TSN - WH Group: An Attractive And Investable Exception

2023-04-23 08:32:29 ET

Summary

• WH Group is an overlooked, undercovered, undervalued consumer staples firm.
• While it benefits from undervaluation, high dividend yields, and respectable financials, it faces significant geopolitical and domestic political risks, and was embroiled in scandal less that two years ago.
• Although the risks associated with this firm would ordinarily make investment in it a nonstarter, I think the risks here are sufficiently mitigated to justify a speculative buy rating.

Introduction

The week before writing this article, a potluck was held at my workplace for reaching a significant milestone. Dietary options were limited at this event, so I ate multiple plates of meat, including some of the tastiest sausage I have had in years. Days later, as I recovered from stuffing myself with such a hearty and savory meal, I found myself perusing stocks on my watchlist. Among them were my “meat kings,” a collection of three publicly-traded top global producers of certain meats. My mind was taken back to that potluck, and I realized that in contrast to how much I appreciated the sausage I had that day, one of the meat kings, pork producer WH Group Limited ( OTCPK:WHGLY ) ( OTCPK:WHGRF ), was severely underappreciated by the authors/analysts of Seeking Alpha. Having observed WH Group for a few years now, I have decided to break its 3-year dry spell in coverage on this site, and give my opinion on this name.

What is WH Group?

The company is a major pork producer based in Hong Kong. The firm is supposedly known in some countries as Shineway; previously officially named Shuanghui International Holdings Limited, the firm changed its name in 2014 to WH Group, short for “Wanzhou Holdings Group.” Its full name roughly translates to “eternal global holdings group,” a nod to its global aspirations.

WH Group started from humble beginnings in 1958, from owning a single plant to credibly claiming to be the largest meat producer in China by 2013. After acquiring American pork giant Smithfield Foods the same year, WH Group became one of the largest pork producers in the world by 2020, earning the prestige of its new name.

There are many other facets to this firm, but this is the backstory of WH Group that one needs to know in order to get introduced to the company.

Why I Like WH Group

WH Group is a meat producer, placing it firmly in the consumer staples category. While I typically prefer to invest in companies in energy, technology, or manufacturing that seem poised for several years of double-digit growth, I recognize that many long term investors are more comfortable balancing these types of investments with reliable firms that can weather bad financial conditions, such as the ones we are in now . Consumer staples firms are a perfect way to hedge against risk for the long term, as their products are necessary for consumers in any market condition, limiting the risk of reduced demand during a downturn. Food companies like WH Group are an excellent example; everyone needs to eat, and many people will choose to eat pork. This guarantees food companies many years of future success if their businesses execute well. However, WH Group has a few advantages over even the average food company.

WH Group’s chief product is pork. Not only is pork beloved by citizens in China , WH Group’s domestic market, but WH Group itself is also a major player in China’s far-reaching global pork industry . China’s pork industry supplies most of Asia with the continent’s supply of pork products, and the country was the leading producer of pork as of 2022. With WH Group as one of China’s leading producers and exporters, and with the pork industry itself set to grow by almost 9% per annum until at least 2028, the company is well-positioned to sustainably endure most market conditions while selling products made from one of the world’s most popular meat sources.

WH Group’s Financials

As a part of the consumer staples sector, steady growth and sustainable profits are what make for a financially attractive firm, and WH Group delivers here. Excluding outlier year 2013, the year before revenue and other metrics at least doubled after acquiring Smithfield Foods, WH Group maintained a stable top line number of about $21-22 billion between 2014 and 2018. Beginning in 2019, a degree of revenue growth occurs, with a noticeable increase to $24 million, $25.5 billion, $27 billion, and $28 billion for each consecutive year from 2019-2022. Some of this is likely due to pandemic related shortages and a bout of swine flu that rocked Chinese pork production for a time.

As revenues increased, gross profit saw no change, ranging from $4-5 billion from 2014-2022; notably, though, gross profit was less than $2 billion in 2013. Net income went from a loss of $260 million in 2013 to consistent positive incomes $750-800 million in 2014 and 2015, ~$1 billion per year from 2016-18, ~$1.4 billion in 2019, a slump to ~$800 million in 2020, a bounce back to ~$1 billion in 2021, and a return to ~$1.4 billion in 2022. Lastly, cash flow from operations, previously only ~$700 million in 2013, immediately doubled to ~$1.5 billion in 2014, staying roughly in this range from 2014-19, jumping to $2.3 billion in 2020, and leveling off to $1.8 billion in 2021 and 2022.

These financials demonstrate two things: 1) WH Group has a profitable and sustainable business that makes a financially viable consumer staples firm, and 2) WH Group’s purchase of Smithfield was a brilliant idea for boosting its financials, proving to be well worth the cost of the acquisition in the long run.

WH Group’s Valuation

In addition to attractive financials, WHGLY/WHGRF has an attractive valuation. WHGLY/WHGRF has a Price to Earnings GAAP ratio of 5.5, a Price to Sales ratio of ~0.27, a Price to Book ratio of 0.79, and a Price to Cash flow ratio of ~4.6. Without the context of its sector’s metrics, multiple measures of WHGLY/WHGRF imply fair or undervaluation, making it a viable value stock in the context of its strong and steady financials.

With the added context of its sector’s ratios, WHGLY/WHGRF looks even better. Valuation metrics in the consumer staples sector are as follows: P/E GAAP of ~22, P/S of ~1, P/B of 2.5, and P/Cash flow of 16.

