Sadia SA: High Protein Buy

Dec. 4.06 | About: Sadia S.A. (sda-old)

I opened a position in Sadia SA (NYSE:sda-old) on Friday, purchasing shares at $30.60.

Industry and Market Description
The meat and processed foods businesses, I believe, have some significant tailwinds for the years ahead. Regardless of the success of Whole Foods (WFMI) and the organic foods movement in the US and Europe, I think the trend is definitively pointing toward much higher consumption of processed and convenience foods worldwide. More people are working, fewer are farming or living near farms, and convenient refrigeration continues to spread to growing lower middle class areas in Asia, South America and elsewhere.

Add that to the fact that higher standards of living internationally almost certainly will bring higher protein consumption, as they have in the past, and I think meat and frozen convenience foods are good investment opportunities. The global trend for meat consumption has it increasing at 2% a year overall, and already we're seeing eye opening statistics -- including the fact that China now consumes half the world's pork.

Meat consumption has climbed something like 500% over the last 50 or so years, and I don't expect to see that trend reverse itself in any meaningful way. That's likely to be quite bad for the environment and for global sustainability, given the inefficiency of a higher protein diet and the dirtiness of the typical factory farm, but for investment purposes that concern is largely incidental.

Company Description
Sadia is a Brazilian food products company, primarily producing and selling pork, chicken and processed refrigerated/frozen foods. They've had a tough year thanks to some problems with the strong Brazilian currency and weakness in some of their exports (the avian flu outbreak and resultant dip in poultry demand, and a Russian ban on Brazilian pork were negatives in the recent past). But management believes that the recently completed third quarter is the beginning of their export and sales growth rebound, and I'm inclined to think they have a good future ahead of them. The shares, while not at their lows, are nicely priced.

Brazil has some natural advantages in this business: inexpensive and available feed grains, inexpensive labor, a good agricultural climate, and a large number of farmers. Sadia has relied on that combination of factors for many years in building both a dominant food company in Brazil, and a significant export business to the rest of the world.

The company's sales are roughly evenly divided between domestic consumption and exports -- exports are a bit low at 44% of the total for the most recent quarter, thanks to the problems I noted above, but management during the conference call definitely noted that they see the balance returning to the 50/50 margin they prefer.
Sadia cows
Domestically, Sadia is primarily a seller of frozen and refrigerated processed food -- everything from frozen chicken nuggets and pizza to ice cream and margarine, including some products like chicken carrot lasagna and cheese chicken burger hot pockets that I can only assume sound better to a Brazilian than they do to me.

The export business, in contrast, is largely in lower-margin products like chicken parts and commodity poultry and pork products. They're slowly adjusting that and trying to market their value-added processed foods in foreign markets, with particular focus on other South American countries and on the Middle East.

Financial Highlights
Sadia management sees continued opportunity for margin growth as they build and invest in their business, with a goal of seeing EBITDA margins increase to 17% by 2010 -- that would be pretty remarkably high for this business, and Sadia's operating margins are already significantly better than many competitors, including US based companies like Tyson or Smithfield (Sadia doesn't really export to the US on any meaningful level, though that might change with a free trade area for the Americas still possible, so comparisons might not be very useful). Gross margins slid dramatically earlier this year, as the fall in the stock price indicates, but have already begun a rebound and ought to return to their historical levels in the high-20s.

The company has a pretty high debt level, but with continued solid sales and growth I think that ought to be manageable, and the debt is helping to finance needed expansion. Right now, as the company believes they're on the cusp of recovering sales and margins, net debt to equity is at 53%, a touch above the board-mandated maximum of 50%.

There is also always a possibility that Sadia will make big acquisitions either domestically or internationally -- they tried and failed to take over their major competitor Perdigao earlier, and have been trying to build up their pork and beef operations, partly as a way to diversify away from potential avian flu exposure.

As with other Brazilian companies, Sadia pays out a minimum portion of earnings as a dividend to shareholders as required by law. The dividend is subject to Brazilian taxation and fluctuates significantly based on the performance of the business, but the TTM dividend rings in at well over 4%, and I expect to see a yield at least equal to that going forward.

I'm planning to hold this position for a long time, and hope to buy more at lower prices if there are further avian flu or similar short-term concerns. The opportunities for increasing sales of processed foods to the growing economies of South America, and the likelihood of increased protein consumption worldwide provide some real opportunity for a company that I think is value priced right now.

As with my investment in Gol Linhas Aereas Inteligentes (NYSE:GOL) (which I'm also considering adding to in the near future), this is in part a bet on the growing Brazilian economy. Rising minimum wages and inflation that is (hopefully) under control should allow for more consumption of prepared foods as well as cheap airline tickets in the biggest country in South America, but the risks with this volatile economy are certainly nothing to scoff at.

Continued strength of the Real can hurt their export performance, and a return to high inflation or a wildly populist turn by the government (neither of which I expect) might be disastrous. On the flip side, one of the cabinet members is the former head of Sadia, so I'd imagine the company has a significant voice in the government.

SDA 1-yr chart:

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