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Summary

  • Pilgrim's has large market share in a highly concentrated industry with high barriers to entry, but has very little pricing power.
  • Pilgrim's has reduced their debt load but margins are stabilizing due to lower feed costs, which may not be sustainable.
  • Being a minority shareholder is major pitfall for Pilgrim's investors.

Pilgrim's (NASDAQ:PPC) is trading at 7.67x EBITDA, and while this appears to be "cheap," the industry as a whole appears as cheap. Two concerns that stand out with Pilgrim's relative to its peers relate to its bout in bankruptcy in 2008 as well as it being majority owned (75%) by JBS SA (OTCQX:JBSAY), one of the world's largest beef processors. I believe that the relationship with JBS SA is more of a benefit than a hindrance from an operational perspective, due to synergies and long-standing international relationships. The downside is that equityholders are minority shareholders and decisions by JBS SA may not be to the benefit of Pilgrim's shareholders -- they may only benefit JBS SA shareholders. I also believe that the bankruptcy in 2008 could have been mitigated had it not been for poor management execution. A new management team, a platform for growth, and low grain prices, all support a sustainable near-term outlook for Pilgrim's, but will this translate into long-term capital gains?

Company Description

Pilgrim's is a producer of fresh, prepared and value-added chicken products to customers across the U.S., Mexico and 100 other countries. Sales efforts are largely targeted towards the foodservice industry. These include chain restaurants, such as Chick-fil-A and Yum! Brands (NYSE:YUM), distributors such as US Foods and Sysco (NYSE:SYY), as well as retail customers such as Kroger (NYSE:KR), Wal-Mart (NYSE:WMT), Costco (NASDAQ:COST), Publix (OTCQB:PUSH) and Sam's Club.

Pilgrim's currently operates in 12 U.S. states, Puerto Rico and Mexico. Plants are strategically located to ensure that customers receive the freshest products. They operate 24 fresh processing plants in the U.S., six prepared foods cook plants in the U.S., one fresh processing plant in Puerto Rico, three processing plants in Mexico, and 13 distribution centers (one in Puerto Rico and 12 in Mexico). In addition, the Company operates eight rendering facilities (five in the U.S., one in Puerto Rico and two in Mexico) and three pet food plants in the U.S. The Company has six additional processing plants that are currently idle. They have a global network of approximately 4,200 growers, 28 feed mills and 36 hatcheries, and seem to be well positioned to supply the growing demand for chicken products.

Industry Overview (Source: Pilgrim's Pride 2013 Annual Report)

The U.S. is the world's largest producer of chicken and is projected to produce approximately 38.5 billion pounds of ready-to-cook broiler meat in calendar year 2014. This represents 20.0% of the total world production. China and Brazil produce the second and third most broiler meat, with 16.9% and 15.6% of the world market, respectively, according to the USDA. The U.S. is the second-largest exporter of broiler meat behind Brazil and is projected to export 7.5 billion pounds in calendar year 2014, which would account for 31.0% of the total world exports and 19.6% of the total U.S. production. The top five exporters controlled over 87% of the market in 2013.

The U.S. market is concentrated with four major chicken producers accounting for over 50% of production. The U.S. chicken industry is largely vertically integrated with major producers owning and operating feed mills and processing plants while contracting out breeding and broiler production to thousands of contractually bound chicken farmers. More than 90% of all chickens raised for consumption are produced by farmers under contracts with processing companies. Processing companies provide the growers with chickens, feed, vaccines and medicines required for the production of broilers. The grower supplies all systems and labor required to bring the broilers up to slaughter weight. The grower is then paid based on the weight gain exhibited by the flock.

The USDA estimates that from 2010 through 2020 there will be an anticipated increase of global chicken demand of 29%, 81% of which is expected to come from emerging markets. Pilgrims should benefit from their parent company and largest stockholder, JBS USA, as this relationship gives them a gateway to emerging market demand.

Pilgrim's benefits from a shorter production lifecycle of broilers compared to other proteins. While production for cattle takes approximately 28 to 39 months from breeding to slaughter and for pork 11 to 12 months, the production lifecycle for the broiler is only ten weeks. There are three key components of broilers that are sold for consumption: the breast, the wing and the leg quarters. An estimated 88% of broiler production in the U.S. is sold in separate parts, rather than as a whole bird. This is due primarily to domestic preferences associated with white meat, as well as increased demand for boneless breasts and wings.

