What's Wrong With Saputo? (TSX:SAP)

For years, Saputo (TSX:SAP) was one of the best performing stocks on the entire Toronto Stock Exchange.

The bull case was summed up something like this: Saputo started in Montreal, expanding by gobbling up competition first in Canada and then into the United States. Then it bought assets in Europe, more in the United States, Argentina, Australia, and, most recently, in England. Since dairy is largely a regional business, the thought was the company could replicate this strategy until it owned a significant chunk of the worldwide market.

People bought the story and the stock performed exceptionally well. It was a huge winner between 2000 and 2015 with the price (split-adjusted) increasing from $3 per share all the way up to the $50 range.

But oh how the turntables have turned.

Saputo shares have been on a steady march lower over the last few years and recently showed up on the TSX’s 52-week low list at just over $30 per share. That’s a 40% decrease despite the overall market growing nicely.

Here’s the recent carnage in chart form:

So what’s up with Saputo? Is it a good buy today, or is the company doomed to head even lower? Let’s take a closer look.

Recent history

Saputo’s latest quarterly results painted a mixed picture.

The Canadian part of the company is doing fine. An increase in foodservice business helped the top line improve 5.2% and adjusted EBITDA to increase by nearly 10% compared to results last year. Since it basically controls the Canadian dairy market the company has had good success pushing through price increases to offset higher production costs.

The story is much different from its U.S. operations. Sales were up more than 6% but adjusted EBITDA fell more than 40%. The company highlighted price pressure in the market and heightened competition in mozzarella as reasons for the crummy quarter. Unfavorable exchange rates also hurt the bottom line when converted back to Canadian dollars.

Both the international and European divisions of the company reported even worse numbers. Both saw revenues decrease as supply chain challenges and increased competition for raw materials ate into both the top and bottom lines.

It all translated into a quarter where overall revenues increased by 2.9% and net earnings fell 62.7%. Even after adjustments, the bottom line decreased by nearly a third compared to 2020.

That is… not great.

Even as we look back over the last few years, a similar story emerges. Saputo consistently increased its top line from 2016 to 2020, with overall revenue increasing from $11B to $14.3B. Operating profits, meanwhile, actually went down during that time. They decreased from $975M to $963M. Results were even worse on a per share basis as the company issued approximately 15 million shares to help pay for acquisitions.

It’s also interesting how Saputo’s dividend really telemarked the challenges the company faced. After more than a decade of double-digit dividend growth, the last four dividend increases are as follows:

$0.64 to $0.66 per share$0.66 to $0.68 per share$0.68 to $0.70 per share$0.70 to $0.72 per share

After spending years with a payout ratio of under 25% of earnings, the payout ratio has crept up to the 50% range. For a company that spends a lot of capex and acquisitions, this is not ideal.

Analysts aren’t really bullish in the short-term, either. They estimate Fiscal 2022’s earnings will end up in the $1.60 to $1.65 per share range, which is right around where the bottom line has been over the last few years. They predict factors like increased wage pressure and poor overall outlook from the U.S. business will continue to keep earnings suppressed. There are also bargains all over the sector, with many of the other big food manufacturers trading at even lower multiples.

Investors are also bearish because, quite frankly, Saputo is mostly in a commodity business without a lot of pricing power. It has operating margins in the 9-10% range, much lower than the 15-20% range enjoyed by many of its competitors.

The recovery

The company is well aware of criticisms and has embarked on an ambitious plan to increase profits.

The Global Strategic Plan plans to use a combination of cost cuts, product innovation, and overall business strengthening initiatives to grow adjusted EBITDA to $2.125 billion by the end of fiscal 2025. That’s a 44% increase compared to 2021’s annual numbers.

The breakdown goes as follows:

The company has all sorts of growth drivers planned, including further expanding local cheese and butter brands to other markets, increasing the value of the ingredients portfolio through acquisitions and strategic partnerships, and using its newly expanded Port Coquitlam facility to produce fluid milk and expand into the dairy alternative beverage production. That last bit could be interesting.

The company has also indicated it plans to be active acquiring other dairy companies, particularly in Western Europe and the United States.

The five strategic pillars to boost growth look like this, from a recent investor presentation:

If Saputo can execute its recovery plan and adjusted earnings do increase 44% compared to 2021, that increases the expected bottom line from $1.74 per share in 2021 to $2.50 per share in 2025. Slap a 20x multiple on that — which is low compared to the multiple it enjoyed in the early-to-mid 2010s — and we’re looking at a $50 stock. Add on the dividend and you’re looking at a total return of about 70% over the next 3-4 years. Not bad.

Saputo trades at just under 18x trailing adjusted earnings today, so I don’t think a 20x multiple is out to lunch. I can easily envision a world where a couple of good acquisitions boost the bottom line even more than expected and the stock ends up in the $60 range.

The bottom line

If you would have asked 2014 Nelson if 2021 Saputo would be a turnaround story, the answer would have been an emphatic no. The company had always executed exceptionally well.

The tricky part is figuring out whether the company can turn things around and get back into investors’ good books. If the answer is yes, it’s a screaming buy today. And even if you lean towards no, I’d argue there isn’t very much downside left at today’s price. Hell, the company hasn’t been this cheap since 2015.

This looks to me like one of those coin flip situations I’ve talked about before. Heads I win, tails I don’t lose much. I like those odds.

Disclosure: No position in Saputo as of this writing