Saputo’s shares are high. They now have downwards price momentum. That’s why Saputo remains a hold for now, even though it raises its dividend each year.
We downgraded packaged food manufacturing stock Saputo Inc. (TSX—SAP) last year. That’s because it was going though a rough patch. Indeed, the company’s adjusted net earnings were $624 million, or $1.59 a share, in the year to March 31, 2019. This was down by 11.7 per cent from adjusted net earnings of $704 million, or $1.80 a share, the year before.
So far in fiscal 2020, Montreal-based Saputo made a significant acquisition in each of Britain and Australia. Despite headwinds, this year the company’s adjusted net earnings are expected to recover by 9.4 per cent, to $1.74 a share. Next year, its earnings are expected to jump by 19.5 per cent, to a record $2.08 a share.
Saputo’s multiple is excessive
The trouble is, Saputo trades at a high price. Divide its share price by this year’s estimate of $1.74 a share and you get an excessive P/E (Price-to-Earnings) ratio of 22.9 times. Divide the share price by next year’s earning estimate of $2.08 a share and you get a P/E ratio of 19.1 times. As a result, if the company falls short of expectations, its share price is likely to fall too. In fact, that’s just what happened. This gives the stock downwards price momentum.
One plus is that after raising its dividends each year since at least 2003 (as far back as we looked), we expect Saputo to continue to raise what it pays you in the years ahead. The growing dividends of such ‘dividend aristocrats’ can offset inflation.
On April 15, Saputo paid $2.1 billion to acquire Dairy Crest Group PLC of the United Kingdom. Dairy Crest is a major manufacturer and marketer of cheese, butters, spreads, oils and value-added dairy ingredients under leading British brands. Dairy Crest operates in seven locations across the UK.
In the year to March 31, Dairy Crest generated revenues of about C$786.3 million. At the same time, its earnings after tax came to $87.1 million, excluding one-time items. Saputo sees the acquisition as a way “to expand its international presence and enter the UK market by acquiring and investing in a well-established and successful industry player with a solid assets base” and experienced management. Saputo plans to report the operations of Dairy Crest as part of a new Europe Sector.
Acquisitions will improve Saputo’s results
On April 26, Saputo agreed to pay C$265 million to acquire the Specialty Cheese Business of Lion Dairy & Drinks of Australia. This business operates two manufacturing facilities. It “produces, markets and distributes a variety of specialty cheeses under a wide variety of Australian brands.”
Saputo writes that the acquisition would let it “further diversify its product offering, adding to and complementing its current activities”. But Saputo will need the Australian Competition and Consumer Commission to accept the acquisition. If it does, Saputo expects to close the acquisition in the second half of this year. Just keep in mind that Saputo calls itself the top dairy processor in Australia. Other dairies will likely want the competition regulator to thwart this potential acquisition.
These acquisitions will add to Saputo’s results in fiscal 2020. They will also balance its sales geographically. Last year, the international operations accounted for less than 22 per cent of the company’s total sales. The US generated more than 48 per cent while Canada provided nearly 30 per cent. With growing foreign operations, North America will become less dominant.
Saputo can afford to make these acquisitions. It generates steady and predictable cash flow. Last year, the company’s cash flow climbed by 6.4 per cent, to $984 million. Its net debt-to-cash flow ratio stood at 2.3 times. That’s reasonable for a provider of consumer staples such as Saputo.
Saputo keeps investing in its operations
Saputo is also investing in its operations. In Canada, it has begun building a new modern facility in the Greater Vancouver Area. This would enable the company to better supply fluid milk to customers in Western Canada. In the US, it expects its newly-built Wisconsin facility to improve its blue cheese manufacturing efficiency. This should help Saputo reach its goal of broadening its presence in the specialty cheese sector in the US.
Saputo continues to integrate its F&A acquisition in the US. In Australia, it’s close to completing the integration of Murray Goulburn. In the UK, Saputo has only started integrating Dairy Crest.
Saputo also keeps on evaluating its existing operations, looking for more profitable ways of doing things. To this end, Saputo closed one of its Wisconsin facilities and consolidated the production into other facilities. Worldwide, it plans to continue to invest to increase its efficiency and to reduce its operating costs. This way, more money is left over to flow into its earnings.
Saputo continues to implement its new ERP [Enterprise Resource Planning] system. It has already implemented it in Argentina, at its Dairy Foods Division (USA) and at Warrnambool Cheese and Butter in Australia. This year, Saputo plans to implement the ERP system at Murray Goulburn. This will align all its Australian businesses under a single system. After that, Saputo will implement the ERP system at the Cheese Division (USA) and the Dairy Division (Canada). It expects to complete these two roll-outs in fiscal 2022 (fiscal years end on March 31).
Saputo Inc. remains a hold for long-term share price gains and modest dividends that grow each year.
This is an edited version of an article that was originally published for subscribers in the June 28, 2019, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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