Saputo's acquistion of Morningstar

Several Canadian companies have made good acquisitions lately and they have produced great return for investors over the last 3 years. These companies are not high profiled and they might not be on the watch list of retail investors.

It seems these companies have the following characteristics:

• making incremental acquisitions that are accretive to their earnings over time 
• making those deals at the right price
• have strong cash flow to pay off debt after the acquisition and have under-levered balance sheet before the acquisition
• they pay off their acquisitions with their own cash flows and might not need to raise money on the stock market (issuing stocks) or the debt market (issuing bonds). Because they don't need to raise money in the capital markets, these companies are not likely to get attention from high profile brokers. (analysts might not follow them closely and you won't hear about them on the news very often)

Companies that have made such acquisitions recently:

• Convenience store operator Alimentation Couche-Tard Inc (ATD.B-T) acquiring assets from Statoil  (ATD.B-T gained 68% over the last 52 weeks)
• Frozen seafood processor Highliner Foods (HLF-T) acquiring Icelandic Group (HLF gained 102% over the last 52 weeks)
• Enterprise software provider Constellation Software - they made 22 acquisitions in 2011. (CSU-T gained 55% over the last 52 weeks)

Dairy processor Saputo (SAP-T) have a reputation of making good acquisitions, They have acquired the Morningstar division from Dean's food today. This acquisition might not boost Saputo's earnings by a mile next year but it might pave the way for smaller deals in the future that will allow Saputo to grow.


Blogger SPBrunner follow the stock and here is her blog: 
http://spbrunner.blogspot.ca/2012/06/saputo-inc.html 

As per SP Brunner:

The total return under this stock over the past 5 and 10 years is at 14.8% and 11.92% per year. The dividend portion of this return is 1.97% and 1.66% per year, respectively. That is dividends made up 13.33% and 13.96% per year of the total return. The capital gain portion of the total return was 12.82% and 10.26% per year, respectively. 

Growth has mostly been good for this stock. The 5 and 10 year growth in revenue per share is 7.6% and 12.5% per year, respectively. Growth in EPS is 9% and 10% per year, respectively. Growth in cash flow is 9.7% and 13.7% per year, respectively. Growth in book value is 7% and 9% per year, respectively. 

You can expect return of 10%-12% a year on Saputo. Saputo is well managed and their return on equity is in the range of 14% to 18% over the last 10 years. Debt to equity ratio before the acquisition is 0.71, Saputo does have the capacity to use leverage to make more acquisitions.Trailing PE of Saputo is in the range of 14x-25x over the last 10 years.The market does realize Saputo as a great company and their stock is not always changing hands on a discount. 


SPBrunner also keep track of Saputo's number on a spreadsheet here:

http://www.spbrunner.com/stocks/sap.htm

Saputo's trail of acquisitions: (from Montreal Gazette)
1954 — Giuseppe Saputo and family, new immigrants with cheesemaking in their blood, start their business in Montreal in humble quarters. It begins to grow immediately as people outside the Italian community take to Italian-style pizza topped with mozzarella.

1997 — Saputo, with son Lino Sr. firmly in control, tries to buy Canada’s Ault Food Inc., but is outbid by Italy’s Parmalat. It would have cost more than $350 million to win Ault, and Lino Sr. said that was more than Ault was worth. Lino takes Saputo public at $17 a share and denies a brush with the Mob.

1998 — Saputo buys Stella Foods Inc., the fifth-largest U.S. dairy processor with 12 plants, for $563 million. Lino Sr. says Saputo’s goal is to become a global cheesemaker.

1999 — Saputo completes the takeover of two U.S. plants of Avonmore Waterford Group and Bari Cheese Ltd. in Vancouver and pays $483 million for Jos Louis and Mae West snackmaker Culinar, saving it from a U.S. takeover, moving the company beyond cheese for the first time.

2000 — Saputo Inc. makes another big deal with the $407-million acquisition of Dairyworld Foods, with several plants in Western Canada, from the Agrifoods co-operative. That creates Canada’s largest dairy processor and North America’s fourth largest. Saputo’s annual revenue hits $3.4 billion.

2003 — Saputo expands into Latin America with the $51-million acquisition of Argentina’s third-biggest dairy processor Molinos de la Plata SA, which exports to several other Latin markets and to Europe. Lino Sr. speculates a U.S. acquisition may get top priority next.

2004 — Lino Saputo Sr. hands over the job as chief executive to his second son, Lino Jr., formerly president and COO of the company’s U.S. division. Saputo rumoured to be eyeing Latin American assets of Europe’s Parmalat.

