The Sanderson Farm headquarters is in Mississippi and is a fully vertically integrated poultry processing company engaged in the production, processing, marketing, and distribution of fresh and frozen chicken products. The company differentiated itself from their competitors (Tyson and Pilgrim’s Pride) in 1997 by changing its marketing strategy in order to cater to grocery and food service customers instead of catering to fast food service. In 2017, 91% of the farm’s total sales were made in the United States, and 9% of the total sales came from selling products to foreign customers in Mexico, central Asia and the Middle East. The revenue is reported in two segments: prepared chicken and minimally prepared chicken. The prepared chicken represented 94.9% of total sales as of last fiscal year 2017, and minimally prepared chicken represented 5.1% of total sales.
Has the company been historically good?
The growth is an imperative component when assessing the financial health of a company. The company has increased its sales since 2008. In midst of the financial recession from 2007 to 2008, the company increased its sales by 17%. In addition, year over year from 2016 to 2017, the company increased its sales by 19%.
To highlight income statement performance:
- The gross margin
Sanderson Farm maintains favorable gross margin compared to its competitors (Tyson and Pilgrim’s Pride). SAFM reported 19% gross margin at the end of its latest fiscal year, which increased by 3% from 2016. Thus, SAFM has more funds available to pay the firm’s expenses aside from its cost of sales. Higher margin exemplified by the marketing strategy of SAFM, which favors selling large-bird products to grocery and food service and excludes selling the lower margin small-bird products.
- The operating profit margin
SAFM’s operating profit margin has increased by 3% year over year (2016-2017), which indicated that SAFM is becoming more efficient in controlling its operating costs compared to its competitors.
To highlight Balance Sheet performance:
- Interest Coverage is 223 as of the latest fiscal year, which means that the operating income is more than 223 times the interest payment on the debt, and the company can easily service its debt.
- Current Ratio is 4.2 times, which means SAFM has 4 times as many current assets as current liabilities.
- Total Debt Ratio is 16%, which indicates that debt financing makes up about 16% of the firm’s capital structure. Furthermore, only 4% of the total liabilities are represented by long term interest bearing liabilities. 12% of its debt are not non-interest-bearing liabilities.
Sanderson Farm has a clean balance that allowed the company to avoid the worst of the industry’s struggle, exemplified by Pilgrim’s 2008 bankruptcy.
Measure Historical Performance:
- Return on Capital Employed: Accounts payable, accrued expenses, and accrued income taxes were excluded from the calculation of return on capital employed because they are non-interest bearing current liabilities. The company has vehicle and equipment operating leases that expire at various dates throughout fiscal 2020. Therefore, an adjustment is made to include all operating leases in the calculation of capital employed by adding the present value of lease to liabilities as an equivalent asset. The return on capital employed with cash included in the calculation is 39% in 2017, and compounded annual growth is 32% since 2012.
- Free Cash Flow:
Bruce Greenwald’s method is used to calculate maintenance capital expenditure in order to exclude maintenance capital expenditure from the calculation of free cash flow. The maintenance capex is simply calculated as a percentage of sales multiplied by increase/decrease in sales to arrive to growth capex.
Free cash flow has increased by 9% compounded annually for the period from 2012 to 2017. Free cash flow to capital employed ratio is 26% with cash included in the calculation, and compounded annually is 20% for the period from 2012 to 2017.
- Growth in operating income per fully diluted share: Operating income per fully diluted share has increased by 44% in 2017 and 35% compounded growth since 2012. This indicates the company is growing, and operating income is not shrinking over time.
- Liability to Equity ratio is 0.23 as of the last fiscal year, which indicates the company is not using leverage aggressively to expand its growth. According to the annual shareholders, the company has no outstanding debt in the 2017 fiscal year.
Customer Base: One customer accounted for 17%, 17.5%, and 16.2% of total consolidated sales for the years 2017, 2016, and 2015. However, the company does not believe the loss of this customer would have a material adverse effect on the company because the company could sell poultry earmarked to any single customer to alternative customers at market prices.
Supplier Base: the company purchased its pullets and cockerels from a single major breeder. The company is continually evaluating its sources.
- Bargaining power of customer: Buyers are more concentrated than sellers due to the price sensitivity of buyers. Thus, the bargaining power is high due to competition.
- Bargaining power of supplier: (Moderate) Companies within the food products industry have two main methods of accessing raw materials: open markets and supply contracts. Purchasing in the open market offers limited control of input prices. Therefore, various substitutes exist for raw materials, which ultimately undercuts suppliers’ buying power.
- Threat of substitutes:lower-margin food products such as those that are canned or dried offer consumers more convenience and longer shelf lives relative to fresh food products.
- Threat of new entrants: new regulatory restrictions on food products act as the primary barrier to entry into the industry; high capital needs serve as another deterrent to entrants.
The per capita consumption of poultry in the U.S is demonstrated in the chart below. Per capita consumption of chicken has increased from 85 in 2007 to 92 in 2017 (0.65% compounded annually). On the other hand, per capita consumption of meat has decreased from 219 in 2007 to 216 in 2017 (0.65% compounded annually). Therefore, we are witnessing a shift from general meat consumption to chicken consumption.
Is it expensive?
- MACAP/FCF: the company is traded at 8 times its free cash flow.
- EV/OI: enterprise value is 5 times its operating income.
- Price to book: the company is traded at 2 times its book value.
- Price to tangible book: the company is traded at 2 times its tangible book value. The price to book is equal to price to tangible book because the company is not acquiring any other company at higher premium price and does not have goodwill cost.
- The Company’s net sales and cost of sales are significantly affected by market price fluctuations of its principal products sold and of its principal feed ingredients, corn and other grain.
- Compensation and Ownership: the total salary for the company’s CEO is $6.6 million, and salaries for its executive officers total $4.8 million. Moreover, the total salaries represent 4% of total free cash flow at the end of its last fiscal year. Total salaries are less than the average total compensation for CEOs of S&P 500 Index, which is $13.94 million, and Sanderson is not overpaying its executive officers. The long-term incentive award is 50% based on average return on equity and 50% based on average return on sales over two years.
- Ownership: Joe Sanderson, CEO owns 3.67% of total shareholders, and executive officers own 1.63% of total shareholders.
- Dividend: the company pays dividends to the shareholders. The company has increased its dividends by 6.4% compounded annually since 2009.
Share buyback: On April 23, 2015, the Company’s Board of Directors expanded and extended the share repurchase program originally approved on October 22, 2009, under which the Company may purchase up to one million shares of its common stock in open market transactions or negotiated purchases, subject to market conditions, share price and other considerations
Disclosure: I am/we are long SAFM.