Saputo Inc. (TSX:SAP) came out with quarterly earnings earlier this month that the market did not like.
Earnings before special items and adjustments came in at $127 million, a full 16% below third-quarter earnings and well below analyst estimates. That led to an adjusted EBITDA of $581 million for the company’s entire fiscal 2015, an improvement of just 3% compared with 2014.
Needless to say, those aren’t great results for a company with the growth profile of Saputo.
It got worse. When commenting on the latest quarter, management told investors that low cheese and milk prices were here to stay at least until the end of the year. The average price of cheese was down 30%, while other milk products suffered double-digit declines.
This is due to a combination of increased supply worldwide and decreased demand from China and Russia, two previous high-flying areas. There was also increased competition here at home, with competitors aggressively pricing instead of letting the product go to waste. Chances are you’ve seen some nice cheese and milk promotions at the grocery store this summer.
Still, management isn’t concerned. “We’re going through a blip here where the dairy solids pricing is depressed. We’re not overly concerned about that kind of stuff,” said CEO Lino Saputo Jr. “We’re in this for the long haul.”
For investors interested in the long term, I think this is a pretty good buying opportunity. Here’s why.
Long-term growth
The dairy industry around the world remains incredibly fragmented. Most countries have several smaller dairies, which usually have a dominant position in a specific geographical region.
These are just the opportunities a company with deep pockets like Saputo salivates over. The company has already expanded to the United States, Argentina, and most recently, Australia. Management has its eyes on several more acquisitions, including assets in Brazil, New Zealand, or even closer to home in North America. This long-term growth story is still intact, even if the price of dairy products has temporarily dipped.
There’s also long-term potential in China, which is still poised for some huge growth over the next few decades, even if it’s experiencing short-term weakness. The average Chinese citizen still only consumes a fraction of milk that the average North American citizen does. To quantify it, per capita consumption could double in China and still be less than half than it is here or in Europe. And remember, China has north of a billion people. A big part of Saputo’s 2014 expansion into Australia was to position itself to be a player in China.
Finally, a reasonable valuation
The big issue with Saputo was always its valuation. The stock regularly traded at more than 30 times earnings as excited investors bid up the price.
These days, the stock is much more reasonably priced. Shares currently trade hands for just 20 times earnings, which is about the same as the average TSX-listed stock. That’s not bad, especially for a company with Saputo’s potential growth profile.
Earnings are still expected to increase next year to $1.75 per share. That puts shares at just 18 times forward earnings, and that’s even without the benefit of another acquisition. Management figures it has another $3 or $4 billion available to spend if the right opportunity comes along, which would add nicely to the bottom line.
It’s been years since Saputo traded at such attractive levels. Yes, shares are still somewhat expensive, especially for this value investor. But investors should be willing to pay a small premium for a company that has such a long and successful history of growth. Investors should take advantage of the temporary weakness in shares and load up. I’m not sure they’ll be this low for long.