2006 — Saputo enters German market by buying a distributor of mozzarella, ricotta and mascarpone. It also bought Biscuits Rondeau in Quebec, saying it would back troubled Culinar and bring it back to profitability after a big restructuring.

2007 — Saputo buys Land O’Lakes’s U.S. West Coast industrial cheese business for $216 million U.S. to secure a long-term fluid milk supply and also the U.K.’s Dansco Dairy Products, a maker of mozzarella, for $12 million to fit with its European expansion.

2008 — Saputo buys the Nielsen Dairy division of Weston Foods (Canada) for $465 million to back up its fluid milk activities in Ontario and also Alto Dairy Cooperative (Alta), a U.S. mozzarella producer for $160 million U.S.

2010 — Listeria contamination prompts the voluntary recall of cheese from one of Saputo’s biggest Montreal plants. It contained the problem by closing down one line of production. About 150,000 kilograms of cheese are affected.

2011 — Saputo buys Fairmony Cheese Holdings, parent of the U.S. DCI Cheese Co., one of the largest U.S. cheese marketers, for $270.5 million U.S. Lino Jr. says the real focus remains on building a global presence in cheese and dairy products.

2012 — Saputo bolsters its position as North America’s second-largest dairy company with a $1.45-billion deal to buy Morningstar Foods.

Read more: http://www.montrealgazette.com/Saputo+timeline+long+road+steady+expansion/7645708/story.html#ixzz2E38PrLob


Canadian cheese maker Saputo (TSX:SAP) buys US dairy company Morningstar for $1.5 billion. Saputo is bolstering its position as North America’s second largest dairy company with this acquisition. Morningstar, a division of dairy industry leader Dean’s food had revenues of about CDN$1.6 billion and EBITDA of $153 million.


Saputo expects the deal to be immediately accretive to earnings. “After giving effect to the acquisition, the combined business of Saputo and Morningstar will increase the basic earnings per share about 11.5% over the Saputo stand-alone basic EPS of $2.53 for the 12 months ended Sep 30 2012.”

The net purchase price represents for Saputo a multiple of 7.9x Morningstar’s EBITDA and the cost of the transaction will be financed through a newly committed bank loan by Saputo.  According to Canaccord Genuity analyst Derek Dley, the deal price is about eight times Morningstar's operating earnings, compared with Saputo's own trading multiple of 11x.

Morningstar makes a variety of dairy and non-dairy products such as creams, ice cream mixes, sour cream and cottage cheese. Its sales mix is 64 per cent foodservice and 36 per cent retail. With Morningstar, Saputo Inc. not only is gaining an important new platform for its U.S. business, but diversifying its U.S. offering to include other products than cheese, Saputo said. “In Canada, we have a lot of dairy categories. The Canadian platform is well diversified. In the U.S., we were more oriented to cheese manufacturing, but this will allow us to diversify more there as well,” he said. Lino Saputo Jr. – Saputo chief executive officer said he will be on the lookout for further acquisition s in the US.“This is a platform now for smaller-type acquisitions,” he said in an interview.Once Morningstar is fully integrated, Saputo will be generating about $1-billion (Canadian) of cash and carrying roughly $1.8-billion of debt, he said. “We still have the ability to easily add, after this acquisition, $2-billion of debt,” said Mr. Saputo.

Canaccord Genuity analyst Derek Dley said in an interview that Morningstar will likely allow Saputo to realize operating-cost savings but not to the same extent as with previous U.S. acquisitions, particularly mozzarella-maker Land O’Lakes West Coast Industrial and mozzarella and cheddar manufacturer Alto Dairy Cooperative. “I don’t think this will be as game-changing,” he said. Saputo has a strong balance sheet, allowing it to finance the deal through a bank loan rather than having to raise equity, he added.

