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I am currently studying towards my Phd in Finance at the Warwick Business School. My area of specialisation is emerging markets, asset pricing, asset liquidity, corporate social responsibility, private equity, capital structure, asymmetric information and moral hazard. Prior to this, I completed... More
  • Why SunOpta Is Under-Priced 0 comments
    Dec 31, 2013 9:47 AM | about stocks: STKL

    Date: 12/27/2013

    Ticker: (NASDAW:STKL)

    Recommendation: Buy

    Price: $ 9.33

    Price Target: $33.89

    Highlights:

    1. SunOpta has shown the ability to grow its revenue at a faster rate than the Global and US organic sector, and this exceptional growth rate is expected to continue in the future.
    2. SunOpta has strategically repositioned it's product mix to cater to packaged organic produce. This strategy is expected to lead to superior growth in both revenue and operating margins going forward.
    3. SunOpta's produce, unlike most of its competitors, is 100% organic and complies with all organic certification requirements in the US, Canada, and the EU. This allows SunOpta to comply with every certification jurisdiction without the need to incur additional costs.
    4. SunOpta's strategy has allowed it to lock in its supply chain and to grow its portfolio mix to a point where it can offer products from raw materials and ingredients, to packaged food. Therefore offering a complete range of products, unlike most of its competitors.

    Business Description

    SunOpta Inc sources, processes, packages, and markets natural and organic food products. The company operates in two segments, SunOpta Foods and Opta Minerals. The company was founded in 1973 and is headquartered in Brampton, Canada. The company was formerly known as Stake Technology Ltd, and changed its name to SunOpta Inc in October 2003.

    The company currently employees approximately 1,830 employees and has facilities located globally. The company operations in North America, in Europe, in Africa, in the Far East, and engages in business in approximately 60 countries.

    Overview of the Organic Food Industry

    Key features of the Organic Food market

    The Global sales of organic food witnessed double digit growth between 2006 and 2008, but growth slowed down during the recession due to organic produce being more expensive than its conventional (NYSEMKT:GMO) counterpart. However, the organic food market has been resilient and has seen annual growth of 1% in 2008/9, and this growth has more than doubled in 2009/10 and in subsequent years.

    In terms of the global market for organic food, North America and Western Europe together make up 90% of the global organic sales in 2012. Within these regions, the US and Germany dominate, accounting for nearly 60% of global sales.

    Figure 1: Global Organic Food Sales by Regions

    (click to enlarge)

    As can be seen from the Figure above, the majority of sales for organic food is generated in North America and Western Europe, however, the growth in organic food has increased in other regions, such as Asia Pacific, Australasia, and Latin America, as consumer preferences and demands change over time.

    The products targeted at babies have been amongst the most recession proof. As the majority of parents are not willing to compromise on the health of their babies, especially in emerging markets, such as China, where food safety is a major concern, products targeted at babies are amongst the most recession proof. The organic baby food market was able to post growth of 7% in 2008/9, while other food segments were negatively affected by the Global recession.

    The global recession of 2008 caused the annual growth rate of organic packaged food and hot drinks to halve in comparison to 2006/7. Organic soft drinks fared particularly poorly, with a decline of 7% in 2007/8.

    Overall, organic packaged food outperformed packaged food, with a 2006-10 CAGR of 5% compared to 2% for packaged food, and organic hot drinks outperformed hot drinks, posting a CAGR of over 6% for 2006-10.

    US organic packaged food sales are just starting to recover from the recession. Organic products demand a higher price than their conventional counterparts, as a result, the sales were more affected by the economic downturn. Before the recession, organic packaged food value sales were enjoying a double digit growth, but sales plummeted in 2009. Organic baby food recorded the most dynamic growth between 2009/10, with an increase in sales of 10%. For American families, the health of their children is paramount, and therefore, they are willing to spend extra to buy organic and ensure the absence of pesticide and chemicals in the food with which they feed their babies.

    SunOpta's Organic Business

    The company was initially founded in 1973 as a technology company (Stake Technologies), and only entered into the organic food industry in 1999, with the purchase of the organic seeds and soymilk business of SunRich for $4.25M. This purchase allowed the company to expand aggressively into the organic food business, and it has been able to increase its revenue base from $47M in 1999, to approximately $1.19B in 2013, largely driven by the significant growth experienced by the organic food segment.

