Saturday, January 07, 2006

Oh no..not chicken again!

Not a comment on what is being served for dinner, but a comment on just how cheap these chicken stocks have gotten. As well, a bit of a humble contribution to the Sanderson Farms (SAFM) versus Pilgrim’s Pride (PPC) debate. I apologize for the heavy use of numbers and stats but a fundamental guy talks this way:

I agree with Geoff Gannon that SAFM may be a somewhat better or at least cheaper choice than PPC. And by the way Geoff, thank you for that kind mention on your blog! I do appreciate it a lot! Both companies would be hurt by lower chicken prices (obviously) but there are subtle differences in their fundamental qualities.

SAFM has just completed on time and on budget a new Georgia complex that will add about 23% in production capacity. With conversions to their Collins facility, production will be up about 26% next year.

Capital expenditures for SAFM were a record for 2005, having spent $128 million on various projects, the major ones being $92.3 million for the GA facility and $15.1 million for a new head office. Despite this well above normal expenditure, the company ended up with negative free cash flow of only $7.5 million. In fact, last year’s capex was greater than the company had spent cumulatively in the last five years. Next year’s forecast capex is going to be much lower than 2005 at $73.4 million, but well above current depreciation expense of about $31 million. The company can easily fund this expenditure internally. EBITDA last year was about $140 million, the lowest level of EBITDA in the last five years has been about $75 million. Consequently, despite this still above average spending effort, I believe that the company will be generating free cash.

The ability to generate large amounts of FCF is the difference in my view between SAFM and PPC. Here is a comparison of FCF margins (FCF divided by sales) for these two companies for the last five years:

SAFM PPC
2005 -0.74% +0.13%
2004 +7.14% +0.14%
2003 +6.01% -0.03%
2002 +3.89% -0.47%
2001 +7.1% -0.03%

When I look at a cyclical business, I like to look at the FCF generation over a five year cycle. The value that the stock market has accorded SAFM on an enterprise value basis (reflecting market cap plus debt less cash) is only 2.65 times the free cash flow generated over the last five years. On the other hand, the EV/5 yr FCF generation for PPC is about 4.2 times, still cheap by just about any standard, but more expensive than SAFM.

SAFM also appears to have superior working capital management. Its cash conversion cycle is only 27 days whereas for PPC it is just over 40 days. SAFM has had faster inventory turns as well.

PPC has enjoyed faster sales and earnings growth as a result of its more intensive capital spending program. But this is the fallacy of looking at sales and earnings growth as important metrics. What really counts to a value investor is how is the capital deployed: what is the return on invested capital? Check out the differences here:

SAFM PPC
2005 20.1% 15.2%
2004 31.5% 7.7%
2003 24.7% 1.1%
2002 14.0% 1.7%
2001 12.5% 5.0%

Finally, in terms of balance sheets and financial strength, both companies are just fine. PPC has total debt to equity of 43% (long term debt to equity of about 21%.) Interest coverage is ample. SAFM has a much stronger balance sheet with total debt to equity of only 3.2% and long term debt to equity of 1.5%!

In conclusion, SAFM has had higher returns on invested capital every year of the last five and a superior free cash flow generation history as well as a rock solid balance sheet. Its production capacity will be up over 20% this year.

On a valuation basis SAFM is trading at EV/EBIT of 4.66 times. Pilgrim’s Pride is trading slightly higher at 4.99 times EBITDA. Just to put it in perspective versus other cyclical businesses, the five largest homebuilders in the U.S. trade at an average of 7.33 times EBITDA for EV/EBITDA or more than 50% higher than SAFM. Homebuilders generally do not have the FCF characteristics of the chicken processing industry and only in this hyper-cycle have demonstrated returns on capital that were anywhere near that of chickens.

3 Comments:

At 12:20 AM, Blogger Geoff Gannon said...

Great post on SAFM and PPC. This one's everything mine should have been. I can't believe I didn't know about this site until just a couple days ago. You're doing great work here; all the value blogs will benefit from it.

 
At 2:53 PM, Anonymous Anonymous said...

