion in 2002, but slipped to $5.0 billion in 2003. In 2004, Maple Leaf paid $499 million for rival meat processing company Schneider Corp. Consequently, revenue grew to $6.4 billion in 2004, and to $6.5 billion in 2005.

Income rose from $0.55 a share (total $57.4 million) in 2001 to $0.71 a share ($84.7 million) in 2002. Restructuring costs cut Maple Leaf’s profit in 2003 to $0.27 a share ($35.1 million), but income improved to $0.89 a share ($102.3 million) in 2004.

In 2005, higher energy prices and costs related to a new restructuring plan cut profit to $0.72 a share ($94.2 million).

Canada accounts for roughly 75% of Maple Leaf’s revenue, so it’s less vulnerable than other companies to the rising Canadian dollar. However, it’s a major exporter of pork to Japan, and a sudden drop in the Japanese yen hurt Maple Leaf’s profit margins in 2005. The company has hedged some of its Japanese sales in 2006 to cut its currency risk.

Maple Leaf is also vulnerable to consumer concerns over avian flu, mad cow disease and other food safety issues. It buys most of its raw materials from independent suppliers, and it is expanding testing to cut this risk.

In March 2006, Maple Leaf’s stock price fell from $17 to $13 on news of more restructuring costs. It now trades at 15.1 times the $0.86 a share it should earn in 2006 before unusual items. The $0.16 dividend has a yield of 1.2%.

Canada Bread, which we view as a buy (see above) accounts for around 40% of Maple Leaf’s profit. Based on current prices, Canada Bread now accounts for about $10.60 per Maple Leaf share. That means you get Maple Leaf’s other businesses for less than $3 a share, even though they contribute 60% of Maple Leaf’s profit.

That means these other businesses trade at roughly 6.0 times their earnings contribution. That’s cheap. While they lack Canada Bread’s growth record, these businesses do offer well-known brands, high market share and a lot of growth potential.

Maple Leaf Foods is a buy.

SAPUTO INC. $35 (Toronto symbol SAP; Aggressive Growth Portfolio, Consumer sector; SI Rating: Average) is the largest dairy food processor in Canada. Its main brands include “Armstrong”, “Frigo” and “Stella”. Canada accounts for two-thirds of its revenue. Saputo also has dairy operations in the United States and Argentina.

Saputo’s revenue fell from $3.5 billion in 2002 (fiscal years end March 31) to $3.4 billion in 2003, but grew steadily to $4.0 billion in 2006. Income rose from $1.54 a share (total $160.2 million) in 2002 to $2.20 a share ($232.1 million) in 2005. However, a writedown cut Saputo’s earnings in 2006 to $1.82 a share ($192.1 million).

The company relies on acquisitions to fuel its growth. Although this adds to its risk, Saputo has a good history of quickly integrating new businesses and cutting their costs.

Saputo is now focusing on expanding to less regulated dairy markets outside of Canada. It recently agreed to buy a German specialty cheese maker for roughly $7 million. This is Saputo’s first operation in Europe, and should pave the way for future European expansion.

Saputo accounts for 6% of total U.S. cheese production. Higher prices for raw milk and lower cheese selling prices cut this unit’s profits in fiscal 2006 by 55%. The rise of the Canadian dollar also hurt earnings. However, changes proposed by U.S. dairy regulators could cut Saputo’s raw milk costs. Gradually rising cheese prices should also expand profit margins. Saputo will probably continue to expand its U.S. dairy operations, either through acquisitions or by opening new plants.

The company is also expanding its baked goods operations, which make snack cakes and tarts. These account for 4% of its total sales. In July 2006, it acquired a Quebec-based baked goods company for an undisclosed amount. The new operations will add $14 million to Saputo’s annual revenue.

Saputo has $91.5 million ($0.88 a share) in cash, and its long-term debt equals just 18% of equity, so it has plenty of flexibility to finance new ventures.

The stock got as high as $40 in July 2005, but has stayed in a narrow range since. It now trades at 16.1 times the $2.18 a share it should earn in fiscal 2007. The $0.72 dividend yields 2.1%.

Saputo is a buy.