    The company's business model implies that it specializes in sourcing, processing, and packaging natural and organic food for thousands of companies across the globe. It has an extremely diverse customer base of over 12,000 companies; including the likes of Costco, Hain Celestial, Whole Foods Market, Starbucks, Kellogg, Kraft, Wal-Mart, Nestle, Target, and many more. The company's revenue base is extremely diverse, with no single customer accounting for 10% or more of sales.

    The company offers identity preserved (NYSE:IP), non-genetically modified (non-GMO), and organic seeds and whole grains, including soy, corn, and sunflower; and organic, non-GMO, and IP grain-based ingredients. The company also offers packaged food products, such as aseptic and refrigerated soy, rice, almond, sunflower, and other beverages; aseptic broths and teas; frozen edamame and vegetable blends; and roasted grains-based snacks for retail and foodservice use, as well as provides animal feed and pet food products, and processing and contract manufacturing services.

    The company also offers fibers and brans, starch-based texturizing agents, fruit-based ingredients, and functional food ingredients; and shelf stable and refrigerated juices, frozen fruits and vegetables, specialty beverages, vitamin waters, electrolyte waters, energy drinks, soups, baby food, and healthy fruit and vegetable based snacks. The company also sources or processes organic fruit and vegetable-based ingredients, sweeteners, cocoa, coffee, grains, nuts, seeds and pulses, and other organic food products. Additionally, it produces, manufactures, distributes, and recycles industrial minerals, silica-free abrasives, and specialty sands and other products and services to the foundry, steel, loose abrasive cleaning, roofing granule, marine/bridge cleaning, waterjet cutting, municipal, recreational, and industrial water filtration industries.

    SunOpta's Organic Business: Evaluation of organic business

    SunOpta's organic business has grown its revenue at an extra-ordinary rate over the past few years. SunOpta has been able to grow its revenue at a rate greater than the rate of growth experienced by the Global and US Organic food sectors (Figure 2 below). The growth has been achieved by a mix of aggressive acquisition of plant and equipment, smaller organic businesses and assets, divestures from non-core business segments, and marketing their products more efficiently to customers.

    Figure 2: Historical growth rate of sales for STKL versus the Global and US Organic sector

    (click to enlarge)

    From figure 2 above, we can see that STKL has been able to achieve much higher growth in sales during 2006-2008. However, STKL performed poorly compared to the Global and US sector in 2009-10, this was due to the global recession having a greater impact on the demand of the products supplied by STKL. However, STKL was able to restructure the business segment and was able to grow its revenue at a greater pace than the recovery experienced by the Global or US sector and has exhibited higher growth rates compared to the Global and US organic sector since 2010/11.

    SunOpta has spent a significant amount of money in the past few years in order to expand the revenue generation from the core organic food segment. In December 2012, SunOpta acquired the grains handling and processing facility of Organic Land Corporation (OLC), located in Bulgaria. The acquisition was made in order to diversify the company's organic sunflower processing operations and to expand its capability to enter into other organic products grown in the region. SunOpta had previously been sourcing non-GMO sunflower kernel from OLC since late 2011. This acquisition has allowed SunOpta to obtain supplier certainty for its sunflower processing operations and also to enter into the emerging Eastern and Western European Market. Russia is one of the fastest growing sectors of demand for organic food produce in the region, and this acquisition should aid SunOpta in catering for the Russian market in particular.

    Organic segmental information

    The Grains and Food group is focused on vertically integrated sourcing, processing, packaging and marketing of grains, grain based ingredients and packaged products. SunOpta expects the aseptic processing and packaging expansion at the US west coast facility to increase the capacity to manufacture aseptic soy and alternative beverages. SunOpta also intends to focus on growing the identity preserved, non-genetically modified (non-GMO) and organic grains business, to expand revenue from natural and organic grains based ingredients and to focus on value-added ingredient and packaged product offerings. The long term target for the Grains and Foods group is to achieve a segment operating margin of 6-8%, which assumes that SunOpta are able to secure a consistent quantity and quality of grains and sunflower stock, to improve the product mix, and to save costs.