Key Competitive Advantages (Source: Pilgrim's Pride 2013 Annual Report)

1. Market Share and Scale - Pilgrim's is a leading chicken producer in the U.S. with a 19.0% market share, based on ready-to-cook production in 2013. Pilgrim's is one of the few producers in the chicken industry that can fully satisfy the requirements of large retailers and foodservice companies due to their broad product range, national distribution and technical capabilities (specialized products). A vertically integrated production process enables Pilgrim's to control production and processing output with changes in demand.

2. Experienced management team -senior operating executives at Pilgrim's have backgrounds with leading agribusiness companies, including Tyson Foods, Inc. (NYSE:TSN), ConAgra Foods Inc. (NYSE:CAG) and Bunge Limited (NYSE:BG). They also benefit from management ideas, best practices, and talent shared with the seasoned management team at their majority stockholder, JBS USA, and its parent company (75% controlling interest), JBS SA, who have over 50 years of combined experience operating protein processing facilities in South America, North America and Australia.

3. Efficiency and Scale -Since 2008, Pilgrim's has closed, idled or sold 11 plants and 14 distribution centers, reduced or consolidated production at other facilities, streamlined the workforce and reduced administrative and corporate expenses including moving corporate headquarters and closing satellite headquarters as part of them becoming a majority owned subsidiary of JBS USA. Since 2010, these efforts have resulted in a $642.0 million cumulative annualized run rate improvement in plant-related costs, sales mix and product yield. This is expected to continue as management finds further synergies with JBS USA.

4. Marquee Customers - strong relationships with leading companies in every customer segment, including Chick-fil-A, Sysco, US Foods, Yum Brands, Kroger, Wal-Mart (& Sam's Club), Costco, Publix and ConAgra Foods. Wal-Mart Stores, Inc., which accounted for 9.7% of net sales in 2013, no others above 7%.

5. Relationship with JBS SA - as a majority-owned subsidiary of JBS SA, they work closely with JBS USA's (JBS SA's United States entity) management to identify areas where both companies can achieve synergies. Pilgrim's seeks to leverage JBS SA's international network by expanding into untapped international markets and strengthening its presence in geographies in which they already operate.

Management Growth Plan (Source: Pilgrim's Pride 2013 Annual Report)

1. Focus on marquee customers - leverage off of scale of operations and supply the growing demand for a broad range of price competitive standard and specialized products. This may lead to lower margins in the short term but over time it will drive out smaller competitors leading to further industry consolidation. Pilgrim's has been an active pursuer of acquisitions to further expand their customer network and improve on scale.

2. Operational excellence - focus will be on cost reductions, more effective processes, training and quality. Management has been keen on keeping costs down and with JBS USA monitoring these costs, there isn't a lot of doubt that this cannot continue to be sustained going forward.

3. Strategically grow value added exports - focus on expanding international sales by seeking opportunities to increase penetration in existing markets and entering attractive new markets. Key international markets include Mexico, the Middle East, Asia and countries within the Commonwealth of Independent States. The relationship with JBS SA has improved access to markets such as Africa, the Middle East, Latin America and Asia. Export sales accounted for approximately 10.0% of U.S. chicken sales in 2013.

Financial Analysis and Valuation

Over the past 5 years, it appears as though restructuring efforts have driven operating performance, namely a consistent decline in cost of goods sold through management's ability to find efficiencies in production and synergies with the parent company JBS SA. They have almost entirely de-levered their balance sheet, which I suspect will continue to lead to substantial free cash flow to equity holders, providing opportunities for buybacks or dividends in the near future. However, management and the parent company, JBS SA, has been very keen on new acquisitions to drive top-line growth while keeping margins in check.

Financial Analysis

(Millions of USD except % and multiples)

2010

2011

2012

2013

LTM

Revenues

$6,882

$ 7,536

$8,121

$8,411

$8,395

COGS

$6,417

$ 7,675

$7,685

$7,566

$7,386

COGS % Sales

93.2%

101.9%

94.6%

89.9%

88.0%

Gross Profit

$ 465

$ (140)

$ 436

$ 845

$1,009

Gross Margin

6.8%

-1.9%

5.4%

10.1%

12.0%

SG&A

$ 210

$ 205

$177

$181

187

SG&A % Sales

3.0%

2.7%

2.2%

2.2%

2.2%

EBITDA

$ 472

$ (145)

$ 396

$ 806

$ 975

EBITDA Margin

6.9%

-1.9%

4.9%

9.6%

11.6%

Gross PPE

$2,741

$ 2,730

$2,750

$2,770

$2,828

Depreciation

$ 211

$ 194

$ 132

$ 136

$ 151

Capex

$ 179

$ 136

$ 90

$ 116

$ 158

Capex% of Beg. Gross PPE

6.6%

5.0%

3.3%

4.2%

5.7%

EBITDA-Capex

$ 292

$ (281)

