Saputo Inc. (TSX: SAP) produces, markets and distributes dairy products, including cheese, fluid milk, extended shelf-life milk and cream products, cultured products and dairy ingredients. The Company has a presence around the world through its Canada Sector, USA Sector, International Sector and Europe Sector, with products sold in over 50 countries. The Canada Sector consists of Dairy Division (Canada). The USA Sector aggregates the Cheese Division (USA) and the Dairy Foods Division (USA). The International Sector includes the Dairy Division (Australia) and the Dairy Division (Argentina).  

Investment Rationale

• Accelerating EBITDA growth: The firm recently unveiled its four-year Global Strategic Plan, which aims to achieve faster organic growth across all platforms. Under this plan, the company targeted Adjusted EBITDA to grow at a single digit growth over the next four years and expect to reach CAD 2.12 billion by the end of fiscal 2025. Around 70% of the Adjusted EBITDA growth would be expected from streamlining initiatives and improving operations and the remaining 30% of expected Adjusted EBITDA growth will come from improved sales volumes across the countries.

Source: Company

• Optimizing workforce and enhancing operations: To optimize and improve its operations, the firm is launching operations-focused projects in production, supply chain, and logistics. In lieu of this, the company is planning to transfer/shift its manufacturing equipment's and workforce from nearby sites to the company's new beverage plant in Port Coquitlam post transition phase. This attempt would decrease the cost duplication, and the advantage would be realized in the second part of the fiscal year. The business is also speeding up continuous improvement initiatives in Australia in order to optimize production.

• Expanding business in the USA: Carolina Aseptic and Carolina Dairy, which were formerly owned by AmeriQual Group Holdings, LLC, were recently bought by the company at a price of USD 118 million. We believe that by acquiring these companies, Saputo would be better positioned to capitalize on the rising demand for aseptic protein drinks and nutritional snacks, which would help the company's organic growth goals.

• Strengthening its Core: In the United States, the COVID-related overstock and continued overcapacity of mozzarella destined for the foodservice market sector has heightened competitiveness. As a result, the firm is concentrating on expanding into additional value-added areas in both retail and food service. The company is increasing its position in the retail sector, notably in the United States, where its activities have traditionally been geared toward food service.

• Accelerating product innovation: As a stated vision, the company is increasing its footprint in dairy alternatives while also extending its dairy range with new formats, flavours, and packaging. We believe the business is well on its approach towards becoming a leader in both the dairy substitute cheese and dairy alternative beverage categories, where it wants to establish a leading position. It recently acquired Bute Island Foods Ltd of the United Kingdom, an innovative maker, marketer, and distributor of dairy substitute cheese products for both the retail and foodservice market segments under the award-winning vegan Sheese brand, as well as private label brands. The firm is attempting to translate its success into worldwide sales, particularly in North America and Australia, which would enhance its cash flows.

• Increasing the value of ingredients portfolio: The company will soon launch activities to maximize the value of its whey, optimize key recipes to differentiate its market offering and strengthen and create commercial connections. Wisconsin Specialty Protein's Reedsburg plant was a major component in the creation of its goal to raise the value of its ingredients providing and enhance the portfolio in the United States and internationally.

• Consistent dividend distribution: Given the strength of a business over the past number of quarters, improved cost structure, strong balance sheet and solid cash flow, the company has paid a consistent dividend, which is noteworthy.

Source: REFINITIV, Analysis by Kalkine Group

• Strong liquidity: The Company's cash and cash equivalents totalled CAD 156 million as on June 30, 2021. In addition to these funds, it has unused credit facilities of CAD 1,841 million under bank credit facilities as of June 30, 2021. We believe the company is well positioned to face current market conditions given its strong balance sheet.

• A potential pullback on the cards: After taking steep correction from the higher levels, now the stock prices are hovering around the horizontal trendline support zone and prices are sustaining above the horizontal trend line support level of CAD 33.60. Moreover, the momentum oscillator RSI (14-period) is trading in an oversold zone which might indicate the possibility of the upside recovery from the lower levels.