    The Ingredients Group is focused on insoluble oat and soy fibre products, and specialty fruit ingredients. SunOpta's investment strategy going forward is to concentrate on growing the Ingredients Group's fibre, fruit and specialty ingredients portfolios and the customer base through product and process innovation and diversification. SunOpta intends to continue to introduce alternative fibre offerings and have recently introduced both rice and cellulose fibres. SunOpta also expects the new aseptic fruit ingredient line at the Southgate, California facility to expand the packaging capabilities and drive increased sales volume and result in cost savings. The focus of the ingredients group is to further increase capacity utilisation, to reduce costs, and to increase margins. The long term target for the ingredients group is to realise segment operating margins of 12-15%.

    According to Euromonitor, organic purchases are more of a luxury for many consumers, rather than a necessity. Studies show that most consumers of organic are occasional buyers, switching between organic and conventional products. This consumer behaviour will contribute to non-essential products with a high fruit and vegetable content, such as sauces, dressings and condiments, showing strong growth over the 2013-2017 forecast period, with a CAGR of nearly 6% sales growth. SunOpta is well positioned to gain from the forecasted growth due to the product mix it offers in the Ingredients group range.

    The Consumer Products Group provides natural and organic consumer packaged food products to major global food manufacturers, distributors, and supermarket chains with a variety of branded and private label products. SunOpta's strategy is to grow the Food solutions and Healthy Snacks operations, and to streamline and focus the Frozen foods operation. SunOpta acquired machinery in 2011 and 2012, whereby they have been able to expand the total filing capacity to 150 million pouches. The long term target is to increase operating margins to 8-10%.

    Private label's share of organics gained and has continued to rise from 2008, as disposable incomes for many consumers dropped and they became more conscious of their spending habits. Private label manufacturers were able to take advantage of this and provided a cheaper alternative to organic branded products. SunOpta's Consumer Products Group has been able to benefit from the switch to private labels and the expectation is that this market share will grow as the product range expands and the product mix is taken up by more supermarkets and distributors.

    In terms of the US and Global sector, the largest contributor to organic beverages is organic fruit/vegetable juice. Organic hot drinks managed to remain recession proof and posted consistent growth over the 2006-13 period. Americans are typically large consumers of coffee and most coffee drinkers appear to be relatively brand loyal, which leads them to stick to their brand of choice regardless of the difference in price between an organic coffee and a usually cheaper regular coffee. Starbucks, which is a customer of SunOpta, was able to account for half of the US organic coffee sales in value, showing that coffee drinkers are willing to spend extra in order to get what they perceive as high quality coffee, and also implying that SunOpta has the ability to grow this particular segment of their product mix.

    The International Foods group includes European and North American based facilities that source and supply raw materials, ingredients and trade organic commodities. The group is focused on leveraging its sourcing, supply and processing expertise to grow the portfolio of organic ingredients. The long term expectation is to increase operating margins to 5-6%. The group expects the cocoa processing facility located in the Netherlands, to increase the company's ability to grow the organic and speciality cocoa business. In December 2012, SunOpta acquired the grains handling and processing facility of Organic Land Corporation (OLC), located in Bulgaria. The acquisition was made in order to diversify the company's organic sunflower processing operations and to expand its capability to enter into other organic products grown in the region. SunOpta had previously been sourcing non-GMO sunflower kernel from OLC since late 2011. This acquisition has allowed SunOpta to obtain supplier certainty for its sunflower processing operations and also to enter into the emerging Eastern and Western European Market. Russia is one of the fastest growing sectors of demand for organic food produce in the region, and this acquisition should aid SunOpta in catering for the Russian market in particular.

    Organic Food Sales Mix

    Figure 3: Historical Sales Mix

    Figure 4: Current Sales Mix

    Figure 5: Future Sales Mix

    SunOpta has restructured its focus on growth opportunities by changing the mix between the Raw materials, Ingredients, and Consumer Packaged divisions.

    The Consumer packaged division, which offers the highest margin out of the three divisions, and which has seen the largest growth in the past and which is forecast to experience the highest future growth rate (Euromonitor), with supermarkets, distributors, and even discounters adopting organic food in their offered range. SunOpta has attempted to benefit from this shift in the organic food market and have been successful in driving sales and operating margin growth by both internal and acquisitive changes in their offered product mix. The strategy of shifting towards a higher percentage of consumer packaged goods, including private brands, is expected to pay dividends for Sunopta in the form of increased sales and operating margin growth.

