In a recent article, I wrote about a world in turmoil: The disaster that hit Japan, revolution in the mid-east and financial problems in Europe. A reader reminded me that in spite of these events, life goes on. Our need to eat is one obvious requirement. There are about 68 companies classified as being in the food processing industry. We screened our list to exclude companies trading as ADRs, trading over-the-counter or with market capitalizations below $500 million. We reduced this list to a final selection of companies that we feel may be under-priced.
The food processing industry is, by definition, reliant on agricultural commodity products. The availability and prices of agricultural commodities is affected by weather conditions, disease, government programs, and competition. Operating costs and selling prices are sensitive to energy prices. These are global companies subject to economic downturns, political instability and other risks of doing business globally.
Archer Daniels Midland (ADM) is one of the world’s largest processors of oilseeds, corn, wheat, cocoa, and other agricultural commodities and is a leading manufacturer of vegetable oil and protein meal, corn sweeteners, flour, biodiesel, ethanol, and other value-added food and feed ingredients. The company also has an extensive grain elevator and transportation network to procure, store, clean, and transport agricultural commodities, such as oilseeds, corn, wheat, milo, oats, and barley, as well as processed agricultural commodities.
During the past five years, the company has experienced significant growth, spending approximately $7.9 billion for construction of new plants, maintenance and expansions of existing plants, and the acquisitions of plants and transportation equipment. The company has recently completed construction of a coal cogeneration facility and two corn dry milling plants which will increase the company’s annual ethanol production capacity by 600 million gallons to 1.8 billion gallons. In addition, the company has completed the initial phase of its polyhydroxy alkanoate (PHA) bioplastic production facility, and continues to work through start up at its propylene/ethylene glycol production facility and a new cocoa processing facility. The company currently expects to spend approximately $1.5 billion to complete the facilities under construction and other approved capital projects through calendar year 2013. There have been no significant dispositions during the last five years.
Bunge Limited (BG) agribusiness is an integrated business involved in the purchase, storage, transport, processing and sale of agricultural commodities and commodity products. The principal agricultural commodities that we handle in this segment are oilseeds and grains, primarily soybeans, rapeseed or canola, sunflower seed, wheat and corn. They process oilseeds into vegetable oils and protein meals, principally for the food and animal feed industries, as further described below. We also participate in the biodiesel industry, generally as a minority investor in biodiesel producers in Europe, Argentina and the United States.
In connection with these biodiesel investments, the company typically seeks to negotiate arrangements to supply the vegetable oils used as raw materials in the biodiesel production process. In 2010, they acquired five grain elevators in the United States, as well as two oilseed processing facilities in Turkey. Bunge is currently constructing their fourth oilseed processing facility in China, located in Taixing in the Lower Yangtze region and are building an integrated soybean processing and oil refining plant within the Phu My Port complex in Vietnam, which they expect to become operational in 2011.
J&J Snack Foods (JJSF) manufactures nutritional snack foods and distributes frozen beverages which it markets nationally to the food service and retail supermarket industries. The company’s principal snack food products are soft pretzels marketed primarily under the brand name SUPERPRETZEL and frozen juice treats and desserts marketed primarily under the LUIGI’S, FRUIT-A-FREEZE, WHOLE FRUIT, ICEE, BARQ’S* and MINUTE MAID** brand names.
J & J believes it is the largest manufacturer of soft pretzels in the United States, Mexico and Canada. Other snack food products include churros (a Hispanic pastry), funnel cake and bakery products. The company’s principal frozen beverage products are the ICEE brand frozen carbonated beverage and the SLUSH PUPPIE brand frozen uncarbonated beverage.
The company’s Food Service and Frozen Beverages sales are made primarily to food service customers including snack bar and food stand locations in leading chain, department, discount, warehouse club and convenience stores; malls and shopping centers; fast food outlets; stadiums and sports arenas; leisure and theme parks; movie theatres; independent retailers; and schools, colleges and other institutions. The company’s retail supermarket customers are primarily supermarket chains. The company’s restaurant group sells direct to the public through its specialty snack food retail outlets, BAVARIAN PRETZEL BAKERY. As of September 25, 2010, two outlets remained open.