$ 306

$ 690

$ 817

EBITDA-Capex % Margin

4.2%

-3.7%

3.8%

8.2%

9.7%

Net Debt

$1,232

$ 1,465

$1,097

$ 307

$ (25)

Net Debt / EBITDA

2.61

(10.11)

2.77

0.38

(0.03)

NetDebt/EBITDA-Capex

4.21

(5.21)

3.58

0.45

(0.03)

Current Capitalization
(Millions of USD)

Currency

USD

Share Price as of Aug-4-2014

$28.95

Shares Out.

259.0

Market Capitalization

7,498.9

- Cash & Short Term Investments

(527.2)

+ Total Debt

502.3

+ Pref. Equity

-

+ Total Minority Interest

3.3

= Total Enterprise Value (TEV)

7,477.3

Valuation

LTM

EV/EBITDA

7.67

EBITDA - CAPEX / EV

10.9%

EBIT/EV

15.1%

Relative Value

Pilgrim's is in line with the industry, but has significantly less leverage than its peers. One thing worth noting is the discount that Sanderson Farms currently trades at, which makes it an appealing M&A target.

Valuation

Pilgrim's Pride

Comp Avg

New Tyson

Sanderson Farms (NASDAQ:SAFM)

Hormel Foods (NYSE:HRL)

JBS SA

LTM

LTM

Est

LTM

LTM

LTM

EV/EBITDA

7.67

7.88

7.66

5.73

11.96

6.17

EBITDA - CAPEX / EV

10.9%

10.6%

9.8%

13.4%

7.2%

11.8%

EBIT/EV

15.1%

10.8%

9.8%

14.7%

7.3%

11.4%

Net Debt / EBITDA

(0.03)

1.31

1.89

0.14

0.23

2.97

Segment Analysis (Source: Pilgrim's Pride 2013 Annual Report)

Fresh Chicken - based on market prices reported by the USDA plus a markup, which is dependent on a customer's location, volume, product specifications, etc. The majority of these products are sold pursuant to agreements with varying terms that set a price according to formulas based on underlying chicken markets, subject to minimum and maximum prices.

Prepared Chicken - the production and sale in the U.S. of prepared chicken reduces the impact of the costs of feed ingredients on profitability. Feed ingredients are the largest component of U.S. cost of sales, representing 46.1% of COGS. This cost is lowered because as further processing is performed, feed ingredient costs become a decreasing percentage of total production cost, reducing its effect on profitability.

Mexico - sales of chicken products in Mexico are attributed to fewer, simpler products, and the live market, which accounts for approximately 33% of chicken sales in Mexico. Chicken products are sold to wholesalers, large restaurant chains, fast food accounts, supermarket chains and direct retail distribution. It is worth noting that Pilgrim's claims that their presence reaches 72% of the Mexican population.

Segmented
($ millions)

2010

2011

2012

2013

LTM

U.S

Prepared

$ 2,262

$ 2,135

$ 2,239

$ 2,047

nil

Fresh

$ 2,835

$ 3,160

$ 3,584

$ 4,123

nil

Export or other

$ 518

$ 808

$ 818

$ 716

nil

Total U.S

$ 5,615

$ 6,104

$ 6,641

$ 6,886

$ 6,888

Mexico

$ 615

$ 720

$ 758

$ 864

$ 846

Other

$ 588

$ 712

$ 722

$ 661

nil

Total

$ 6,819

$ 7,536

$ 8,121

$ 8,411

$ 7,734

U.S

Prepared

33%

28%

28%

24%

Fresh

42%

42%

44%

49%

Export or other

8%

11%

10%

9%

Total U.S

82%

81%

82%

82%

89%

Mexico

9%

10%

9%

10%

11%

Other

9%

9%

9%

8%

Total

100%

100%

100%

100%

100%

Market Share Analysis

Pilgrim's management maintains that Pilgrim's controls about 19% of the market in the United States. I decided to put this number to the test given the high barriers of entry and high degree of customer buying power (due to low switching costs and lack of product differentiation). The total market share calculated below is based on average market prices for broilers in any given year multiplied by broiler production in that year as estimated by the USDA. It is not an exact estimate but gives you a close indication. This exercise was well worth it, as management weren't far off on their 19% estimate - roughly 16% according to my calculations. This data is not available for Mexico.

