High Liner Foods: Finding Value In Fish Sticks
Summary
- Stable business with slowly-increasing revenues.
- Poor execution in 2017 has hindered margins and share prices.
- High Liner's stock price has suffered, with its dividend yield at its highest-ever level.
- I value shares at ~ C$13.50/share in one year, which would represent 28% upside, including dividends.
** High Liner Foods is publicly-traded on the Toronto Stock Exchange under the symbol HLF. However, its financial reporting is done in US dollars. All figures in this article are listed in US dollars unless otherwise noted.
Thesis
High Liner Foods (TSE:HLF; OTC:OTCPK:HLNFF) is a small-cap Canadian food-processing company that focuses on frozen fish products. Its 2017 execution was spotty, marred by production challenges and a recall in the busy Lent season. The year also included worse-than-anticipated results from its May 2017 Rubicon acquisition.
Perhaps, as a result, High Liner's share price has dropped from $26 CAD in September 2016 to a close of $11.03 CAD on March 5, 2018. Forward dividend yields have swelled to ~ 5.3% (based on $0.145 CAD/quarter dividends), the highest yield in the company's 15-year dividend history.
HLF data by YCharts
Despite this, High Liner's business model and positioning in the market are unchanged. It is the leader in its segment in Canada and second in volume in the United States. Margins (especially gross and EBITDA) fell in 2017 due in part to production challenges that are unlikely to recur. Revenues are stable and slowly growing - CAD adjusted revenues rose 3.0% in 2017 and USD adjusted revenues rose 1.3%.
At its current price, HLF offers attractive value on a stable food service brand, despite potential headwinds in the form of shifting consumer preferences and rising seafood costs. I value shares at ~ C$13.50/share in one year, for 28% gains, including dividends.
Business
High Liner Foods is a Canadian food-processing company that specializes in processed frozen seafood. Its most recent quarterly report states:
We are the leading North American processor and marketer of value-added (i.e. processed) frozen seafood, producing a wide range of products from breaded and battered items to seafood entrées, that are sold to North American food retailers and foodservice distributors. The retail channel includes grocery and club stores and our products are sold throughout the U.S., Canada and Mexico under the High Liner, Fisher Boy, Mirabel, Sea Cuisine and C. Wirthy & Co. labels. The foodservice channel includes sales of seafood that are usually eaten outside the home and our branded products are sold through distributors to restaurants and institutions under the High Liner, Icelandic Seafood and FPI labels. The Company is also a major supplier of private-label value-added frozen premium seafood products to North American food retailers and foodservice distributors.
The first quarter is typically HLF's strongest quarter due to the promotion of seafood during the Lenten period. The timing of Lent (based on the timing of Easter) can impact HLF's quarterly results.
Source: High Liner Investor Presentation, November 2017
High Liner is widely available in both the United States and Canada, with a stronger presence in Canada. HLF uses All Commodity Volume ("ACV") to measure its market presence. ACV is a percentage which approximates the proportion of grocery stores and club stores (excluding Costco) where HLF products can be purchased.
| 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | |
| ACV (Canada) | 100% | 100% | 100% | 100% | 100% | 100% |
| ACV (United States) | 66% | 82% | 84% | 81% | 87% | 89% |
High Liner notes that this metric excludes Costco (COST) due to its data collection sources. HLF's products are well-represented at Costco, so its actual ACV is higher than shown in the figures above. HLF is the #1 brand in Canada in value-added (processed) frozen seafood and is estimated to be the #2 brand in the United States (by volume).
Growth and Business Headwinds
High Liner grows both through organic sales volume growth and through acquisitions of other frozen seafood businesses.
Over the past several years, organic growth has been challenging for the company. Consumer preferences have been moving away from High Liner's traditional breaded and battered frozen seafood products. The prevalence of these products in HLF's portfolio has made sales growth difficult and has reduced the efficiency of its manufacturing efforts, hindering margins. To combat this, the company is working to improve its current products and to deliver new products which better-align with changing consumer preferences. HLF has noted a desire to diversify its product portfolio to include more species experiencing the most growth in the marketplace, including Atlantic salmon and warm-water shrimp.