Source: REFINITIV, Analysis by Kalkine Group

• Risks associated with investment: The group’s income is interrelated with international cheese and dairy ingredient market prices; hence, price volatility is likely to hamper the company’s profitability and cash flow. Increase in input costs coupled with changing consumers preferences may dampen the overall company’s performance.
  

Financial overview of Q1 2022 (in millions of CAD)

Source: Company

• In Q1 2022, the company’s revenue totalled at CAD 3,488 million, up CAD 97 million or 2.9%, as compared to CAD 3,391 million for the same quarter last fiscal year.
• Overall, sales volumes were higher as compared to the first quarter of fiscal 2021, mainly due to an increase in the foodservice market segment and, to a lesser extent, in the industrial market segment. However, sales volumes decreased in the retail market segment.
• Operating costs excluding depreciation, amortization, and restructuring costs stood at CAD 3,198 million, up CAD 174 million or 5.8%, as compared to CAD 3,024 million in the previous corresponding period. Higher operating cost was mainly due to the volatility in the dairy commodity market along with higher cost of raw materials and consumables used.
• The company reported lower EBITDA at CAD 290 million in Q1 2022 compared to CAD 367 million in the previous corresponding period mainly due to higher input costs such as transportation, fuel, consumables and packaging, which increased across the divisions due to inflationary pressures.
• The finance charges in the reported period came down at CAD 18 million compared to CAD 25 million in the previous corresponding period, mainly due to gain on hyperinflation derived from the indexation of non-monetary assets and liabilities in Argentina.
• On the back of lower EBITDA in Q1 2022, the company reported lower earnings before income tax at CAD 139 million against CAD 197 million in pcp.
• The company paid higher income tax at CAD 86 million compared to CAD 55 million in pcp. The increase was primarily due to one-time non-cash income tax expense of CAD 50 million.
• Primarily due to above discussed rationale, the company posted net income of CAD 53 million in Q1 2022, compared to CAD 142 million in the previous corresponding period.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which forms around 51.83% of the total shareholding. Jolina Capital, Inc. and Placements Italcan Inc hold the company's maximum interests at 31.52% and 10.27%, respectively. The institutional ownership in the stock stood at 19.86%, and ownership of the strategic entities stood at 41.95%.

Valuation Methodology (Illustrative): EV to Sales based Valuation Metrics

Note: Premium (discount) is based on our assessment of the company’s growth drivers, economic moat, competitive advantage, stock’s current and historical multiple against peer group average/median and investment risks.

Stock recommendation

The pandemic's disruptive impacts continued to harm the company's performance in the first quarter of FY22, with continuous swings in consumer demand, inflation, dairy commodity volatility, heightened competition, and supply chain hurdles dragging down the company's bottom line. Despite these obstacles, the company is confident that the mitigation measures are in place and the first wave of initiatives being implemented under its global Strategic Plan would enable them to deliver organic adjusted EBITDA growth this fiscal year, with a goal of reaching CAD 2,125 million by the end of FY25.

Furthermore, the company is pursuing appropriate pricing measures, as well as diversifying its business and boosting the profitability of its product portfolio, as seen by three recent acquisitions in dairy substitute cheese, value-added ingredients, and speciality cheese. Furthermore, the firm is streamlining and enhancing its operations in order to decrease cost duplication, and we expect the advantage to be realized in the second half of the fiscal year, which would be a key positive.

The company has paid a regular dividend based on the performance of the business over a number of quarters. Also, the stock is hovering near the horizontal trendline support zone, and we feel it is due for a price pullback. Therefore, based on the above discussed rationale and valuation, we suggest a "Buy" recommendation on the stock at the closing price of CAD 34.35 on September 10, 2021. We have considered Metro Inc, Alimentation Couche-Tard Inc, Maple Leaf Foods Inc etc., as a peer group for comparison purpose.

*Depending upon the risk tolerance, investors may consider unwinding their positions in a respective stock once the estimated target price is reached.

One-Year Technical Price Chart (as on September 10, 2021). Source: REFINITIV, Analysis by Kalkine Group

*The reference data in this report has been partly sourced from REFINITIV.

*Recommendation is valid at September 13, 2021 price as well.

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