MLFNF - Maple Leaf Foods: Undervalued And Poised To Outperform

• Maple Leaf Foods' margins have been pressured given a number of short-term events such as supply chain disruptions.
• MLFNF is positioned to reap the rewards from their long-term investments to markedly improve profitability.
• I believe MLFNF represents an asymmetric risk/reward opportunity.

Maple Leaf Foods ( MLFNF ) remains one of the most undervalued stocks in my portfolio and is poised to perform well in an inflationary environment. MLFNF is a Canadian protein food production company that has been under the radar for years. The stock has traded in a bounded range over the last few years, and I believe it is poised to outperform.

Recent Financials

In MLFNF's Q1 report, it reported strong revenue of $1.12B (up 6.7% y/y) and non-GAAP EPS of $0.03 per share. Additionally, despite the business being interrupted from a number of COVID impacts, such as inflation and supply chain disruptions, MLFNF was still able to remain on target to achieve their goal of 14%-16% of adjusted EBITDA margin in the Meat Protein this year.

In the quarter, the plant protein business grew 5%, and MLFNF's management guided for neutral or better adjusted EBITDA in the second half of 2023, which would mark a significant improvement from recent results.

Net earnings in the first quarter were $13.7M, which was a decrease from the same period last year when MLFNF had $47.7M. However, this decline was driven by relatively short-term factors, including COVID-19 operational and supply chain disruptions, and inflationary impacts.

Management summed up the challenges well in the earnings call :

Our Meat Protein revenues were strong, and they grew by 7.5% compared to the same quarter a year ago. While the Meat adjusted EBITDA margins were pressured as you can imagine in these conditions, the fact is - and dare I say - only 300 points of compression from a year ago is actually quite an accomplishment. If you can imagine, trying to operate a business with a third of your people missing 1 day, half of your ingredient supply not showing up the next, and suppliers jacking the price by 15% of another set of ingredients the next day, all repeating itself over and over and over during the quarter.

Equally, with the pricing now in the marketplace for Q2 and a stabilization of those effects, global conflict obviously aside and I will come back to that, we're still confident that we will get to the lower end of our 14% to 16% adjusted EBITDA margin by the end of the year. These are clearly unprecedented transitory effects in the first quarter, and we're working our way out of that for the balance of the year.

I'll delve into these challenges in more detail below.

MLFNF also increased its quarterly dividend by $0.02 per share from the same period last year, and it now stands at $0.20 per share each quarter, or $0.80 per share on an annual basis.

Finally, management provided important updates on capital expenditures. First, their new state-of-the-art poultry facility will be completed by mid-year and operations will be fully ramped up at the end of 2023. Once fully operational, management expects this facility will add $100M annually to MLFNF's earnings. Second, their new bacon facility will be fully operational by the end of 2023 as well, and they expect this facility will also add an incremental $30M annually to their adjusted EBITDA. Those levels of savings at a company with a market cap of roughly $2.4B is very impactful.

Negative Short-Term Impacts

This quarter was challenging for MLFNF for three principal reasons that MLFNF's management outlined in the earnings call :

There were three materials, but transitory factors that impaired and impacted our margins. The first factor was the rapid onset of the Omicron variant of COVID-19. The result was a tornado of severe short-term implications, including dramatically elevated levels of employee absenteeism at our facilities, disruption of production schedules, reduced labor efficiency, added overtime costs, and lower service levels.

To put this in context, we faced absenteeism rates of as much as 30% in our manufacturing plants. We're also impacted by a shortage of truck drivers, and we experienced incoming shipping delays to all of our facilities. Throughout the quarter, our labor availability gradually normalized, and we do not expect to experience lingering challenges related to absenteeism into the second quarter.

The second factor is the sustained effects of inflation. In February, we spoke about the acute levels of inflation we are experiencing in labor, commodity costs, packaging, ingredients, and freight costs. We shared that we had initiated a price increase to the market, effective for the beginning of April. That pricing action is now fully in market, and we will realize the benefits in the second quarter, which will contribute to a significant and sequential recovery of our margins from Q1. But we have obviously not priced for the potential implications of the war in Ukraine, and we are examining this closely, at which point we will respond with further pricing action as it becomes necessary.

Lastly, our operations in Western Canada were plagued by abnormally disruptive winter weather conditions, impacting our ability to transport hogs and finished goods. We obviously expect this will fully normalize heading into the spring. I am quite proud to say that despite this incredibly challenging environment, we were able to deliver exceptional top line growth, while continuing to advance our strategic priorities, setting us up well for the remainder of the year as we progress toward delivering the lower end of our 14% to 16% adjusted EBITDA target.

All three of these factors should abate in the coming quarters, as management guided. With vaccines becoming more prevalent and the COVID pandemic pivoting to an endemic phase, absenteeism should come down. Additionally, margins were compressed from elevated costs, but MLFNF was able to increase their prices, which wasn't effective in Q1, but now is effective and management said the higher prices haven't had a negative impact on sales. Finally, the especially disruptive winter conditions will obviously abate now that the winter is over.