HLF's Diverse seafood offerings. Source
Despite consumer preferences moving away from battered fish, the frozen seafood market also presents growth opportunities. Seafood is a healthy, sustainable protein source, and HLF states that North Americans do not consume enough seafood. Long-term growth may also be found through a growing and aging population, leading to a focus on healthier eating.
Rubicon Disappointment
HLF also expands through acquisition, including six acquisitions since late 2007. The most recent of these acquisitions was the purchase of privately-held Rubicon Resources, which imports and distributes sustainably - sourced frozen shrimp products in the private-label United States market.
Rubicon was purchased for $100.6 million ($75.0 million in cash and 2.43 million shares worth $25.8 million at the time) on May 30, 2017. The purchase of Rubicon was intended to support HLF's organic growth through expediting species diversification, with the addition of Rubicon's frozen shrimp products to the HLF portfolio.
However, performance of the Rubicon unit has been disappointing. HLF's most recent quarterly report notes that Rubicon's contribution to adjusted EBITDA in 2017 "is significantly below the annual pro forma Adjusted EBITDA expected from this business when it was purchased due to raw material cost increases that have not been fully passed on to customers, along with lower than expected volumes, particularly in the fourth quarter of 2017."
In the final seven months of 2017, Rubicon contributed $117.1 million in revenue, $14.0 million in gross profit - gross margins of only 12.0% compared to 16.2% for HLF in 2017 and 19.5% in 2016. I estimate that ~ 54% of HLF's sales occur in the last seven months of the year, which would give Rubicon annualized sales of ~ $216 million (down 7.5% from $234 million in 2016).
Rubicon is expected to make similar Adjusted EBITDA contributions in 2018 as in 2017, aside from reflecting a full 12 months. HLF expects Rubicon margins to improve, but sales volumes will decline as one of Rubicon's major customers continues to procure certain products directly from shrimp producers. Rubicon contributed only $3.8 million to Adjusted EBITDA in seven months of 2017, compared to pro forma EBITDA of $16.0 million in 2016.
2017 Results
| (in $USD, millions) | 2017 | 2016 | % Change | 2017adj | 2016adj | % Change |
| Sales (millions of lbs) | 291.8 | 277.3 | 5.2% | 272.5 | 274.9 | -0.9% |
| Sales | $1,053.8 | $955.0 | 10.4% | $944.8 | $921.8 | 2.5% |
| Gross Profit | $186.1 | $201.8 | -7.8% | $185.6 | $200.5 | -7.4% |
| Gross Margins | 17.7% | 21.1% | -350 bps | 19.6% | 21.7% | -210 bps |
| Adjusted EBITDA | $66.1 | $81.4 | -18.8% |
HLF's 2017 results were hindered by poor performance from Rubicon (discussed above), a product recall in April 2017, and production challenges arising from the September 2016 sale of a scallop facility in New Bedford, MA. Adjusted figures above remove the impact of Rubicon, the product recall, and 2016 sales from the New Bedford scallop facility.
Product recall: Certain breaded seafood products sold in Canada were recalled due to a milk allergen that was not declared on the label. The recall was due to an ingredient supplied by a U.S.-based ingredient supplier. This recall resulted in $13.5 million in net losses through consumer refunds, customer fines, the return of product, and incremental costs. HLF expects to recover substantially all of these losses from the supplier, but that recovery is not yet reflected in HLF's results.
Production challenges: In February 2016, HLF announced it would cease value-added fish operations at New Bedford to reduce excess production capacity across its network. This will improve operation efficiency and help HLF optimize its supply chain. HLF management cited "residual manufacturing challenges associated with production transferred from our previously owned New Bedford facility, which resulted in an inability to meet heightened demand in March related to a late Lent and which was worsened by production interruptions at the Company's facilities as a result of the product recall" as a reason for lower sales volume in 2017.
Well, if you look at what happened last year, right, I mean we did have a slip up in our planning in Q1 of last year. And then just as we were solving those issues, we got hit by this massive recall."
- Henry Demone, CEO of High Liner Foods, on Fourth Quarter 2017 Earnings Call
These problems appear to be one-time in nature and should not recur in future years.
