Bachoco Share Valuation: Chicken-Feed Price

|
 |  About: Industrias Bachoco, S.A.B. de C.V. (IBA)
by: Ricardo Espinosa

While looking for a company with a price/sales ratio under 1 using the finviz.com screener, I found Bachoco Industries (NYSE:IBA), a company whose products I have known for many years. The company trades on the NYSE under the ticker symbol IBA. In 1997, Bachoco began trading on the NYSE and the BMV (Mexican stock exchange). There's about a 50/50 split between the percentage of free float that's in the NYSE and the Mexican stock exchange and each ADR represents 12 shares.


Exchange

Country

Ticker Symbol

Securities

BMV

Mexico

Bachoco

Shares

NYSE

U.S.

IBA

ADR

Click to enlarge

Get to know Bachoco

Bachoco is the biggest producer of chicken products in Mexico, taking around 35% of the chicken market, and the second largest producer of eggs with around 5.6% market share. It also has about 3.3% market share in the balanced feed industry. (Source: Company's 20-F)

Chicken represents 62% of its volume sales, followed by balanced feed with 26% and eggs with 10%, and has been growing/declining as follows:

Click to enlarge

The bad news is that balanced feed volume has been declining, and could be a red flag if it wasn't for the fact that its core business, chicken, has been growing fast enough to balance this effect and then some.

Mexico had an estimated production of 2,945.4 thousand tons of chicken meat in 2012, with a per capita consumption of 56.8 pounds a year, compared to 34.8 pounds in 1994. The U.S. has a per capita consumption of 96 pounds per year. The USDA Post forecast of Mexican commercial broiler meat production for 2014 is 3.05 million metric tons as the sector's continued consolidation along with improved production systems has enabled the industry to overcome the challenges of the 2012 and 2013 Highly Pathogenic Avian Influenza outbreaks across the country. The United States exported over $1.1 billion in poultry and poultry products to Mexico in 2012 and is on pace to far exceed that level in 2013. This trend should continue in 2014 as well. During the first five months of 2013 approximately 98 percent of Mexico´s chicken and turkey imports originated from the United States. This is why Bachoco's 2011 acquisition of OK Foods was very strategic, as it allowed the company to diversify revenues from a growing protein-hungry population.

Bachoco has over a thousand production facilities in Mexico and the U.S. (mostly farms) and 64 distribution centers located throughout Mexico to ensure freshness and minimize transportation time and costs. Bachoco owns around 80% of the farms and employs a network of contract growers.

The company has had some bad luck in the past few years. In 2008, its processing plant in Monterrey caught fire; in April 2010 an earthquake affected 9% of its total egg production; and in February 2013, the outbreak of avian influenza H7N3 was detected in several of its breeders and laying farms located in the state of Guanajuato, central Mexico. (Incidentally, these production-capacity-causing-damages have been incorporated as an annual occurrence in the DCF valuation under the three scenarios.)

The company has been growing organically and though aggressive acquisition of competitors and suppliers, taking advantage of vertical integration and increased market share to boost margins.

In 2011, the company entered the U.S. market and increased its export business with the acquisition of the American poultry company OK Foods, with operations in Arkansas and Oklahoma, for around $120 million dollars (announcement linked above). These facilities process around 150 million chickens per year, and employ over 3,000 workers. U.S. chicken sales represent more than 20% of Bachoco's total sales, which is effectively beginning to diversify sales geographically.

In 2012, the company issued $1,500 million pesos worth of debt (around $120 million) to pay higher interest-bearing debt and acquire OK Foods. Fitch gave a AA (MEX) rating on the debt that matures in 2017, with an interest rate of TIIE (sort of like LIBOR, but for Mexico)+0.60% (around 4.1% cost of debt).

Stock ownership

The Robinson Bours family owns 73.25% of the total shares outstanding, and the ADR price could decline if the family sold a substantial amount of their shares through the two Mexican trusts where they hold them.

Via its trust, the family sold 9.5% of Bachoco through the Mexican Stock Exchange at market price. As a result, the family trust holds 21.25% of Bachoco. The control trust still holds 52% of the company.This should help volume increase. If you look at the volume, you will quickly notice that this stock has not been overrun by HFT and traders, as daily volume is around 22,000 per day, and might deter short-term traders from buying this stock, but that's okay for the value investor.

Share Valuation

The stock is cheap when seen through various metrics. Its price/sales ratio and EV/Sales are below 1, at 0.63 and 0.53, respectively. So the market thinks the company is worth $0.53 of every $1 it generates in revenue. Graham's formula for share value has a result of $44.71, higher than the current trading price.

Taking a measure I like for quick calculations of company value (EBITDAx8), I get a $44.29 price per share. And now, let's look at my favorite part: the DCF results.

DCF Valuation under three scenarios

Business as usual: Sales growth is slow to moderate, at 1.5% to 2% during four years, and then starts declining in 2018, then recovers to 1% growth by 2020 and forward. Margins are also pressured during this period and gross profit margin oscillates between 15 and 17.5% (2013 had 17.6% gross profit margin). The company is unable to reduce costs and operates at the same level of expenses it had in 2013. The company, although it is not growing sales so much, keeps purchasing assets worth over $80 million USD each year, at the levels it was during its competitor acquisition phase, but somehow fails to grow revenues by more than 2% a year. The company keeps earning around 3.1% on its cash balance and hedging contracts still represent less than 5% of assets.