USDA Estimates ($ millions)

2010

2011

2012

2013

Broiler Production (million lbs)

36,910

37,202

37,039

37,830

Broiler Exports (million lbs)

6,765

6,971

7,274

7,416

Market Prices ($/lb)

$ 0.83

$0.79

$0.87

$ 1.00

Total Market Size

$36,207

$34,897

$38,375

$45,110

Pilgrim's Total US Sales

$5,615

$6,104

$6,641

$6,886

Pilgrim's Total mkt share

16%

17%

17%

15%

Market Size US Consumption (000's)

$30,598

$29,390

$32,076

$37,717

Pilgrim's Total U.S. Sales

$ 5,097

$ 5,296

$ 5,823

$ 6,170

Est. Pilgrim's mkt share

17%

18%

18%

16%

Export Market Size (000's)

$ 5,608

$ 5,507

$ 6,299

$ 7,394

Pilgrim's Total Export Sales

$ 518

$ 808

$ 818

$ 716

Est. Pilgrim's Export mkt share

9%

15%

13%

10%

Analysis of COGS - Are Current Levels Sustainable?

The chart below showcases the change in COGS since going insolvent. It is clear that feed costs are the drivers of COGS, and therefore margins. Feed costs consist primarily of corn and soybean meal.

($US Millions)

USA

MEXICO

TOTAL

2013

2013

2013

Decline in COGS

-134.5

Increase COGS

13.8

-120.7

Decreased Sales Volume

-57.9

Decreased Sales volume

-10

Insurance Costs

-24.1

Foreign Currency

24.3

Feed Costs

-14.6

Fertile Eggs

4.7

Derivative Gains

-13.6

Feed Costs

3

Disposal of Egg business

-12

Improved Processing Performance

-8.8

Freight and Storage Costs

-10.1

Other

0.6

Compensation & employee relations

-9.7

Rental and Lease Costs

-5.2

Other

12.7

Change in COGS

-134.5

Change in COGS

13.8

-120.7

USA

MEXICO

TOTAL

2012

2012

2012

Decline in COGS

-20.1

Increase in COGS

30.4

10.3

Pork Business Sale

-295.2

Feed Costs

108.7

Plant Closures

-62

Increased Sales Volume

48.3

Decreased Depreciation

-59.2

Overhead

-81.6

Decreased Fleet Expenses

-11

Foreign Currency Translation

-44.9

Feed Costs

365

Other

-0.1

Derivative Gains

54

Packaging and Ingredients Costs

4

Other

-15.7

Change in COGS

-20.1

Change in COGS

30.4

10.3

USA

MEXICO

TOTAL

2011

2011

2011

Increase in COGS

1073.6

Increase in COGS

187.3

1260.9

Feed Costs

773.1

Feed Costs

72.6

Inventory

215.2

Increased Sales Volume

79.2

Freight, Storage and Handling

29.9

Foreign Currency Translation

35.5

Additional distribution costs

72.8

Utility maintenance and other

-27.6

Other

10.2

Change in COGS

1073.6

Change in COGS

187.3

1260.9

USA

MEXICO

TOTAL

2010

2010

2010

Decrease in COGS

-429.3

Increase in COGS

80.8

-348.5

Production efficiencies, cutbacks

-360.1

Increased production volume

80.8

-279.3

Derivatives gain

-69.2

Decrease in COGS

-429.3

Increase in COGS

80.8

-348.5

Feed Costs - Key Determinant of COGS and a major issue relating to bankruptcy

Below the Corn and Soybean Meal price charts show approximately where management would have gone long the futures contract, just before prices collapsed in 2008. Keeping in mind that Pilgrim's filed for bankruptcy protection in December 2008, where prices were already at low levels.

Corn price chart ($/metric ton):

(click to enlarge)

Soybean Meal price chart ($/metric ton):

(click to enlarge)

Bankruptcy and JBS SA

Pilgrim's Pride Corp. filed for protection from creditors under Chapter 11 of the federal Bankruptcy Code on Monday December 1, 2008 after heavy debt and low chicken prices put them in a squeeze. Pilgrim's listed $3.75 billion of assets and $2.72 billion of liabilities. The company lined up $450 million of debtor-in-possession financing led by Bank of Montreal.

Due to a slower economy chicken processors were unable to raise chicken prices enough to offset the rising costs of feed. Pilgrim's attempted to protect itself by buying feed in advance of use, otherwise known as hedging. Unfortunately, the hedging occurred right before grain prices tumbled, which left Pilgrim's with a lot of expensive feed. At one point in 2008, Pilgrim's locked in feed prices when corn futures were trading around $8 (subsequently fell to $3.50 in late 2008). Its grain costs soared by more than $900 million in 2008 even as prices plunged amid a glut in corn crops, a combination of poor risk management and bad timing.

