With families gathering all over the United States today enjoying their Thanksgiving Day turkeys, I thought it would be interesting to analyze the #1 and #2 turkey producers in the USA and run each through a stringent free cash flow analysis.
The #1 brand, Butterball, a unit of Seaboard Corp.(NYSEMKT:SEB) processes about 18% of all turkeys in the U.S. followed by #2 Hormel (NYSE:HRL) (Turkey Products). With the USDA estimating that Turkey meat production in 2014 to be around 6 billion pounds, there may be an opportunity for the investor to make some serious bucks off of the birds. From this analysis we should give the reader a clear picture of which company is the better deal, so no one ends up owning a turkey of a stock.
This analysis will use the following six free cash flow ratios:
- Price to Mycroft Free Cash Flow
- Mycroft/Michaelis Growth Rate
- Free Cash Flow Payout Ratio
- Free Cash Flow Reinvestment Rate
Those new to this analysis can find an introduction by going here that will explain in detail how each of these ratios is calculated. When used together, these unique ratios will generate a quantitative picture of a company's underlying fundamentals, including strengths and weaknesses.
The "2014 Mycroft Free Cash Flow Per Share" estimates in the table above for both companies were generated by taking the trailing twelve months (TTM) free cash flow result for each and then adding my Mycroft Michaelis Growth Rate into the equation in order to generate forward looking estimates for 2014. That growth rate is generated by using my FROIC ratio (Free Cash Flow Return on Invested Capital). Basically FROIC tells us how efficient operations are as it zeros in on how much free cash flow is generated for every $1 of total capital employed.
Hormel has a FROIC of 17%, which means that for every $100 of invested capital it generates $17 in free cash flow. Seaboard, on the other hand has a FROIC of 0%, which means that for every $100 of invested capital it generates $0 in free cash flow. This can be attributed to the fact that its free cash flow result for 2013 came in negative.
The following tables are the free cash flow results for each company for the last ten years.
Now my Mycroft/Michaelis Ratio takes that 17% FROIC for Hormel and the 0% FROIC result for Seaboard and multiplies each by each firm's free cash flow reinvestment rate. The reinvestment rate that I use is a free cash flow reinvestment rate instead of the standard one used by analysts that simply uses net income:
Free Cash Flow Reinvestment Rate = 100% - (Free Cash Flow Payout Ratio).
Free Cash Flow Reinvestment Rate = 100% - (Total Dividend/Total Free Cash Flow).
By replacing net income in the payout and reinvestment ratios with free cash flow, I am thus able to make my analysis more precise by incorporating capital spending (Cap Ex) into the equation.
Therefore from this we can determine that Hormel has a reinvestment rate of 67% and went on to use 33% of its free cash flow to pay out its dividend. Thus by taking 17% (FROIC) x 67% = 11.39% (rounded off at 11%). From there we add the dividend yield of 1.6% (rounded off at 2%) and we have a Mycroft/Michaelis growth rate of 11% + 2% = 13%.
Seaboard on the other hand has a reinvestment rate of 100% as it pays no dividend. Thus by taking 0% (FROIC) x 100% = 0%, which is Seaboard's Mycroft/Michaelis growth rate.
Hormel's Mycroft Free Cash Flow per share of $2.38 was generated by taking its TTM free cash flow per share and multiplying it by (100% + 13% or 1.13). Once we have our result, we then take its current market price of $44.95 and divide it by $2.38 and get a Price to Mycroft Free Cash Flow result of 18.89. I consider a Price to Mycroft Free Cash Flow per share result of less than 15 to be good for purchase, and anything under 7.5 to be excellent.
Seaboard Corporation's Mycroft Free Cash Flow per share of $-6.69 was generated by taking its TTM free cash flow per share and multiplying it by (100% + 0% or 1.0). Once we have our result, we then take its current market price of $2,778.51 and divide it by $-6.69 and get a Price to Mycroft Free Cash Flow result of -415.32. When you see a company with a "Negative Free Cash Flow" result such as we have with Seaboard, we cannot determine a positive buy, hold, sell or short price result. Therefore I have simply put "Negative Free Cash Flow" in the table below for Seaboard to indicate that it would be best to avoid its stock.
The higher you go above 15, the more overvalued a company becomes. I use a Price to Mycroft Free Cash Flow per share result of 22.5 as my sell price, and 45 as my short price.
An appropriately priced stock should trade around a Price to Mycroft Free Cash Flow per share result of 15. This benchmark result was determined by backtesting.
Buy (opinion) = A Price to Mycroft Free Cash Flow per share result of less than 7.5 is considered excellent (50% below the initial Hold level), and anything under 15 is attractive.
The result I give as my Buy opinion in the table above uses a Price to Mycroft Free Cash Flow per share result of 7.5.
Hold (opinion) = 15 to 22.5 (I use 15 in the table).
Sell (opinion) = 22.5 or higher (50% above the initial Hold level). (I use 22.5 in the table).
Short (opinion) = 45 or greater. The Price to Mycroft Free Cash Flow per share result of 45 was determined by going back to the peak of the market (in the year 2000) and averaging the Price to Free Cash Flow per share results for the key players at that time. (I use 45 in the table).
The CapFlow ratio result that you see in our first table above is an original ratio I created in order to tell me how much Capital Spending is used as a percentage of Cash Flow. A result of less than 33% is considered ideal.
With Hormel coming in with a CapFlow of 16%, means that 84% of the company's cash flow is actually free cash flow and can be used to buy back stock, which I am a big fan of.
Seaboard unfortunately came in with a CapFlow of 105%, which means that its capital spending was actually 5% more than its total cash flow. This again is further proof that the company's Management has some serious issues that it needs to deal with.
In conclusion, Hormel clearly is the better deal, of the two, because it has excellent free cash flow results and generates a lot of FROIC, to go along with a decent Mycroft Michaelis Growth Rate. Seaboard obviously has some capital spending issues that it needs to address and unlike Hormel it has little in the way of consistency as the ten year free cash flow table above (second table) clearly shows. Therefore if you are interested in investing in turkey producers, then Hormel is clearly the best way to go in my opinion.