Excluding the exceptional items above, sales (in weight) dropped 0.9% in 2017, partly from the manufacturing challenges during Lent. In USD, total sales increased 2.5% excluding exceptional items, or 1.9% in domestic currency (counting $1 CAD as $1). Canadian adjusted sales rose 3.0% ($342.8 million CAD up from $332.8 million CAD) while USD adjusted sales, including Mexico, rose 1.3% to $680.7 million from $672.1 million.
Adjusted gross margins declined from 21.7% to 19.6% with gross profit falling $15.7 million. This decline was due to a drop in sales volume, unfavorable product mix changes, raw material cost increases, and plant inefficiencies from transferring value-added fish operations from New Bedford, MA to other manufacturing facilities. The 2016 results had also benefited from foreign exchange hedging results which did not recur in 2017 and a stronger CAD in 2016 relative to 2017.
Adjusted EBITDA fell $15.3 million, or 18.8%, in 2017. In domestic currency units, adjusted EBITDA dropped 22.2% or $19.6 million. Adjusted EBITDA declines reflect the lower gross profit, although $11.5 million USD has been added back from the impact of the product recalls (but $2.0 million USD in losses have not been added back).
After taxes and interest costs, HLF posted a net profit of $31.4 million in 2017, compared to $32.3 million in 2016. This result would have been much worse (with drops akin to those in gross profit and Adjusted EBITDA) but for the positive impact of the tax changes in late 2017. HLF recorded a non-cash income tax recovery of $11.2 million recognized in the fourth quarter of 2017 associated with the Tax Cuts and Jobs Act.
Dividend Yield
Source: High Liner Investor Presentation, November 2017
HLF has paid a quarterly dividend since 2003. Its yield is currently the highest it has been during that time, with a yield over 5%. HLF's last two dividends were each $0.145 CAD, for an expected annual dividend of $0.58 CAD compared to a closing price on March 5 of $11.03 CAD, for a 5.3% forward dividend yield.
HLF Dividend Yield (TTM) data by YCharts
Despite the drop in 2017 performance, this dividend should be safe. HLF paid $0.565 CAD/share in dividends in 2017 and delivered $0.98/share in basic EPS, for a payout ratio of 58%. Analysts on Yahoo Finance (although there are only three) expect $0.87 CAD/share in EPS in 2018, and $1.06 CAD/share EPS in 2019. This should give HLF management the ability to pay and increase its dividend in the coming years.
Debt Ratio
Source: Nov 2017 Investor Presentation (outdated by one quarter)
Management expects that improving adjusted EBITDA and debt repayments will reduce the company's net interest-bearing debt to Adjusted EBITDA metric to under 4.5x by the end of 2018. HLF's long-term target ratio is 3.0x.
As of December 30, 2017, HLF had net interest-bearing debt of $387.9 million with 2017 Adjusted EBITDA of $66.1 million, for a ratio of 5.9x, up from 3.1x in 2016. This ratio rose due to the addition of $135 million in debt (due to the purchase of Rubicon and a large increase in working capital) and a $15 million drop in Adjusted EBITDA (partly due to higher raw material costs and the product recall).
Reducing this ratio to 4.5x would require a net debt reduction of $90.5 million or an increase of Adjusted EBITDA of $20.1 million, or a combination of debt reduction and EBITDA expansion.
Challenges
Gross margins were substantially lower in 2017 than in 2016. Adjusted gross margins dropped 210 bps, and gross margins dropped 350 bps. Part of this decline is due to Rubicon, which attained gross margins of 12.0% in its seven months as part of HLF. However, this is also due to product mix:
[E]ven when you exclude Rubicon, as I mentioned in my remarks, our gross margin percentage is down. That is primarily driven by mix in the business, unfortunately, so we continue to see some declines in our higher-margin value-added business and some increases in our lower-margin procured business. And so that has the impact on the margin mix."
Paul Jewer, CFO of High Liner Foods, on Fourth Quarter 2017 Earnings Call
Other factors that are at play include plant performance - improving, but still not where it needs to be - and rising raw material prices. Each of these factors (product mix, plant performance, and rising raw material prices) will continue into the coming year. As Paul Jewer said of value-added products, "[I]t's difficult to achieve margin growth in a declining category."
One of High Liner's challenges will be to innovate and diversify its seafood business, finding ways to be profitable outside its traditional breaded-and-battered seafood category. Seafood itself may be healthy, but fish sticks and fish and chips do not have a reputation for being nutritious.
