Thoughts On The GNP Acquisition By Pilgrim's Pride

| About: Pilgrim's Pride (PPC)

Summary

Deal is immediately accretive to the company's bottom line in 2017.

In my opinion, you can read more into management's feelings on the market cycle because of this acquisition.

The timing of this deal shows that management is incredibly bullish on the chicken market, right in the face of market negativity.

If things were as bad as some paint it, it is highly unlikely Pilgrim's Pride would be executing this deal right now.

The recent announcement that Pilgrim's Pride (NYSE:PPC) will be acquiring GNP Company is a welcome reprieve to those of us that see the value in the company. As investors likely already know, accusations of price index manipulation of the Georgia Dock index continue to swirl in the media, and the interest from the press doesn't seem to be waning. Why should it? It has all the trappings of a great story: an evil corporation set on manipulating fair value of its products in order to squeeze more money out of consumers. My retort to those accusations is worthy of a research note in and of itself, but for now, my focus is on this purchase. In my opinion, there are plenty of reasons that investors should rejoice that Pilgrim's Pride has made this deal, which might not be immediately clear when digesting the disclosure:

Immediately Accretive, Adding Diversification

At a $350M cash purchase price, Pilgrim's Pride has guided that the deal carries roughly a 5.2x EBITDA multiple. This puts the EBITDA of the acquired business at $67M, which, when you consider a 5% as a likely interest rate for the purchase, puts the pre-tax income contribution at roughly $50M annually (assuming current EBITDA is a fair representation of a mid-cycle multiple). Use Pilgrim's extremely consistent 35% tax rate, and the net result is that this business will add $29M to the bottom line annually, or $0.11/share. That isn't ground breaking, but it also is not pocket change. Further, if Pilgrim's can extract the $20M in expected synergies that the company guided to, diluted annual earnings per share contribution rises to $0.17/share annually. Not bad at all.

Beyond the bottom line value proposition, GNP Company provides chicken further of the value chain, as the company nearly wholly offers certified organic, no antibiotic chicken, which further moves Pilgrim's product mix towards what consumers are demanding: higher quality chicken. This means better margins and more insulation from the more commoditized and mass-produced offerings of smaller players within the industry. Moves like this are key to the long-term bull case for Pilgrim's Pride, which is reliant on a more consistent, and less violently cyclical, margin profile.

JBS S.A. Support

JBS (OTCQX:JBSAY) and its controlling stake in Pilgrim's is often a point of contention. Often, it is pointed out that JBS, given its leverage, has the incentive to push Pilgrim's towards capital returns policies that benefit the controlling parent company. I don't disagree, but I'm also not one to complain about the special dividends that have been put in place over the past several years. I am also sure JBS has both nudged Pilgrim's management towards those policies and has happily benefited from them. In my opinion, as long as leverage remains under control and Pilgrim's Pride continues to generate the free cash flow that it does as an independent entity, I'm perfectly fine with management directing capital use in this way.

However, this acquisition is important because JBS S.A. has supported it fully. This shows that JBS is not just set on harvesting money from Pilgrim's Pride whenever it can; if accretive acquisitions with high expected payback present themselves, JBS is more than willing to support the use of capital in this way, even if it likely results in smaller special dividend payments in the immediate future. For investors concerned with being bullied by a controlling shareholder, this should be particularly comforting.

Georgia Dock Tie-In

This deal also ties back to Georgia Dock concerns. The most recent Georgia Dock price quote (11/28/16) has not budged from historical trends, and remains elevated compared to other pricing indices. Clearly, no one is capitulating if there is some nefarious motivation by those reporting chicken prices to the Georgia Department of Agriculture. This comes despite the likely pressure from senior management to make sure that the numbers are, and have been, reported properly.

That narrative fits with this purchase. The GNP Company acquisition comes during a time where the company is facing scrutiny from regulators, and investor speculation is running rampant on how much damage could be done if Georgia Dock index legitimacy is called into question on a large scale. Management appears to be shrugging it off. That either means obtuseness or confidence; I'm hoping for the former. The timing of this purchase, which is not small at $350M, shows that management does not appear to be concerned, at least given their evaluation of the market over the next year. If management felt there was any real reason to believe either chicken pricing would collapse or Pilgrim's Pride was going to be inundated with a tidal wave of both consumer/customer lawsuits and tough contract renegotiation, it is very unlikely that they would have moved ahead with a transaction of this size.

Takeaway

It is easy to like this purchase just for the obvious value-add, but I think you can draw some seemingly otherwise unconnected assumptions based on this deal. Pilgrim's Pride management is notoriously tight-lipped, which is a likely product of having a Brazilian majority shareholder. Investors need to understand that domestic companies are generally much more open than South American counterparts, and the wall that shareholders see between them is likely a product of a different investing culture. While that isn't generally my cup of tea, in a case of such strong value as what I see here, I'm willing to look past that. I'm anxious to see how this plays out over the next several years, and hopefully my read on this deal is not just confirmation bias.

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Disclosure: I am/we are long PPC.

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.

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