This article is derived from a stock pitch that that made it to the final round of the Investors of Tomorrow stock pitch competition a few weeks ago. You can download the pitch here. All information in the pitch is as of February 15th, 2021. If you have any feedback or additional insight on this topic, please reach out to me on LinkedIn or email me at firstname.lastname@example.org.
Maple Leaf Foods (TSE: MFI) is the largest public packaged meats company in Canada offering meat and plant protein products. The company sold its meat rendering and bakery businesses in 2013 and 2014 and entered the plant protein market in 2017 and management has stated their intention in a recent earnings call to keep plant protein in a “prominent position…in the long-term playbook”. Therefore, while plant protein only accounts for 5% of total revenue today (the rest is meat protein sales), it’s expected to be a large part of the company’s future. The company is relatively large as well ($3B market cap, $3.8B EV) and sells to customer around the world, with primary end markets in Canada, the US, China and Japan.
Maple Leaf Foods’ value chain is pretty easy to understand. The company produces hogs and poultry in its production facilities, sends the meat over to one of hundreds of meat processing plants and finally ships the processed meat to one of 2 distribution centers in Canada. From there, the meat is sent to end markets around the world including grocery retailers, foodservice and food manufacturers.
As a mature company, MFI grows its revenue at a modest rate (3.4% CAGR from 2015 to 2020). More interesting however, is the different strategies that management is using to grow the company and respond to secular trends. As consumers embrace plant protein, MFI has started rapid expansion in the space and is sacrificing profitability to do so. Improving margins and revenue growth in the meat protein segment offer the stability needed to pursue this aggressive growth strategy in plant protein and it seems to be paying off so far.
From a credit and liquidity perspective the company is doing fine. Debt/EBITDA is creeping steadily to 2.9x (the industry average is 3.0x), up from 1.0x two years ago. However, asset coverage (403%) and interest coverage (6.1x) remain high and should provide easy access to capital in the future. Additionally, MFI is the only Canadian company with sustainability-linked credit facilities containing targets which, if achieved, allow the company to amend interest rates starting in 2021. Therefore, it can be expected that interest coverage will increase in the near future as well.
As far as industry trends go, the signs are rather positive. The global meat-alternative market will grow at a 15.6% CAGR through most of the next decade and meat protein has been growing as well, albeit slower. While reduced demand for meat from foodservice has hurt MFI and its peers, retail meat sales are up significantly, with retail plant and meat sales in the US up 61% and 28% during the pandemic.
Thesis I — Market Overreaction to Rising Hog Prices
In response to growing meat protein demand at the peak of the pandemic, suppliers began producing more hogs. However, once demand began to subside, it led to a backlog of hogs. The oversupply of hogs pushed prices down from its high of $0.97/pound in 2019 to almost $0.40/pound in mid-2020.
Hog prices are starting to rise again and this has investors worried as hog prices are a key raw material for meat protein companies. Shares of MFI and its peers have fallen more than 5% YTD.
However, MFI, relative to its peers, is insulated from this cyclical shift since the company owns more sows than its public and private competitors and therefore, can produce its hogs without the fear of market volatility. MFI owns approximately 64k hogs, while Olymel and HyLife own approximately 52k and 50k hogs respectively. Therefore, I expect MFI’s operating margin (9.3% in 2020) which is already higher than its peers (8.0%) to diverge further from its peers as peers are more susceptible to market volatility.
Thesis II — Unrealized Potential of MFI’s Recent Acquisition
On January 11th 2021, MFI announced the acquisition of a plant protein facility in Shelbyville, Indiana. MFI’s share price fell and continued to do so for days following the acquisition. However, when other peers like Tyson Foods and Hormel Foods announced their entry and expansion into the plant protein market, their share prices saw jumps of 2% and 3% respectively.
I believe that the market has not yet realized the acquisition’s potential. During MFI’s 2020 Q4 earnings call, the company said that the plant will produce an estimated 4.5M+ kg of tempeh (a natural product made with fermented soybeans) annually. This will account for roughly 1.8% of total US tempeh production starting in 2022. It’s evident that management intends on expanding in this space as they stated that they intend on pursuing a “scalable approach to meet…demand for tempeh products”. Tempeh is also expected to grow at a 5% CAGR through 2027 and I believe that the acquisition has potential because it allows MFI to capture market share right as tempeh is entering the mainstream.
Thesis III — Expansion Opportunities in the Far East
In 2020, a novel strain of African Swine Flu spread throughout many Eastern countries including China and Japan. This disease has reduced the countries’ supply of hogs and as a result, pork imports have increased considerably in these two countries over the last year as these countries source meat from overseas.
I believe that MFI has the opportunity to develop a strong competitive advantage. 15% of the company’s revenue already comes from China and Japan so the company has a relationship with Chinese and Japanese end markets. Therefore, MFI can capitalize on this opportunity by signing long-term contracts to supply hogs. Since other major Canadian meat companies have yet to set up operations of this scale in the region, this can be a significant driver of MFI’s earnings growth in the future.
Please see the file linked above to explore this in greater detail but a comparable companies analysis suggests that MFI trades in line with peers at the moment. Since I believe the market has yet to price in MFI’s competitive and operational advantages, the company will trade at higher multiples in the future. A DCF has also been included in the stock pitch and my assumptions present a 34.5% upside with an implied share price of $32.72.
Maple Leaf Foods is one of the most notable brands in the Canadian meat and plant protein industries and I believe that the company is an attractive long-term investment.
As I mentioned earlier, if you have any feedback or additional insight on this topic, please reach out to me on LinkedIn or email me at email@example.com.