Summary:
- The Morningstar deal increases the depth of Saputo's operation in the US. Saputo will be diversifying its offering to include products other than cheese. After the acquisition, the US division will be the biggest in terms of sales. US operation of Saputo will be a mirror image of their Canadian operation after the acquisition.
- The purchase price of $1.6 billion represents the biggest ever acquisition for Saputo. The deal is accretive to the earnings of Saputo and will boost its annual EPS by 11%.
- The purchase price of the acquisition is not excessive. The price of 8 times EBITDA is lower than Saputo's own trading multiple of 11x.
- The Morningstar acquisition is strategic, it will be a platform for further acquisition by Saputo in the US.
- The balance sheet is under-levered and Saputo is raising debt to pay for the acquisition. There is capacity for additional acquisition with debt according to the management team of Saputo.
- Saputo have been a consolidator of the dairy industry and they have the desire to become the top 5 dairy processor of the world. Currently they are the top 12 th largest dairy processor in the world. Saputo have a track record of making good acquisitions.


http://money.ca.msn.com/investing/news/business-news/saputo-buys-us-dairy-producer-for-usdollar145b-1
http://www.montrealgazette.com/business/Saputo+billion+deal+based+Morningstar+Foods+most+expensive/7644660/story.html
http://www.theglobeandmail.com/globe-investor/saputo-buys-us-dairy-company-morningstar-for-15-billion/article5910616/

Why US hedge funds are not buying investment properties in Vancouver

Hedge funds in the US have raised more than $8 billion to buy properties in the US lately and I am wondering why Canadian hedge funds are not buying properties in Canada like their peers in the US.  

"According to investment bank Jefferies & Co., major financial firms led by Colony,Blackstone Group LP,  Och-Ziff Capital Management and Oaktree Capital Group LLC have raised more than $8 billion to buy houses, largely in markets pummeled by the housing crisis."

http://online.wsj.com/article/SB10000872396390443696604577644700448760254.html

Professional investors make their decisions on real estate investments based on Cap rate (capitalization rate). Cap rate is calculated with this formula:

Operating income of the investment properties (rent minus the expenses like property tax) / price you pay for that investment.

If you paid $250,000 for your investment property, your cap rate is 10% if you receive $25000 in operating income (rent minus all expenses excluding mortgage interest).

Let’s find out what kind of return US hedge funds are getting on their property investment. As per the article from bloomberg.com, US hedge funds estimated they can earn 9% annual yield on their investments. It seems the Cap rate of some US properties can be as high as 9%.

“Sylvan could buy a home for about $50,000 that needs another $50,000 in repairs, such as replacing windows and air conditioning, plumbing and electrical systems, Chang said. The houses will rent for about $1,250 to $1,500 a month, he said…... Based on that cost, investors would get about 9 percent annual yield on their money.”

http://www.bloomberg.com/news/2012-08-01/ex-morgan-stanley-analyst-forms-firm-to-buy-rental-homes.html

What about the Canadian real estate market? Everybody knows the Canadian real estate market is cooling down lately but it outperformed bonds or stocks investments in the past 5,10 years. Smart investors have made lots of money in bricks and mortars, so are the smart guys in hedge funds piling in to take advantage the soft market conditions in real estates? I did a little research on the Cap rate in one of the hottest real estate market in Canada -- Vancouver--- according to vancouvermarket.ca, Cap rates of residential properties in Vancouver are at a multi decade low - 4%

When will we witness the end of declining capitalization rates? Logic would dictate that this trend cannot be sustained; however, with continued low bond yields, debt financing can continue to be characterized as ‘cheap’, and many investors will continue to be attracted to Vancouver’s overall low-risk profile.”

http://www.vancouvermarket.ca/2012/07/13/cap-rate-compression-how-much-longer-can-it-last/

So how safe are investment properties in Vancouver? Let’s say you have paid 20% down on a $250,000 rental property and the cap rate is 4%, you have secured a 5 year mortgage of 3% with 20 year term. For real estate investors in Vancouver, they can earn a net return of 1% above their cost of capital as long as they can secure 3% mortgage rate until the mortgage is paid off in 20 years. So what is your margin of safety in earning a positive return?

Canadian 1 year mortgage rate - data from Bank of Canada:

2011: 3.35% to 3.5%

2010: 3.35% to 3.6%

2009: 3.6% to 5%  

High and low over the last 20 years: 12.25% in 1991 and 3.1% in July 2012

http://www.ratehub.ca/5-year-fixed-mortgage-rate-history

Movement in interest rates are unpredictable, however mortgage rates are at 20 year low right now and the odds of mortgage rates rising might be high over the next 20 years. If your cap rate is 4%, the odds of earning a positive return relative to your cost of capital over the next 10, 20 years might not be good.

What about making a capital gain in your investment properties? Will hedge funds buy properties in Vancouver to take advantage of rising prices in the future? Institutional investors like hedge funds figured: Real estates are long life assets, if the odds of earning a positive return above the cost of capital (mortgage rates) is low, the odds of prices going much higher like the past 10 years might be low as well --- So hedge funds might not buy rental properties in Vancouver, they might go elsewhere looking for opportunities with higher cap rates.

