Why Income-Hungry Investors Shouldn’t Ignore the Food Industry

What changes are in store for some of Canada’s food producers?

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The food production sector offers enormous opportunities to companies that can position themselves correctly to benefit from the growth expected in global food and calorie intake. The global population is rising rapidly and almost 800 million more people are expected to be born by 2020, meaning more food must be produced to feed everyone.

In addition, rapid urbanization and growing per-capita incomes in developing countries are resulting in the increased consumption of meat, dairy, vegetables, and fruit as a starch-based diet becomes more balanced. In China, for example, city-dwellers consume nearly 75% more meat and almost 25% more fruits and vegetables than those in rural areas.

Acquisitions are pushing food company valuations higher

This opportunity for growth is not new, but a recent spate of acquisitions seems to indicate that a higher value is now being placed on companies that may be able to benefit from these trends.

Saputo (TSX: SAP) was recently involved in a heavily contested battle to acquire the Australian dairy producer Warrnambool — a transaction that finally took place at a price more than double what it was before the bidding began and at a forward EV/EBITDA multiple of around 13 times.

In the U.S., Hillshire Brands (NYSE: HSH), a major processed meat producer, is being courted by multiple buyers including Pilgrim’s Pride (NYSE: PPC) and Tyson Foods (NYSE: TSN). Bid valuation multiples for Hillshire are now around 15 times the historical EV/EBITDA.

Investment opportunities in two major Canadian companies

Saputo has been very active recently on the acquisition front, having acquired Warrnambool for around AU$460 million, the Canadian dairy products producer Scotsburn for $61 million, and the U.S. dairy producer Morningstar for US$1.45 billion. The company is now among the top 10 dairy producers in the world.

Saputo announced its Q4 2014 results on Thursday, with adjusted earnings per share increasing by 20%. Solid growth was reported for the operations in the U.S. and Australia, while Canada struggled as a result of higher raw material and operational costs.

The positive aspects from an investment perspective are the company’s strong historical track record, very competitive market position, solid balance sheet, strong operational cash flow, active share buyback program, and positive outlook for growth, especially in the Chinese market through Warrnambool. However, investors could be concerned that the company may overpay for its acquisitions in its ongoing acquisition program.

The valuation of the company is not cheap, with an EV/EBITDA valuation of around 11.5 times for the next 12 months, but is in line with the valuation of a representative peer group.

Maple Leaf Foods (TSX: MFI) is a processed meat manufacturer that makes sliced meats, bacon, and canned meats. It holds leading market positions in several categories and operates in Canada, the U.S., the U.K., and Asia.

The company did not perform well in 2013, and also reported a net loss from continuing operations of $125 million for the first quarter of 2014. The poor performance was due to increasing raw material input costs not matched by increased sales prices, as well as business transformation expenses and disruption caused by closing old facilities and moving to new, modernized ones.

Restoring profit margins is a key objective and company management plans to reach a 10% EBITDA margin by 2015. In comparison, the level in 2013 was 2.8%. While 2014 is still expected to remain a challenging year for the company, 2015 may be much better, with consensus forecasts indicating an EBITDA  profit of $260 million compared to $82 million expected for 2014.

Maple Leaf Foods recently sold its 90% interest in Canada Bread to Grupo Bimbo of Mexico for net proceeds of $1.65 billion. The cash will be used to redeem debt, leaving the balance sheet in a very sound position.

Based on the 2015 profit forecast, the company is valued on an EV/EBITDA multiple of 7.5 times, which is at a substantial discount to its peers. At this price level it could easily become a takeover target.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Deon Vernooy does not hold a position in any company mentioned above.

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