Plant Protein

MLFNF was squarely focused on investing in growth in the plant protein segment but recently pivoted their focus and is now resolved to deliver profits from this segment. MLFNF already has a strong grasp on the retail channel and is now expanding on creating brand awareness to galvanize sales. In the foodservice channel, they launched Field Roast Chao Cheese at all 240 Biggby Coffee stores with Chao Cheese being featured in-store on their signature vegan bagel. They also announced a partnership with the leading cater York Street Market who will feature Lightlife and Field Roast in a number of their menu items. Finally, in Canada, Mary Brown's added Lightlife chicken tenders at over 200 locations and our Field Roast Italian Sausage Crumble was added to the menu at all 410 Booster Juice locations.

Management guided for adjusted EBITDA neutral or better by the second half of 2023, with a gross margin of 30%, which would represent a marked improvement from the negative 14% gross margins that the plant protein segment delivered in Q1.

In summing up the discussion on the plant protein segment on the earnings call, management said:

In summary, our Plant Protein business has a very, very solid foundation from which to grow, and we remain confident in our ability to pivot to profitable growth as we chart a new path forward.

Valuation

Maple Leaf Foods remains incredibly undervalued based on trading multiples and the future upside. During the earnings call , management noted this undervaluation with a helpful explanation:

Our view is that the equity of Maple Leaf Foods is seriously undervalued and, while of course that is not ours to determine, we do see a clear path to surface this value in three ways. The first is through pivoting the business model in Plant Protein from a heavy investment state to a moderated and EBITDA positive investment posture, which will occur in the latter half of 2023.

Secondly, we now have - and I pause for a moment on the statistic. 21% of our balance sheet today is in unproductive assets; unproductive assets, 21%, that defined as new plants that are in start-up mode. It's a remarkable statistic. In the next 2 years, these assets will go from unproductive to highly productive, generating the returns that we expect and that we invested in. And the third is once these two significant milestones are achieved, and they will be, we see the need to change the channel on the narrative of Maple Leaf Foods.

Maple Leaf Foods has been carefully engineered to not be a commodity meat company. We are a brand focused CPG company and we need to up our game in demonstrating this. We expect to demonstrate it by delivering best-in-class operating margins, which is the combination of our current performance and the returns on new plant start-ups will absolutely deliver. We expect to demonstrate this by generating significant cash flow, which will rapidly reduce the debt from our current investment period on our balance sheet.

MLFNF's management put their money where their mouth is and authorized a share buyback program to purchase about 10% of its public float . Management clearly believes shares are undervalued and is taking advantage of this low price to drive shareholder returns by purchasing stock back at this level.

Maple Leaf Foods trades at a discount to its peers. Hormel Foods ( HRL ) trades at a price-to-sale ratio of 2.1x while Sanderson Farms ( SAFM ) trades at .849x and Beyond Meat ( BYND ) trades at a healthy 3.486x price-to-sales. The only company in the peer group with a lower price-to-sales valuation than MLFNF's is Tyson Foods ( TSN ), which has a lower annual growth rate to MLFNF's. Additionally, MLFNF had a much earlier start on plant-based protein products and that division is becoming stronger and will likely be stemming losses soon, as discussed above.

Chicken prices have been surging with increased demand amid tight supplies . In 2021, Cargill and Continental Grain Company recognized the value of owning chicken producers and announced an offer to purchase Sanderson Farms for $203 per share.

This transaction is still pending and requires antitrust approval, which may not come given the consolidation in the industry. Sanderson Farms is the third-largest chicken producer, only behind Tyson and Pilgrim's ( PPC ). Others in the industry may realize the power of consolidation and may seek to acquire MLFNF at this current level, especially given that Maple Leaf Foods has been constructing a state-of-the-art poultry manufacturing plant in Canada that will be the largest single investment in the industry of the Canadian food industry . In discussing the plant, MLFNF's CEO stated:

The plant is expected to be one of the most technologically advanced poultry-processing plants in the world, incorporating leading-edge food safety, environmental, and animal welfare processes and technologies. Construction at the London site is expected to begin in the spring of 2019, with start-up planned for the second quarter of 2021.

ESG Angle

Maple Leaf Foods became the first major carbon-neutral food company in 2019 and further aims to reduce their environmental footprint by 50% by 2025. With institutional investors, such as BlackRock, and other shareholders increasingly pushing companies to reach ESG goals, MLFNF's carbon-neutral status is important. A recent WSJ survey evaluated 5,550 publicly-traded companies on ESG metrics and found that Nestle ( NSRGF ) ( NSRGY ) was the only food company scoring in the top 100. This industry needs to improve its ESG scores, and MLFNF can help a company in doing so.

Risks

MLFNF is a large and profitable meat producer at a time when consumers expect to pay more for meat, and demand looks very strong. There is not too much downside to MLFNF at this level. Nonetheless, if MLFNF is not able to optimize its supply chain and continues to face inflationary pressures on the supply side, and if demand dwindles from consumers and they do not accept the higher prices, MLFNF may languish at these levels.

Conclusion

MLFNF is poised to outperform and is currently trading at an undervalued level. Given the number of positives on the horizon, with the limited downside risk, I believe MLFNF represents an asymmetric risk/reward opportunity.

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