    Influence of regulation

    The United States Department for Agriculture (USDA) and the Canadian Food Inspection Agency (CFIA) recognise the two countries' organic standards as equivalent. Under these standards, only products with organic content greater than or equal to 95% may be labelled as 'organic', or bear the country's organic seal.

    In Canada, multi-ingredient products with 70-95% organic content are allowed to bear the claim 'contains x% organic ingredients' but cannot use the organic logo and/or the claim 'organic'. The same product in the US may use the words 'made with organic ingredients', and list the three main organic ingredients on the packaging's main display. In both countries, any product containing les than 70% organic ingredients is not allowed to mention the word 'organic' in the main display, but may identify which specific ingredients are organic in the ingredients list.

    The organic rules in the European Union require that in order to use the word 'organic' on the main display panel, the product must contain at least 95% organic ingredients. When a product contains between 70% and 95% organic ingredients, the word organic is not to be displayed anywhere on the main panel, but may be used in the ingredients list.

    Monsanto Co has recently teamed up with Novozymes A/S, a Danish biotech company, to develop microscopic organisms that help plants grow and resist pests, a move that could enable Monsanto to circumvent some concerns over its genetically modified seeds. Monsanto agreed to pay Novozumes $300 million as payment for the joint venture.

    SunOpta unlike Monsanto and some of its other competitors, sources and provides products that are 100% certified non-GMO. This provides SunOpta with a large competitive advantage compared to its peers in that it will be able to provide products that are labelled as 100% organic in almost all the geographical regions it caters to. This competitive advantage makes SunOpta a very attractive business to be acquired by larger entities such as the Hain Celestial Group, which would want to acquire SunOpta in order to enhance their organic credentials and to comply with the organic label requirements.

    Demand for SunOpta's products

    The consumer demand for organic food products can be classified into three main groups:

    Figure 5: Types of customers

    (click to enlarge)

    The Mass Market demand is being borne by two key factors: increasing obesity levels, and an aging population. At present 62% of the population of the US are overweight or obese according to their Body Mass Index (Source: WHO). Overweight and obesity worldwide is increasing, and is expected to reach 2.3 Billion people by 2015. As a means to lose weight and to reduce the risk of diseases caused by obesity, consumers are told by doctors and nutritionist to change their diet and to incorporate healthier food options, including organic food produce.

    According to Euromonitor, the global population aged over 65 reached 577 million in 2012, and has gone up by 12% since 2007, and this trend is expected to continue. As the global population gets older and richer, the older consumer base is looking for ways to prevent the onset of age-related diseases. As a result, the demand for healthier food options, including organic food produce from this particular type of consumer is expected to grow significantly in the short to long term.

    SunOpta is well positioned to take advantage from these demographic shifts with its product mix and is able to offer products that suit the Mass market type of consumer, the premium indulgent type of consumer, and the conscious type of consumer.

    Industrial Consolidation

    The organic food sector in the US has recently witnessed consolidation of the industry, with larger players buying smaller entities in order to grow their revenue and the product mix.

    In December 2013, Boulder Brands (NASDAQ GM :BDBD) paid $48 million to acquire the Phil's Fresh Foods LLC, owner of EVOL foods (NASDAQ:EVOL). EVOL manufactures and markets premium frozen convenience foods with a focus on pure and simple ingredients. EVOL's product offerings include burritos, quesadillas, entrees, bowls, and skillet meals. Boulder's reasoning behind the acquisition was to accelerate their growth rate and to diversify the product mix to include higher-growth natural brands.

    In December 2013, The WhiteWave Foods Company (NYSE: WWAV) agreed to acquired Earthbound Farm for $600 million. WhiteWave is a consumer packaged food and beverage company operating in North America and Europe. While Earthbound Farm is an organic food brand. Earthbound Farms produces and markets its range of organic packaged salad, an extensive range of organic fresh fruits and vegetables, frozen fruits and vegetables, and dried fruits and snacks. WhiteWave's existing product mix includes branded plant-based foods and beverages, coffee creamers and beverages, and premium dairy products. The acquisition of Earthbound was undertaken in order to expand the product mix and to allow WhiteWave to enter in the organic packaged and fresh food segment.

    In December 2013, SYSCO corporation (NYSE: SYY) also agreed to acquire US Foods for a total consideration of $8.2 Billion, including cash payment and debt refinancing. The deal would allow Sysco and US Foods to obtain a broad product portfolio, supply chain certainty, to increase their geographic coverage and scale.