The troubles at Pilgrim's were emphasized by their high debt load. The bloated debt burden began in December 2006, when the company paid $1.1 billion to buy rival Gold Kist Inc. in a hostile takeover bid and gained control of 26% of the nation's bird-slaughtering capacity, pulling ahead of Tyson Foods. The deal saddled Pilgrim's with a debt load that became more difficult to manage and refinance as credit dried up, feed prices rose and a glut formed in the poultry market. Pilgrim's inevitably took a $501.4 million impairment of goodwill relating to this acquisition.

In September 2009, Brazilian beef giant JBS SA agreed to pay $800 million to buy a majority stake in Pilgrim's and reached an all-stock deal with a Brazilian beef-industry rival. JBS SA agreed to buy 64% of Pilgrim's stock under the U.S. Company's bankruptcy reorganization plan. JBS valued the deal at $2.8 billion, which included debt. The then-current Pilgrim's shareholders got a 36% stake, valued at about $450 million, in the new company.

Marquee risks in investing in Pilgrim's Pride

  1. Recent bankruptcy (2008) and the clout that surrounds that.
  2. Controlling shareholder, JBS SA for 75.5% of equity. This control could lead to non-accretive acquisitions that benefit JBS SA's shareholders and not Pilgrim's.
  3. Potential of increasing exposure to exchange rate fluctuations relating to export growth strategy. Costs in U.S. dollars, sales in foreign currencies, which means that they are short the dollar when exporting. Currently the only real exposure is to the Mexican Peso (which trades very much in-sync to the USD).
  4. Negative PR relating to Farming/slaughter practices- if Pilgrim's is exposed to poor treatment or storage of chickens, it could mean losing significant clients such as Wal-Mart. Example is when McDonald's dropped their egg supplier and the supplier subsequently went bankrupt.
  5. Customer Buyer power
  6. Size of most customers, such as Wal-Mart.
  7. High overhead costs in a highly concentrated industry.
  8. Low switching costs - product is not highly differentiated
  9. Reliance on the price of grain costs, including corn and soybean meal. A 10% increase in feed costs would have resulted in an increase to cost of goods sold of approximately $336.5 million, excluding the impact of the usage of derivatives (2013 annual report).

Summary of Research

Pilgrim's is a top 5 chicken processor in the United States with plans of expanding internationally by utilizing a branch network already in place by its parent, JBS SA. The benefits to this will be economies of scale as well as increased diversification of revenue streams from a geographical perspective. Pilgrim's currently only sells in the USA and Mexico, therefore, an international expansion could be an area of growth if executed properly. I suspect that management will grow with bolt-on acquisitions, and JBS SA will be very hands-on during these negotiations. A further incentive to grow internationally is that the current customer-base that is served in the USA has a large global footprint. These customers could be willing to extend their current domestic relationship abroad, particularly if JBS SA is part of the negotiations and offerings are combined from the two entities. This foray into exporting will be guided by JBS SA, who had $40 billion in sales in 2013.

Pilgrim's is fairly priced from a relative value perspective, but contains much less risk due to the small debt load that it is currently carrying. It is clear that the parent, JBS SA, has shouldered a lot of this debt load while forcing a substantial amount of free cash flow used to cover debt service, with the goal to enhance the company's balance sheet. Now that the debt has been paid down, it opens the door for opportunity to give equity holders a share buyback or begin paying dividends. Given the recent bankruptcy a long-term commitment to dividends is not likely and therefore I would expect a share buyback to occur if this were something that JBS SA would entertain. The alternative, and probably more realistic, is to use this cash flow for acquisitions to further expand Pilgrim's footprint nationally and internationally.

Pilgrim's has shown that they are not shy of acquisitions. They recently placed a bid for Hillshire Brands before being outbid by Tyson Foods, who purchased it for north of 15x EBITDA with $300 million in estimated synergies. In my opinion these kinds of acquisitions benefit JBS SA's shareholders and not Pilgrim's, creating problems from a minority shareholder perspective. The lack of voting rights puts the cash flows to equity holders in question, and therefore, a short-term catalyst like a buyback or dividend does not have high odds. Adding in the uncertainty surrounding feed costs, estimating cash flows is quite difficult -- hence the lack of clarity as to whether or not this company is in fact "cheap."

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Source: Pilgrim's Pride: Deep Value Or Value Trap