The company operates in four business segments: Food Service, Retail Supermarkets, The Restaurant Group and Frozen Beverages.
Lancaster Colony Corporation (LANC) is a diversified manufacturer and marketer of consumer products focusing primarily on specialty foods for the retail and foodservice markets. They also manufacture and market candles for the food, drug and mass markets. Less significantly, they are also engaged in the distribution of various products, including glassware and candles, to commercial markets. In recent years, our strategy has shifted away from operating businesses in a variety of industries towards emphasizing the growth and success we have achieved in our Specialty Foods segment.
Sanderson Farms (SAFM) is a fully-integrated poultry processing company engaged in the production, processing, marketing and distribution of fresh and frozen chicken products. In addition, the company is engaged in the processing, marketing and distribution of prepared chicken through its wholly-owned subsidiary, Sanderson Farms, Inc.
Zhongpin Inc. (HOGS) is principally engaged in the meat and food processing and distribution business in the People’s Republic of China. They are developing what they believe is a nationally recognized brand of high-quality, fresh -tasting , healthy and nutritious meat and food products targeting China’s middle class . As of December 31, 2010, their product line included over 390 unique meat products, including chilled pork, frozen pork and prepared meats, and over 35 vegetable and fruit products. The sell these products on both a wholesale basis to 31 fast food companies in China, 59 processing factories and other purchasers, and on a retail basis through an exclusive network of showcase stores, branded stores and supermarket counters.
The company currently has 13 processing plants in China, located in Henan, Jilin and Sichuan provinces and in the municipality of Tianjin. Their total production capacity for chilled pork and frozen pork is approximately 1,566 metric tons per eight-hour day, or approximately 563,760 metric tons on an annual basis.
In addition, they have production capacity for prepared meats of approximately 250 metric tons per eight-hour day, or approximately 90,000 metric tons on an annual basis, and for vegetables and fruits of approximately 83.3 metric tons per eight-hour day, or approximately 30,000 metric tons on an annual basis.
They also have annual production capacity for food oil (pork oil) of approximately 20,000 metric tons. They use state-of-the-art equipment in all of our processing facilities and sell all of our products under our “Zhongpin” brand name.
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We can see from the above table that ADM, BG and HOGS have seen market beating returns over the past twelve months. All of the companies, with the exception of HOGS, pay a dividend. The median PE ratio for the 68 companies categorized as being in the food processing industry is 17.50; the average PE is 22.77. On a PE basis, these companies appear to be selling at a discount to their industry.
Looking to the price-to-sales ratio, we find the industry median to be 0.84X and the average 1.07X. In this case, JJSF and LANC sell above both the median and average. On a Price-to-Book basis, JJSF and LANC are selling above industry multiples of 1.81X and 2.94X. The market may be expecting growth rates for JJSF and LANC that are higher than what is expected for the industry.
We find that multiples based on enterprise value to be informative in that debt is a factor. The median EV/EBITDA ratio for the industry is 13.22X and the average is 17.46X. These companies are selling as substantial discounts on the basis of EV/EBITDA. We find the industry median for EV/sales to be 0.99X and the average 1.26X. With the exception of LANC, these companies are selling at a discount, based on this metric. The median EV/invested capital ratio for the food processing industry is 1.59X and the average is 2.14X. Lancaster Colony again appears to be selling at a premium to its peers.
Overall, based on these multiples, the six companies in our study appear to be undervalued.
For the trailing twelve months, all companies reported a profit. Analysts are projecting mixed results for 2011. Some companies are expected to see a decline in earnings and Sanderson Farms is expected to show a loss. Looking to 2012, all companies are expected to report both positive earnings and growth over 2011. It is troubling to see that four of the six companies are reporting negative free cash flow for the trailing twelve months. Positive free cash flow is necessary to sustain dividend payouts. For the companies that do pay a dividend, the payout ratio is not excessive, and in some cases, provides room for growth.
All six companies appear to have strong balance sheets that will provide downside protection. None have excessive levels of long-term debt.
Our conclusion is that these are strong, undervalued companies that provide an opportunity for capital appreciation while paying a dividend.