Price is what you pay, Value is what you get. Hedge fund managers might determine the value of properties in the next 10-20 years based on the price they have to pay now, value of investment properties can not be determined by how prices behaved in the past 15 years.

                                         

Winpak - why boring companies can be a good investment

Company background:

Winpak(WPK-T) is in the business in manufacturing high quality packaging materials and the production of related innovative packaging machines. Winpak distributes products to customers primarily in North America for the protection of perishable foods, beverages and in health care applications. Winpak is closely aligned with Wipak, which is one of Europe’s leading manufacturers of packaging materials. Wihuri Oy of Finland is the controlling shareholder of Wipak and Winpak.

Winpak integrates the whole production process of its products from getting the raw materials to delivering the end product to customer. Winpak can react quickly to market requirements and can readily design materials that respond to a customer’s special needs. This core competency is supported by a technical organization with its engineering expertise and low cost manufacturing through the use of advanced technology.

Company performance:

Dividend yield: 0.81%

Return on Equity: 14.6%

Median Return on Equity (last 5 years): 11.5%

Net debt to total equity: 0

5 year compound return on stock price: 17% per year

10 year compound return on stock price: 3% per year

Winpak stock price increased 204% or 17% per year over the past 5 years. Over the past 10 years, the stock returned 23% or 3% per year. Compound growth of EPS was 22% per year and 9% per year over the past 5 and 10 year period. Expectation was high on the stock back in 2002 and the average PE was 22 times earnings back then, investors got disappointed and the stock sold off and reached a bottom average PE of 11 to 12 times in 2008-2009. The stock rallied strongly off the bottom from 2009 to 2012 when EPS grew nicely due to improving profit margins and modest sales growth.

Compound growth rate of sales was 7% and 8% in the 5 year period and 10 year period. Compound growth rate of EPS in the last 5 year and 10 year period was 22% and 9%. Winpak is targeting to grow its revenue to over 1 billion by 2015. This represents a higher compound revenue growth rate compare to the previous 5 and 10 year period.  

EPS has been growing faster than the growth rate of sales in the last 5 years due to the company’s effort to increase the profit margin of the business, in fact EBIT margin almost doubled from 6.85% in 2007 to 14.66% in 2011. Winpak’s profit margin is one of its strength and it is among the group of companies with the highest margins in the industry.Significant growth in profit margins might not be possible for the next 5 years but profit margins can be improved with enhanced production efficiency. Return on equity was 7.4% in 2007 and it doubled to 14.6% in 2011. Decent ROE ratio shows the quality of the management team in delivering growth and efficiency gains. 

The ability to generate cash is one of the strength of the business. Record operating cash flow in 2011 is the result of high profit margins and modest sales growth. Winpak focus on its organic growth opportunities and spent a record $48.9 million on capital expenditure in 2011. Cap ex in the last 3 years was $21.4 million, $39 million and $48.9 million, this all covered by the operating cash flow of the company. The company was increasing its cash balance on the balance sheet in the last 4 years and the cash balance covers all the liabilities according to the latest quarterly report.

The dividend yield on the stock is low @0.81%. Although the company was growing at a modest rate over the last 5 and 10 year period, the dividend was not increased for over 10 years. The operating cash flow of the company is more than enough to cover all the capital expenditure and the dividend but the company’s priority is to grow the business instead of returning cash to shareholders.

Major shareholder:

Antti Aarnio-Wihuri of Finland holds 52% of the shares of Winpak as per INK company insider report. Winpak is closely aligned with Wipak, which is one of Europe’s leading manufacturers of packaging materials and is ultimately controlled by Wihuri Oy of Finland.  Antti Aarnio-Wihuri is the controlling shareholder of Winpak, Wipak & Wihuri Oy and he is the board chairman of Winpak since May 18 1985.

Recent analyst downgrade:

Two analysts cover the stock as per Reuters with 1 buy rating and 1 outperform rating. Earnings missed analyst estimate in the last 2 quarters by -12.3% and -8.8% .  In the past 90 days analyst downgraded EPS estimate of 2013 by -5.8% and price target was revised downward by -3.2%. 

Valuation:

PE ratio (trailing 12 months): 14.3 times

Median average PE (last 5 years): 12.10

Price to book value ratio: 2 times

Median average price to book value ratio (last 5 years): 1.46  

Price to cash flow ratio: 9.9 times

Winpak’s trailing 12 month PE ratio and price to book ratio are above the median values of the last 5 years. The company have reported record sales and EPS for 5 consecutive years and this is priced into the current stock price. The company seems to be fairly priced @ 12 times forward earnings, valuation is above peer average but the performance of Winpak is also superior.

