AdvancePierre Foods (APFH) announced a bolt-on acquisition just a few months after it became a public company. I like the bolt-on move given the appealing multiples, as the company has shown real underlying strength in the second quarter. Despite these improvements, shares remain too expensive to my taste as investors search for defensive names in this uncertain environment. Leverage remains very high, as GAAP multiples remain elevated as well.
Despite the valuation and leverage concerns, I applaud the deal and underlying momentum. While I find shares on the expensive side, I will not contemplate a short as the company has the capacity to grow into the valuation.
A Bolt-On Deal At Appealing Multiples
AdvancePierre announced the purchase of Allied Specialty Foods in a $60 million cash transaction. Allied produces raw and cooked beef as well as Philly steak products for foodservice companies, adding both products and geographical coverage to the overall business.
While no sales contribution has been released, the purchase seems highly accretive. Allied is anticipated to contribute $11 to $13 million in EBITDA by 2017, suggesting a mere 5 times EBITDA multiple being paid for the business. This EBITDA number does include some unspecified number of anticipate synergies.
The purchase should add $0.07 to $0.09 to 2017s earnings per share. With 67 million shares outstanding, the earnings contribution is seen at roughly $5 million after taking into account taxes and financing costs. That suggests that a mere 12 times earnings multiple has been paid, being a very appealing multiple.
A Small Deal, But Lucrative
The $12 million EBITDA contribution of Allied is modest, as AdvancePierre expects adjusted EBITDA to come in at $285-$290 million this year. This suggests that the deal could boost earnings by some 4%.
Allied reported a solid second quarter, with volume growth in the three core segment coming in at 3.2%. Actual revenues were down by 5.4% towards $371 million. This was the result of the divestment of some low margin businesses as well as price cuts.
While top-line sales numbers are challenging the company has made great improvements to its margins. Operating margins improved by more than 4.5% towards 12% of sales.
The company guided for sales of $1.54 to $1.59 billion for the year and adjusted EBITDA of $285-$290 million. Assuming that Allied Foods runs similar EBITDA margins at 18% of sales, the acquisition could add $60-$70 million in annual sales. If that is realistic, AdvancePierre is a $1.6 billion business going forwards, posting adjusted EBITDA of some $300 million.
The company continues to operate with a leveraged balance sheet. While cash holdings stand at $68 million, total debt stands at $1.28 billion, for a $1.21 billion net debt load. Following the purchase of Allied, this net debt position will increase towards $1.27 billion, for a leverage ratio just above 4 times.
Alongside the second quarter results, the company guided for full year adjusted earnings of $1.65 to $1.75 per share. With 67 million shares this suggests that adjusted earnings come in at $115 million per year.
We know that adjusted EBITDA runs at $300 million a year. Depreciation & amortization charges come in at $65 million. If we assume that debt could be refinanced at a 5-6% interest rate, interest expenses would fall towards $60-$75 million per annum. If we assume a normalized tax rate of 30-35%, these assumptions translate into earnings of $110-$115 million per year.
This calculation confirms that the adjusted earnings guidance looks fair, although the company will incur some one-time charges, including refinancing costs, among others.
AdvancePierre has risen towards $26 per share, marking gains since the IPO. This gives the company a market value of nearly $1.8 billion as the business is valued at close to $3 billion if you include net debt. Based on the outlook, the company trades at around 10 times EBITDA.
In that light, the 5 times multiple being paid for Allied looks very appealing. It indicates that the $60 million purchase price marks a $60 million discount compared to Advance´s own valuation. That is equivalent to nearly $1 per share.
If we generously use the non-GAAP earnings outlook of $1.65-$1.75 per share, the valuation multiple looks reasonable at 15 times earnings. Note however that these are non-GAAP earnings, as GAAP earnings multiples come a few turns higher, while the balance sheet remains highly leveraged at +4 times.
The good news for investors is the predictability of the business, a sound deal and a +2% dividend yield, combined with organic sales growth volumes and a recent very strong performance in terms of margin gains. The need for stability, "bond-equivalent" investments and high valuations in the overall foodservice industry, makes the valuation not appealing in my eyes.
Business Improves, But Remains Too Expensive
Following the IPO of the business back in July of this year, I had a look at the prospects for the business. Shares were sold at $21 per share, rose to $23 on their opening day of trading, and have risen towards $26 at the moment of writing.
I called shares expensive on the back of strong demand for defensive names, poor sales trends and high leverage. This was despite the margin gains being achieved. The company has reported strong second quarter earnings ever since, with both volumes and margin gains being quite impressive.
While I can certainly appreciate those improvements, and the nice bolt-on deal of Allied, the investment case does not remain interesting to me.
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.