Pilgrim´s Pride (PPC) announced a bolt-on acquisition which takes place at favorable valuation multiples, while offering strategic appeal as well. I like the deal for these reasons as the overall valuation of Pilgrim´s has become more appealing following a 50% decline in the share price from 2014 highs, although that followed very strong momentum in the years before.
Strong current cash flows yields and occasional special dividends all favor an investment, yet current earnings are still driven by very strong margins. While margins have come down a long way from the 2014 peak, they are still above their long term average as a further reversal towards the long term average might continue to pressure earnings. Using average margins throughout a cycle, and taking into account above average idiosyncratic risks, I see appealing value in the mid-teens.
Revisiting The Past
Pilgrim´s Pride´s history is somewhat dominated by the fact that it went bankrupt in 2008. The company suffered from a $2.7 billion debt load at the time, being mainly the result of the acquisition of Gold Kist in 2007. This debt pile became an issue when the company started to lose money in 2008, as corn prices spiked, causing massive losses. When the economy went into recession, consumers were furthermore cutting back on spending, including on foodservice, hurting the company in twofold.
Brazilian beef producer JBS decided to come to the rescue, allowing Pilgrim´s to emerge from bankruptcy. It made a $800 million cash infusion, thereby obtaining a 64% equity stake in the business. It goes without saying that this investment has been brilliant with the benefit of hindsight of course.
Developments Ever Since
Since emerging out of bankruptcy, sales have been rather constant. Revenues have largely fluctuated between $7 and $9 billion between 2008 and today. A recovery in chicken prices, restructuring of the business, and lower input costs have done miracles for margins however.
After being modestly profitable in 2009/2010, PPC posted negative operating margins of 5% in 2011, as shares fell back towards $3 per share. The losses caused fears that the company might again run into financial troubles, despite the cash infusion made by JBS.
Margins recovered in 2012 and 2013 and hit a high of 14% in 2014, being a very strong result which triggered a huge rally in the shares. Shares more than ten-folded and hit a high of $37 in 2014. Ever since, shares have given up half their value as margins retreated towards 8-9% as of now.
It should be said that two special dividends have contributed to the share price decline. These two dividends totaled little over $8.50 per share, being paid out in 2015 and 2016. In actual dollar terms, the dividends represent a roughly $2 billion payout, allowing JBS which still controls the business, to recoup all of their initial investment and some more.
Despite these special dividends, PPC has deleveraged rather quickly, actually operating with a net cash position in 2014, before operating with a net debt load again a year later following the special dividends and the $380 million purchase of Provemex in Mexico.
The Current Stance
To further strengthen its operations, PPC announces a bolt-on move with the acquisition of GNP, a producer of premium chicken products (including organic product offerings) in a $350 million cash deal. With the deal, PPC will expand its geographic coverage, and adds relative new production assets, being helpful to reduce the break-even level of production costs.
PPC reports that it paid a 5.2 times EBITDA multiple, suggesting a current $67 million EBITDA contribution. After taking into account $20 million in cost savings as well as $28 million in tax savings, the multiple drops to just 3.9 times. Besides favorable EBITDA multiples, the deal offers strategic rationale as well as organic offerings are generally in demand, being very appealing.
PPC ended the third quarter with $86 million in cash and $1.01 billion in debt, for a net debt load of $919 million. This debt load will increase to $1.27 billion following this transaction. The company reported adjusted EBITDA of $877 million on a trailing basis by the end of the third quarter. Including synergies and the bolt-on deal, this number increases to roughly $960 million, for a 1.3 times leverage ratio. This remains manageable, certainly as the company does not pay out regular dividends, allowing for relative quick pace of deleveraging.
The company ended the third quarter with 255 million shares outstanding which trade around $18 at the moment, for an equity value of $4.6 billion. Including net debt of $919 million ahead of the deal, the enterprise valuation worked out to be $5.5 billion.
This indicates that PPC trades at 6.3 times adjusted EBITDA, suggesting that the company made a great deal. If GNP deserves a similar EBITDA multiples including synergies, PPC might have paid $200 million more for the business, equivalent to $0.80 per share.
What Are Stable Margins?
PPC is benefiting from consolidation in the industry, driven by Tyson Food´s (NYSE:TSN) purchase of Hillshire Brands, which not only benefited that company but all players in the industry. Consolidation and favorable input costs allowed these companies to report record margins in recent years.
This makes it hard to say what sustainable margins can be. Operating margins averaged at 3% over the past decade, ranging from -12% in 2008 to +14% in 2014. Industry consolidation has structurally improved margins, and if we exclude the 2008 outlier given the incidental situation at the time, perhaps a 5% margin number looks realistic.
Margins have come down a long way already from the 2014 records. Third quarter reporting margins came in at 8.1%, down a lot from the 11.7% margin in the second quarter and 9.6% reported in Q1. Some incidental items did pressure margins during the most recent quarter, yet they remain volatile given the nature of the industry.
Applying 5% ¨average¨ margins on a $8 billion revenue base leaves operating profits of roughly $400 million going forwards, although one could add roughly 10% to that number given the announced bolt-on deal. After accounting for $50-60 million in interest expenses and a 35% tax rate, net earnings could come in at $225 million, or at roughly $0.90 per share.
Applying a market multiple of 17-18 times earnings to such average earnings potentially yields a $15-16 valuation. While this is not enticing note that margins currently still trend above average margins, allowing PPC to earn ¨excess¨ earnings, even if margins are down year on year already. Despite the decline in operating margins, earnings still trend at $1.60-$2.00 per share at the moment.
Given these strong earnings vis-a-vis the current market price, and 50% retreat seen already from 2014 highs, a lot of risks appear to have been priced in already. That said, the sector faces above average risks in terms of publicity, in terms of worker treatment, animal treatment and safety issues. Diseases and recent controversy regarding Georgia Dock pricing makes that I remain cautious, even after the 50% sell-off seen already and solid current earnings yield, as well as nice bolt-on deal being announced. For the controversy regarding the industry Benchmark Georgia Dock prices, please read articles of ¨ManBearChicken¨ on this very same website.
If I use a $0.90-$1.00 per share through the cycle number and come up with a modest 15 times multiple for earnings throughout the cycle, it remains a bit too early to pick up shares in order to get a decent risk-reward, at least in my opinion. Unless shares hit levels below $15, I remain cautious as it remains a cyclical play of course with above average idiosyncratic risks.
At $15 per share the free cash flow yield and prospects for occasion fat special dividends should be enticing enough to create sufficient appeal from a risk-reward stance.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.