Valuation
| 2017A | Recall | Rubicon FY | 2017adj | Chg (Est) | 2018E | |
| CAD Revenue | C$340.0 | C$2.8 | C$342.8 | 10.9% | C$380.0 | |
| USD Revenue | $791.8 | $6.0 | $99.4 | $897.2 | 1.3% | $908.7 |
| Total Revenue ($1 = C$1.296) | $1,201.9 | |||||
I estimate that HLF will have 2018 revenue of $1.2 billion USD. This is based on HLF's estimate of $370-390 million CAD in 2018 revenue, and applying a 1.3% growth rate to HLF's USD 2017 revenue, adjusted to reflect the addition of a full-year of Rubicon sales and the reflect the product recall of 2017. This estimate may be conservative, since 2018 is unlikely to see a repeat of the 2017 shortages during Lent.
If HLF can maintain its 2017 Adjusted EBITDA margin of 6.3% (down from 8.5% in 2016), this would imply $75.4 million in Adjusted EBITDA. This estimate may be conservative - 2017 was marked by a shortage during the crucial Lenten period, so HLF should operate more efficiently in 2018. However, this may be offset by a full-year of lower-margin Rubicon performance.
| 2014A | 2015A | 2016A | 2017A | 2018E | |
| Adjusted EBITDA | $83.3M | $78.2M | $81.4M | $66.1M | $75.4M |
| Enterprise Value | $964M | $649M | $678M | $672M | $723M |
| EV/Adjusted EBITDA | 11.6 | 8.3 | 8.3 | 10.2 | 9.6 |
| Share Price (March 1) | C$24.42 | C$15.00 | C$18.05 | C$11.03* | C$13.53 |
| USD/CAD Rate (Feb. 28/29) | C$1.25 | C$1.38 | C$1.31 | C$1.30* | C$1.30 |
| Net interest-bearing debt | $364.8M | $313.1M | $252.1M | $387.9M | $374.4M |
| Shares Outstanding (Basic) | 30.7M | 30.9M | 30.9M | 33.4M | 33.4M |
* As of March 5, 2018.
Based on an Adjusted EBITDA of $75.4 million in 2018, HLF shares could be worth ~ C$13.50 in one year. Including an expected C$0.58 of dividends, this represents 28% gains over the year.
This estimate is based on the average EV/Adjusted EBITDA over the past four years for HLF, using share prices and exchange rates from shortly after the late-February release of annual results. The average EV/Adjusted EBITDA over this period is 9.6 - these 28% gains are possible even with a decline in EV/Adjusted EBITDA over the next year.
This estimate reflects a constant exchange rate over the next year, and constant debt aside from a $13.5 million payment (reflecting the eventual recovery of losses from the product recall, through suppliers and their insurance). Shares have also been kept constant, which is a reasonable assumption given their flat nature over the past four years - the only increase was in 2017, when 2.43 million shares were issued for the purchase of Rubicon.
Conclusion
High Liner Foods is an attractively-priced, stable food processing company. Shares have been battered over the past 1.5 years, falling from heights of over $26. Despite that fall, revenues have not faltered, and have continued to increase.
Execution problems hurt HLF's performance in 2017, with the company suffering shortages during the important Lenten period and suffering a product recall around the same time. However, those pressures are only one-time events, and HLF management is focused on increasing efficiency.
The business will face some headwinds in the form of rising seafood costs and shifting consumer preferences away from certain core areas. However, management is focused on coming up with solutions to those problems, and HLF has a diverse array of seafood products.
HLF is attractively priced, despite potential headwinds, offering a sustainable dividend yield of ~ 5.3%, the highest dividend yield in the past 15 years. Even assuming EV/Adjusted EBITDA contraction back to the four-year mean, investors could see 28% gains in HLF over the next year. These gains will be even greater if HLF management is able to improve plant efficiency and margins further.
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Analyst’s Disclosure: I am/we are long HLF.TO. 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.
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Comments (31)
1. production efficiency (operations) which they have addressed and are continuing to work on
2. Rubicon's integration.I too believe that they will bring down their debt levels this year and should see it more aligned with historical levels in the future. I still believe that another acquisition is on the table (Clover Leaf).
