It seems so long ago now that Maple Leaf Foods was a basket case, a company with a chain of out-of-date meat-processing plants and a stock that appealed to only value investors. A lot has happened since, of course, after a jab from an activist investor started a multiyear restructuring and modernization that has turned the company around.
Now, the company is posting dazzling earnings that match its gleaming new factories and investors are rewarding it: The shares hit a 52-week high of $32.67 Tuesday, more than triple its financial-crisis era lows.
Part of that excitement is about what's coming next: Dissatisfied with the low multiples investors give commodity-meat producers, Maple Leaf is emphasizing its branded products and even moving into healthy, sustainable and "alternative" proteins. This step is coming at a very high cost, however, given the price paid for a recent acquisition.
The hazard now is whether the markets are already giving the company credit for getting the next stage of its evolution right – and how much Maple Leaf might fall if management can't pull off the next transformation.
First, we shall give credit where it is due. Maple Leaf's problem several years ago was its old, underperforming manufacturing plants, as well as a broad product line that included bread and pasta. To fix itself, Maple Leaf axed inefficient plants and sold off non-meat businesses.
The turnaround was lengthy and expensive, but it has worked. Margins of EBITDA, or earnings before interest, taxes, depreciation and amortization, went from subzero in 2013 to the mid-single digits in 2015, and hit double digits in every quarter of 2016. Analyst Michael Van Aelst of TD Securities notes Maple Leaf now produces 85 per cent to 90 per cent of its prepared meats in four large "state-of-the-art" facilities and moves products through only two modern distribution centres.
Irene Nattel of RBC Dominion Securities Inc. writes Maple Leaf's strong close to 2016 "confirm[s] the company has the right manufacturing footprint and strategy to continue to sustain double-digit profitability." Now, she notes, Maple Leaf "has moved its focus to executing on the growth agenda," and "investing capital to drive the business forward."
A big part of the new plan is targeting customers who want something different from the processed meats that have historically been the core of the company's business. Maple Leaf has been emphasizing its "raised without antibiotics" products.
An acquisition announced last month just before the year-end earnings underscores the plan: Maple Leaf paid $140-million (U.S.) to buy Lightlife Foods Inc., a Massachusetts company that sells $40-million worth of "refrigerated plant-based protein foods" each year. Examples include burgers made from black beans or quinoa, hot dogs made from soy, a variety of tempeh products and a number of other things I refuse to eat.
The good news is that Lightlife is more profitable than Maple Leaf, so it will help boost the company's margins, and there's no doubt it's a leader in a fast-growing sector. What investors need to keep in perspective, however, is how much Maple Leaf paid to get a piece of the action – analysts estimate the purchase price was around 20 times Lightleaf's EBITDA, or a multiple nearly twice as high as what investors are paying for Maple Leaf shares. As well, Lightleaf really won't contribute meaningfully at the company any time soon; since Maple Leaf has more than $3-billion (Canadian) in annual sales and $343-million in "adjusted EBITDA" in 2016, Lightlife is providing only about 2 per cent of the company's revenue and profits right now.
Indeed, Maple Leaf's sales are a mix of branded and unbranded consumer products and commodity meat sales; analysts say an appropriate multiple should blend the two. Mark Petrie of CIBC World Markets Inc., raising his target price to $35 in February, started using a multiple of 12 times the company's EBITDA, below branded consumer-products peers but well above the six times to seven times EBITDA at which the more "basic" producers trade.
The hazard, note a number of analysts, is that a profitability misstep or other execution problems could waylay Maple Leaf's trek toward those higher multiples. Kenneth Zaslow of BMO Nesbitt Burns Inc., who has a "market perform" rating and $31 target price, says that while Maple Leaf's margins are now higher than those of agri-giant Tyson Foods Inc., its multiple exceeds Tyson's by an even greater amount.
Mr. Zaslow's "downside scenario" of $22 a share suggests any "poor execution" and a drop in protein prices could push Maple Leaf's earnings down, with those inconsistent results sending Maple Leaf's multiple down to seven times EBITDA, more in line with the commodity producers. I encourage investors buying Maple Leaf at its new highs to not dismiss such talk as baloney.
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