Target Price: $47.42

Assigned probability: 60%

Optimistic Scenario: Sales growth reaches 5% during 2014, and gradually slows down each year to reach 2% growth by 2024. The gross margin stays in good levels, ranging from 17 to 20%, but below 2010 levels. The company is only investing at 2013 levels because it has now stopped purchasing rivals and has good financing results every year. This is derived from its hefty cash balance, which is apparently being invested in CETES (Mexican government's answer to T-Bills, which yields around 3.1%) combined with inexpensive hedging practices.

Assigned probability: 25%

Target Price: $59.05

Pessimistic Scenario: The company fails to grow in revenues forever, and its margins are pressured as the industry suffers from price wars or the company's input prices grow all the time, leaving gross margin at a terrible 15% and unable to grow, even through acquisitions. The company gets desperate and tries to use its cash to invest in new assets and competitors, but magically fails to boost sales every single year. Assigned probability: 15%

Target Price: $26.74

This weighted DCF valuation gives an average price of $47.23. This represents 12.6% upside from the current price. As I have done in my previous articles, I used a WACC of 10%. It was fun to think about CAPM and Beta when deciding which WACC to use, and then I remembered French Fama himself wrote "Beta is weak." Imagine I use CAPM to provide a cost of capital. With a 0.83 beta, what market premium to use? The 5-year 18.50%? The 10-year 6.61%? Ridiculous.

A higher-than-necessary WACC will punish the expected cash flows of a company, resulting in a better value for an investor, as he is buying cheaper than what strict theory would suggest.

Click to enlarge

Creating value for shareholders?

The company plans to pay dividends of about 20% of its net income. The latest cash dividend payment of 1 peso per share was approved on December 6, 2013 to be paid on December 23. That is 12 pesos per ADR (around $0.92), which would make Bachoco's yield 2.1%. Not bad for a cash-generating machine. Sure, REITs have higher yield, but I would rather have a real business rise in share price while getting some dividends than relying mostly on dividends from MBS rather than share price increases.

The board has approved a repurchase plan that expires on April 23, 2014, for up to around 12 million shares per year. The buyback program is most likely going to be renewed next year.

The company is sitting on a good deal of cash. With around $574 million dollars, this represents more than 20% of 2013 revenues. This may have something to do with the somewhat recent memory of the "Tequila" effect in 1994, along with expansion/acquisition plans.

A decrease in inventory and increase in accounts payable has helped this company boost its already hefty cash flow position into 2013 while paying down principal from loans for about $85 million dollars so far, lowering its cost of capital.

The company has been returning ROIC levels of above 20%, thereby creating economic profit of $150 million dollars in 2012, and around $180 for 2013, which look a lot like its cash flow for those periods.

Piotroski´s F_Score

This company has scored 8 out of 9. The turnover fell from 14.0 to 13.8 for 2013, which is not an important decline. 8 out of 9 is still an outstanding result.

1. ROA

1

Positive return on assets

2.CFO

1

Positive Cash Flow from Operations

3. ΔROA

1

Improved return on assets

4. ACCRUAL

1

No accounting red flags

5. ΔLEVER

1

Decreased its interest-bearing debt

6. ΔLIQUID

1

Improved current assets to current liabilities ratio

7. EQ_OFFER

1

Bought back equity or did not issue more

8. ΔMARGIN

1

Improved net margin

9. ΔTURN

0

Decreased asset turnover

Click to enlarge

Conclusion

The more I dig into this company's numbers, the more I think this stock is a good value that is still flying under the radar of U.S. analysts. The company's ability to generate continuously growing cash flow, aided by the recently acquired U.S. operation should keep the stock with a "floor" price at around $25, but I consider anything under $40 to be a buy area, and anything close to $60 a sell area. The company's acquisitions will keep expanding its production capacity in Mexico and the U.S., improving its ability to compete in the poultry markets. Bachoco also seems to be reducing costs respective to revenues every year, which should help improve its operating cash flows.

Click to enlarge

Keep in mind that because the ADR that trades under ticker symbol IBA represents 12 shares of Bachoco, which trade in pesos, you are affected by currency exchange. It will be interesting to see in December which factor helps gains from a U.S. buyer's perspective - the underlying fundamentals or the exchange rate between the Mexican peso and the dollar. You can see an inverse relationship between IBA and USD/MXP on the next graph, courtesy of Yahoo Finance. This means your ADR will benefit when the U.S. dollar depreciates against the Mexican peso, and will drop in value if the dollar appreciates. The current oil reforms that passed last year are huge and should attract more dollars to Mexico, theoretically depreciating the dollar against the peso, but only time will tell.

Click to enlargeIt's also good to see the market finally begins to start deflating some of the optimism baked into the valuation of international markets. The ADR price is coming closer to $40 (or lower), and a great buying opportunity approaches. Stay tuned for the next valuation, I have Best Buy (NYSE:BBY) and Green Mountain Coffee Roasters (NASDAQ:GMCR) on the list, but feel free to request others.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in IBA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.