1. Is the company undervalued?
EV/EBIT: 10.01
Price/Sales: 0.96
Price/Book: 2.51
Sanderson Farms trades at a large discount to the market, while offering investors consistent revenue growth. With that said this by no means a compounder or highly profitable business. However, $SAFM has the potential to delivery above market returns in an extremely durable and low risk industry.
2. Can I easily explain what the company does?
Yes, they produce and process chicken.
3. Does the cash flow statement line up with income statement?
Yes, cashflows have been consistently higher than reported earnings:
Most of their free cashflow went towards capital expenditures, debt repayment, and dividends. I have absolutely zero issues with these capital allocation decisions.
4. Is the Balance Sheet Healthy?
Total Debt: $30.92M
Total Cash: $245.4M
Current Ratio: 2.93
FORTRESS BALANCE SHEET!!!!
5. How profitable is the business?
Gross Margins: 15.14%
Operating Margins: 9.62%
ROIC: 18.33%
10-yr Revenue CAGR: 6.4%
As you can see $SAFM is a below average business and the trailing 12 month data is actually overstating their profitability:
While their margins are woeful, Sanderson Farms appears to be making solid capital allocation decisions as evidenced by relatively high ROIC, ROE, and ROA. Furthermore their revenue growth is impressive and considerably more predictable than other industries IMO. All in all, $SAFM is a better business than their margins would indicate.
6. Is management rewarding shareholders?
Sanderson Farms offers a 0.94% dividend, but no share repurchases. In fairness they’re not issuer of equity either, but given their strong free cash flow I would prefer to see more shareholder love from management.
7. How does the company stack up against their peers?
Pilgrims Pride Corporation $PPC is $SAFM’s biggest competitor:
$PPC Price/Sales: 0.49
EV/EBIT: 48.9 (this is overstated)
Operating Margins: 1.41
$PPC had negative earnings in June of 2021 if we replace that with 2020 numbers a “normalized” EV/EBIT would be 28.5, which is still much more expensive than $SAFM. Furthermore margins and revenue growth have been similar for the two historically. However $PPC offers no dividend and has significantly more debt, which makes Sanderson Farms the most attractive investment.
8. What’s the counter argument?
The counter argument is that margins are at a cyclical peak and earnings will fall sharply in the coming year.
This argument makes sense to me given that Sanderson’s feed costs are up almost 50% YOY. I’m skeptical that $SAFM will be able to pass these costs on to their customers. Moreover if we apply Sanderson’s 10-yr average operating margin to last year’s revenue, their EV/EBIT would be 16.11. 16X is probably a fair multiple given the nature of $SAFM’s business and leaves no room for a multiple re-rate.
9. Is the company unsexy, uncool, or contrarian?
$SAFM has 8 analysts covering the firm with; 4 holds, 1 outperform, and 3 buy ratings out. I was surprised to see this level of excitement coming from Wall St. and for that reason I would consider the stock to be consensus. With that said $SAFM is certainly unsexy and uncool, as this is a rust belt stock.
10. Is there something I think the market may be missing?
Mr. Market seems to be sniffing out Sanderson Farms’ higher than normal operating margins. Nonetheless their balance sheet has significantly improved and frees up meaningful cash for management moving forward. I would not be surprised to see a share repurchase plan announced shortly, which is likely not priced into today’s valuation.
Final Thoughts:
$SAFM offers a nice risk adjusted bet for conservative investors. However it’s difficult to forecast what margins will be in the future and 6% revenue growth doesn’t exactly knock my socks off. Moreover there’s been massive wreckage in small cap value land and much better opportunities elsewhere. For that reason it’s a pass and something I most likely will not keep watching.
***Disclosure: I have no position in the security mentioned above, nor do I have any plans to purchase within the next 72 hours. This article is intended for educational purposes only and in no way should be interpreted as investment advice