    The above recent acquisitions show that there is a growing appetite for increased consolidation in the organic food sector, with larger players try to increase their product mix and geographic reach, by buying smaller entities. SunOpta is well positioned to attract interest from larger players in the sector, especially players who want to obtain a larger product mix, to gain easier entry into growing geographic regions, for obtaining supply chain certainty, and for products that contain no-GMO, and as a result, could be marketed as a premium product to end consumers. In particular, the ability for SunOpta to sell its product range throughout its geographic reach as certified 100% organic without incurring any additional costs to comply with regulation, is an extremely attractive proposition for any company thinking of acquiring an organic food producer.

    Value of SunOpta's Organic

    Given the growth potential of the organic divisions of SunOpta and the ability of these divisions to historically post significant growth, the analyst consensus for the estimated growth from the organic segment is expected to be in the region of £1,143 million for 2014.

    The recent acquisition of EVOL by Boulder for a Price/Sales multiple of 1.92x 2014 revenue would be appropriate given the similarity of the product mix between EVOL and SunOpta, especially the 100% organic nature of the products.

    This price multiple would value the organic segment of SunOpta at roughly $2,195 million, or approximately $33 per share. This valuation is in line with the valuation obtained from using the average Price/Sales multiples of similar organic food companies in the US.

    OPM Segment

    SunOpta holds a 66.22% ownership interest in Opta Minerals Inc (TSX: OPM). Opta Minerals is a producer, distributer, and recycler of environmentally friendly industrial materials. It provides custom process optimization solutions and materials that are used in the steel, foundry, loose abrasive cleaning, and the municipal water filtration industries.

    OPM bought the two companies in 2012, which were bought in line with the strategic purpose of increasing short term and long term return. OPM bought Babco Industrial Corp for $18M. Babco was achieving revnues of $13.12M and a Net income to shareholders of $1.82M. The second purchase was that of WGI Heavy Minerals for $14.96M, which was a publicly traded company. WGI was generating $32.8M in revenue, and the group bought $16.8M of net assets, of which 96.2% were tangible assets

    According to Euromonitor, the notion of environmentally friendly industrial materials has gained consumer awareness, however, with less stringent rules and lower costs, more manufactures are turning to the sustainability trend rather than that of organic materials. The organic certification of products highlights to consumers that the product offers perceived health, but more commonly, environmental benefits. However, other types of certification, such as Fairtrade and sustainability through the likes of the Forestry Stewardship Council (NASDAQ:FSC) provide alternatives for manufacturers to highlight their corporate responsibility ideals.

    The OPM division therefore faces a more competitive growth environment, than that faced by the Organic Food segment, given that the division not only has to compete with other providers of organic based industrial materials, but also a fierce competition against providers of sustainable industrial materials. Perhaps due to this perceived inability to grow as significantly as the Organic food segment, SunOpta's management have been thinking about divesture of the OPM division.

    Valuation of OPM division

    The OPM segment is currently a publicly listed entity (TSX: OPM, SunOpta has a 66.7% ownership and the current market value is $30.8 million and the Enterprise value is approximately $88.93 million. SunOpta could potentially receive upto $59 million from the disposal, which would equate to nearly $0.89 per share.

    Total value of SunOpta

    Given the growth history and potential of the organic food segment, the majority of the value is derived from the organic food segment. The organic food segment is worth up to $33 per share, while OPM may deliver up to $0.89 per share, given a potential value of SunOpta of $33.89 per share.

    Summary

    SunOpta's organic food segment has a product mix that is well positioned to exploit changes in the organic food market, including demographic shifts, changes in the distribution channels, and changes in the consumer perception concerning organic food produce. This would allow SunOpta to profit from its strategic decision to focus the product mix on the higher profit margins of the packaged food segment, and thereby drive both sales and operating margins going forward.

    The OPM segment is expected to face fiercer competition and is expected to grow at a lower rate compared to the Organic food segment. For this particular reason, the management of SunOpta are seeking to divest from OPM and to focus purely on the Organic food segment.

    Given the current price of SunOpta, the recommendation is to BUY the stock, given that the stock is heavily under-priced at the moment, given the strength of the portfolio held by the segment, in terms of geographic reach, as well as product offerings.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Business relationship disclosure: This article has been written on behalf of Small Cap Street LLC.

    Stocks: STKL
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