Turning to specific stocks, what attracted you to Mexican chicken producer Industrias Bachoco (IBA)?
JV: As the prices of soybeans and corn started to take off, we looked throughout the agricultural-product value chain for companies whose share prices may have been significantly down as a result. We looked at U.S. chicken producers and noticed that both Tyson Foods and Pilgrim’s Pride were losing money in Mexico. When we tried to figure out why, we uncovered Industrias Bachoco. It was beating the U.S. producers handily in its home market, but its share price was also being hit at the time by perceived economic weakness in Mexico and concern over Avian bird flu making its way into the country.
Bachoco has leading market shares of over 30% in chickens and 12-13% in eggs in Mexico. What would appear to be a mature business actually has great growth prospects, given that per-capita chicken consumption in Mexico is growing 7% annually.
The company has a couple big competitive advantages in its market. The first is cultural and protects it somewhat from foreign competition: Mexicans like to buy their chickens whole, not chopped up into parts, and they like the chickens yellow, which comes from putting marigolds in the chicken feed. The second significant advantage – against all competitors – is its refrigerated distribution network throughout Mexico, including warehouses and trucks. As they continue to buy smaller competitors and expand their network, this asset becomes more valuable.
Is there still significant family ownership?
JV: The founding Robinson Bours Almada family still has about 80% voting control. Warren Buffett says he can know from a one-page letter the quality of a company’s management and we would say the same thing here. The quality just leaps off the page when you look at what they’ve done and how they talk about the company and its strategy.
The company has $300 million in net cash on the balance sheet. Would you like to see them do something with that?
JV: Given the currency and economic risk in Mexico, we don’t fault them for holding a decent slug of cash for a rainy day.
What they’ve telegraphed – and what we agree would be a great opportunity – is that they will continue to make opportunistic acquisitions in Mexico, Central America and even in the U.S.
DN: The value that Tyson and Pilgrim’s Pride provide to the economic chain in the U.S. is slicing and dicing the chicken and packaging it on a volume scale. Bachoco’s opportunity would be to provide the 10 million-plus Mexicans living in the U.S. with the whole yellow chickens they prefer. Their plants are F.D.A. approved, so they could do that either by exporting to the U.S. or by buying a smaller U.S. producer.
Have rising input costs hurt them?
JV: Profits will bounce around due to fluctuating feed costs, but their market position allows them to pass on most of the cost increases. Even with volatility in earnings – which can create buying opportunities – the earnings power of the company continues to grow nicely. Normalized free cash flow today is around $125-150 million per year, roughly double what it was when we first bought into the company four years ago.
What upside do you see for the shares, currently trading at $29?
DN: Excluding the $300 million in cash, the company’s enterprise value is around $1.15 billion. On that basis, the shares trade for roughly 9x what we consider to be base-case annual free cash flow. Taking into consideration the low double-digit annual cash-flow growth we expect and ascribing additional value to the distribution network, we put the intrinsic enterprise value at closer to $1.7 billion, 50% above today’s level. That will move higher as the company continues to grow.
What could go wrong?
JV: Some sort of bird flu in Mexico would obviously be a problem, as would a peso devaluation that caused a big recession. We don’t hedge our currency exposure, but do require a wider margin of safety given the currency risk. Also, we take some comfort that the company’s great balance sheet will allow it to weather any storms without enduring any lasting pain.
Because of the company’s competitive strength in Mexico and its growth potential both inside and outside its home market, we consider this a better opportunity than Tyson was in 1985, when it was roughly Bachoco’s current size.