The company’s cash and cash equivalents balance at the end of third quarter 2012 is $120.3 million. There is no long term debt and the cash on hand is enough to cover all the liabilities stated on the balance sheet. According to the annual information form “With the amount of cash on hand, existing term loan facility, an informal investment grade credit rating and the company’s ability to generate positive cash flow from operations, the company is in a good position to fund an acquisition if needed”. The valuation of the company’s share is above peer average and this increase the chance of Winpak in making an accretive acquisition. However, the management team of Winpak is conservative and they made two acquisitions only over the last 10 years (2002 &2008). The chances of Winpak making an accretive acquisition might be low due to its conservative management style.

Verdict:

Winpak is well-financed and is in a good position to pursue acquisitions that will result in a positive surprise in the share price. However, the track record of this management team seems to favor organic growth instead of mergers and acquisitions. The probability of an accretive acquisition might not be high but a dividend increase is possible if the company realizes they are not going to pursue a big acquisition in the medium term. A dividend increase might result in positive response in the share price in the near term.

The business of Winpak is well run and it is backed by a patient controlling shareholders with a long term view on the development of the company.  The growth target of the management team is reasonable. Winpak is a good company with good ROE numbers, stable growth & steady profit margins. You might consider adding it to your portfolio if you like good boring business with modest growth potential.

In the first 9 months of 2012 revenue increased 3.4% and net earnings increased 10.5% to 77 cents per share. Profit margin was more or less unchanged. It seems growth in earnings might slow down after 5 consecutive years of out-performance.  Recent analyst down grade of the stock is pointing to the fact that investor expectation might be high but not unreasonable.

Transalta - High Yield High Risk

Transalta tumbled almost 21% over the last 6 months and value investors are wondering if this is a good chance to pick up a good dividend paying stock at a bargain price. Transalta is known to be a company that paid stable dividends to investors over the years and its 6.72% dividend yield seems to be attractive right now. Let's investigate and find out if this is a good opportunity to pick up Transalta stock.

While the 29 cents quarterly dividends looks attractive, Transalta has not raised its dividends since 2008 and some analysts said the Transalta's dividend is too high relative to its earnings and the dividends is at risk. The payout ratio relatively to earnings of Transalta (Dividends/Earnings) was 128.9%, 116% and 88.5% respectively over the last 3 years while the payout ratio relative to cashflow was 43.6%, 31.5%, 37.4%. Looking at these numbers it seems the dividends looks safe but the company might struggle to raise it in the future because Transalta has been paying all its earnings to shareholders instead of investing it in promising growth projects

In December, 2010, TransAlta took Sundance 1 and 2 offline and the company then moved to terminate a “power purchase arrangement” (PPA) with TransCanada Corp., which had the right to buy the power from Sundance 1 and 2 at an attractive price. Transalta is currently involved in a contract dispute with Transcanada Corp and an arbitration hearing is schduled for April 2012 , with a decision expected in July. Should the decision go against Transalta, the company might have to pay a stiff penalties.

In a recent report, National Bank Financial analyst Patrick Kenny estimated a maximum financial liability of $363-million, consisting of $263-million in accrued penalties and $100-million in repair costs, assuming TransAlta takes six months to fix the units.
That could slice an additional $1.50 a share from NBF’s valuation of $19, said Mr. Kenny, who has an “underperform” rating on the stock.

Transalta will be in the penalty box until the contract dispute with Transcanada clears up. The stock price might pops if the hearing goes in Transalta's favor or drop if it goes in TransCanada's favor. Looking at the track record of Transalta, the growth in dividends has been at 3% and 1.5% over the past 5 and 10 years and dividend increase has been few and far between. As far as growth goes, there has not been much growth in the company's cash flow, earnings or book value. Looking into the future, investors have to consider if a 7% yield is worth the downside risk if the contract dispute goes against Transalta's favor.

For more info on Transalta, blogger Susan Brunner have a good overview of the company in her blog below:
Investment talk with SPBrunner
http://spbrunner.blogspot.ca/2012/04/transalta-corp.html

Globe and mail article: TransAlta: A stock that's run out of juice
http://www.theglobeandmail.com/globe-investor/investment-ideas/yield-hog/transalta-a-stock-thats-run-out-of-juice/article2383355/