Sanderson Farms (NASDAQ:SAFM) continues to post spectacular profits among very favorable operating conditions in the poultry industry. The country's third largest poultry processor, with a capacity of 9.4 million heads a week, reported very strong earnings on the back of strong pricing and low feed costs.
Net after-tax profit margins came in around 12% for the past quarter, far above the 10-year average of around 3% in what is a very volatile industry. As these conditions are not likely to last forever, I am cautious attaching a premium valuation to the through-the-cycle multiple on this great operator. This is despite the appealing headline price-to-earnings ratio. Therefore, I urge caution, and recommend only buying on further dips.
Fourth Quarter In Review, Prices Drive Growth
Sanderson reported sales of $760.9 million for the final quarter of the year, a 4.6% increase compared to the same quarter a year before. Reported revenues came in just above expectations at $758.3 million.
The company estimates that prices were up some 7% compared to last year, remaining at very high levels. In terms of the specific meats, it was notably boneless breast meat prices which rose by nearly 16% year-over-year. Jumbo wing prices rose by 5.2% for the final quarter after seeing some weakness over the entire year, as bulk leg quarter sales dropped by 6.5%.
The company did not specify the volumes for the final quarter in the press release, yet it acknowledged that volumes were up a modest 0.5% for the past year.
Margins Are Fueled By Lower Feed Costs
The strong pricing was very much welcomed, but the real profit driver has been the fall in feed costs. Corn and soybean prices dropped by 23.2% for the quarter on an annual basis, as they came in 10.5% lower for the entire past year.
The reported sales growth was impressive, but the real profit contribution came from the fact that the company managed to lower the absolute dollar amount of costs by $46 million despite the growth in sales. Lower feed costs are of course the main driver behind this fall in costs, with operating earnings improving to 18.7% of sales which is much better than the 9.9% reported last year.
This essentially allowed Sanderson to report net earnings which doubled compared to last year, coming in at $93.1 million on an after-tax basis, or $4.04 per share. Analyst have been quite close with their expectations, on average anticipating Sanderson to post earnings of $4.01 per share.
For your information, on the conference call, CEO Joe Sanderson stressed that the company paid $182 million less in feed grains for the entire year of 2014, just indicating how large the benefit of lower food prices has really been.
Strong Balance Sheet, Appealing Current Valuation
Sanderson ended the quarter with a strong balance sheet which contained some $166 million in cash and equivalents as the total debt load came in at just $20 million.
Shares currently trade around $85 per share, which combined with 23 million shares results in equity being valued at $1.95 billion. Subtracting the net cash holdings implies a valuation of operating assets of $1.8 billion.
This values the operating assets of the company at roughly 0.65 times sales which came in at $2.77 billion this year. Sanderson reported steep earnings of $249 million this fiscal year, arguably at a very favorable point in the chicken cycle amidst strong prices and lower feed costs, which results in a price-to-earnings ratio of just around 7-8 times.
Growth In A Volatile Industry
Sanderson Farms is the third largest poultry processor with a market share of 7.4%, according to a WATT PoultryUSA survey. The company is still much smaller than its two larger competitors Tyson Foods (NYSE:TSN) and Pilgrim's (NYSE:PPC), which have market shares of 21.3% and 17.5%, respectively. Note that these numbers are based on the 2013 capacity.
Sanderson currently has 9 processing plants and aims to open its Palestine plant in Texas in 2015, adding roughly 1.25 million heads per week in capacity, thereby growing to a total capacity of 10.6 million heads. The company has shown phenomenal organic growth, growing the volume of pounds processed from roughly 700 million pounds in 1997 to 3 billion at the moment.
These growing volumes resulted in revenues increasing from $1.1 billion in 2004 to $2.8 billion, or close to 10% per year. Earnings have been a much more volatile story, with the company reporting modest losses in 2006, 2008 and a big loss in 2011, offset by generally more frequent and larger profits in the other years in between. Of course 2014 results will be outstanding, driven by the unusual operating circumstances at the moment. On average, after-tax net profit margins came in at 3% over the past decade, ranging anywhere between -7% and +9%.
This outperformance has been driven by its status as a low cost producer, very strong balance sheet which provides real flexibility during downturns, and good organic growth. Important to consider given the volatile foreign exchange environment is the fact that 11% of Sanderson's sales go abroad, or close to $300 million. Of these exports, 14% goes to Russia, which is something to keep in mind, although sales are relatively minor.
Sanderson Farms provides great information to its investors with regards to the sensitivity of its key input costs. The company buys close to 90 million bushels of corn which results in a $0.10 per bushel move, costing or making the company some $9 million per annum. Given the plunge in corn prices over the past years, this provided a real tailwind to 2014s results. The same applies for soybeans which have seen a steep price decline as well, with Sanderson being a buyer of some 800,000 tons per year.
These very favorable input cost developments have really lifted the shares, allowing the company to invest $110 million in the Palestine complex this year, while handing out money to investors and adding to the war chest. Capital expenditures for the complex are seen at little less than $40 million for 2015, creating better free cash flows next year, even if commodity prices might increase again, as they have done recently.
Current economic circumstances are clearly not sustainable with competition kicking in and market conditions inevitably reversing. Applying an average net after-tax margin of 3% to the current revenue base results in net earnings of some $80 million, or close to $3.5 per share. This values the business at 22 times average earnings after backing out the cash, which is a bit elevated despite the strong track record and balance sheet. As a matter of fact, shares hit highs of $104 earlier this year amidst the momentum run. I am still a bit uneasy to acquire shares at the current price.
Back in September, I last had a look at the prospects for Sanderson's shares which at the time traded around $93. I concluded that the appeal was limited, despite the appealing price-to-earnings multiples, as the current excessive margins are not likely to continue forever. Shares have fallen back some 10% despite the blowout fourth-quarter profitability numbers, as investors fear for a return to ¨normal¨.
This makes the business very difficult to evaluate, as it all depends on the ¨normal¨ profitability of the business given that Sanderson enjoys strong chicken pricing amidst a demand for protein and strong beef prices, while input costs represented by corn and soybeans are very soft.
An 18 times multiple on fair earnings of 3% on an after-tax basis yields a valuation of around $70 per share after adding the net cash back into the valuation, which is still some 20% from current levels.
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