Rick

A nice quick write-up. It looks obvious that SAFM is at late a superior managed company in an otherwise commodity business. Don't know how long the current margin can be maintained before it is compressed again. Over the longer period 10 years, it doesn't seem to be a good industry to invest in. However, this doesn't mean this can't be a profitable stock to trade. However, trading in cyclical stocks is tricky.

I only have one quibble with your numbers. My CCC number of SAFM and PPC are different from yours. Don't know who is right. I am only using 10Ks. My SAFM CCC is close to 54 days for 2005. Please comments.


my SAFM data from 2005-2001:

Inventory Turn 9.76 11.14 12.01 11.44 11.97 11.54
Inventory/COGS (DIO in days) 37.40 32.76 30.40 31.90 30.49 31.62
AR/Rev (DSO in days) 14.09 17.08 19.33 20.16 20.78 52.59
AP/COGS (DPO in days) (2.61) 4.92 (3.06) 2.72 1.63 3.15
Cash Conversion Cycle (CCC days) 54.10 44.92 52.80 49.34 49.63 81.07
Estimated Cash Needs (based on CCC) $132,321 $111,028 $113,073 $93,768 $89,057 $134,701
Excessive WC (based on CCC) $(24,690) $39,596 $(30,837) $(25,316) $(12,088) $(63,367)
Excessive WC (%) -19% 36% -27% -27% -14% -47%

my PPC data from 2005-2001:

Inventory Turn 9.33 7.86 7.23 7.25 6.36
Inventory/COGS (DIO in days) 39.11 46.44 50.47 50.34 57.36
AR/Rev (DSO in days) 18.59 22.06 17.70 12.29 15.66
AP/COGS (DPO in days) 20.91 23.95 23.56 25.25 27.60
Cash Conversion Cycle (CCC days) 36.79 44.55 44.60 37.39 45.42
Estimated Cash Needs (based on CCC) $527,186 $622,315 $312,315 $256,487 $263,837
Excessive WC (based on CCC) $(122,585) $(238,589) $(101,196) $(77,450) $(60,487)
Excessive WC (%) -23% -38% -32% -30% -23%

 
At 2:53 PM, Anonymous Anonymous said...

Rick

A nice quick write-up. It looks obvious that SAFM is at late a superior managed company in an otherwise commodity business. Don't know how long the current margin can be maintained before it is compressed again. Over the longer period 10 years, it doesn't seem to be a good industry to invest in. However, this doesn't mean this can't be a profitable stock to trade. However, trading in cyclical stocks is tricky.

I only have one quibble with your numbers. My CCC number of SAFM and PPC are different from yours. Don't know who is right. I am only using 10Ks. My SAFM CCC is close to 54 days for 2005. Please comments.


my SAFM data from 2005-2001:

Inventory Turn 9.76 11.14 12.01 11.44 11.97 11.54
Inventory/COGS (DIO in days) 37.40 32.76 30.40 31.90 30.49 31.62
AR/Rev (DSO in days) 14.09 17.08 19.33 20.16 20.78 52.59
AP/COGS (DPO in days) (2.61) 4.92 (3.06) 2.72 1.63 3.15
Cash Conversion Cycle (CCC days) 54.10 44.92 52.80 49.34 49.63 81.07
Estimated Cash Needs (based on CCC) $132,321 $111,028 $113,073 $93,768 $89,057 $134,701
Excessive WC (based on CCC) $(24,690) $39,596 $(30,837) $(25,316) $(12,088) $(63,367)
Excessive WC (%) -19% 36% -27% -27% -14% -47%

my PPC data from 2005-2001:

Inventory Turn 9.33 7.86 7.23 7.25 6.36
Inventory/COGS (DIO in days) 39.11 46.44 50.47 50.34 57.36
AR/Rev (DSO in days) 18.59 22.06 17.70 12.29 15.66
AP/COGS (DPO in days) 20.91 23.95 23.56 25.25 27.60
Cash Conversion Cycle (CCC days) 36.79 44.55 44.60 37.39 45.42
Estimated Cash Needs (based on CCC) $527,186 $622,315 $312,315 $256,487 $263,837
Excessive WC (based on CCC) $(122,585) $(238,589) $(101,196) $(77,450) $(60,487)
Excessive WC (%) -23% -38% -32% -30% -23%

 

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