With beaming financials, a lack of investment coverage, and clear undervaluation, WHGLY/WHGRF may be one of the few value stocks investors and analysts missed while pivoting to defensive names during the market crash last year. Remarkably, it appears to still be undervalued today, ripe for value investors interested in an overlooked consumer staples firm.

WH Group’s Competition

As I mentioned earlier, WH Group is part of a group of three companies I call the meat kings. While I won’t mention one of them here, as I may write it up in a separate article, I will compare WH Group to the other meat king, Tyson Foods, Inc. ( TSN ).

Where WH Group specializes in producing pork, Tyson excels at producing chicken. Similarly to WH Group, Tyson’s flagship food is also the most popular meat in its home market, the United States; Tyson’s main meat also enjoys significant international popularity that insulates it from unfavorable market conditions.

This makes both firms solid defensive plays for long term investors, especially since the chicken market, like the pork industry, is also set to grow throughout this decade. Suffice to say, these two firms are sufficiently similar for further apples-to-apples comparisons in my view.

WH Group vs Tyson – Diversification

Regarding diversification, since its acquisition of IBP, Inc over two decades ago, Tyson has become one of America’s largest producers of pork and beef as well, making it a massive producer of multiple types of meat beyond just chicken. This grants Tyson an edge in product diversification that WH Group does not have, offering added resiliency one might prefer in a consumer staples company, and making it a more attractive investment in the space on this basis.

WH Group vs Tyson – Financials

Comparing the financials of these two companies, while WH Group doubled revenue after 2013, stabilized for a few years, and gradually increased since ~2018, Tyson followed a similar path, with revenues staying in the ~$30-40 billion dollar range until 2018, after which point the company reliably stayed above $40 billion and climbed steadily to over $53 billion in 2022. Tyson’s gross profit sharply jumped from the $2 billion range in 2013 and 2014 to the $4-5 billion range in 2015, where it hovered until 2020, after which it jumped to the $6 billion dollar range. Tyson’s net income and operational cash flow both steadily increased from 2013 to 2022, with net income rising from $780 million to $3.2 billion in that 10 year timespan, and operational cash flow taking a bumpy ride from $1.3 billion to $3.8 billion from 2013 to 2021, before taking a noticeable dive in 2022 with op. cash flow of about $2.6 billion. From this data, it seems Tyson requires more revenue than WH Group to generate similar amounts of profit and cash flow, indicating a less efficient, lower margin business. This difference may be due to greater costs/complexities involved in managing the added diversity of Tyson’s business.

WH Group vs Tyson – Valuation

While WHGLY/WHGRF had metrics far below the sector averages, TSN is only moderately below the averages, with TSN sporting a GAAP P/E of 9, P/S of 0.4, P/B of ~1.1, and P/Cash flow of ~9. TSN and WHGLY/WHGRF generate similar amounts of profit and cash flow, as highlighted in the financials, yet investors are paying a bit of a premium for TSN over WHGLY/WHGRF, as demonstrated in TSN’s less attractive valuation ratios.

On a strict valuation basis, both of these names are cheaper than the average consumer staples stock, but WHGLY/WHGRF is a better deal for value investors, given the slightly stronger financials and greater undervaluation.

WH Group vs Tyson – Dividend

Regarding dividends, WH Group has paid a dividend that has fluctuated significantly in absolute terms. The company has bounced from an annual dividend of $0.69, to $0.51, to $0.81, to $0.45, to $0.48 for each consecutive year of the 2018-2022 period. Compare this to Tyson’s more predictable increasing dividend amounts of $1.28, $1.55, $1.71, $1.80, and $1.86 for the same period. Dividend investors, especially retirees, may prefer Tyson’s more consistent growth in dividend payout over WH Group’s lumpy distributions.

However, what WH Group lacks in consistency, it makes up for with a higher yield – WH Group’s dividend yield has averaged almost 4% over the past 5 years, compared to Tyson’s average yield just over 2%. WH Group also has a higher yield right now, at around 4% compared to Tyson’s 3%. Lastly, both WH Group and Tyson have dividend payout ratios of ~28%, indicating relative dividend safety for both firms at time of writing.

WH Group vs Tyson – Summary

In sum, while Tyson may have the edge in product diversification and dividend growth, WH Group has a superior dividend yield, greater undervaluation, and better margins on its business. It will be up to investors to choose which traits they prefer in their consumer staples firms, but for me, WH Group is the better pick when considering these factors. Even though the firm’s choppy dividend makes for a roller coaster of an income stream, and even though its less-diversified business leaves it quite vulnerable to pork-specific pitfalls like swine flu, WH Group’s lower valuation and higher yield results in more bang for my buck, and I would be fairly comfortable stomaching the extra risk and dividend fluctuations involved in owning this firm to gain these benefits, especially with its leaner and higher-margin operations.

Why I Dislike WH Group – Investment Risks

To be frank (pun intended), most of what I dislike about the prospect of investing in WH Group stems from external factors unrelated to the company’s business operations or financials.

To start, the firm is headquartered in Hong Kong. This wouldn’t have necessarily been a negative in and of itself just a few years ago, as Hong Kong was a politically separate entity from the greater mainland China. However, in recent years the People’s Republic of China forcibly, and arguably illegally , transformed the relatively politically liberal hub of Hong Kong into a new territory of the larger, autocratic country.

I have a general rule against investing in firms based in autocracies or other illiberal nations. This is due in part to moral and ethical concerns of placing capital in those nations, but also due to empirical evidence of reduced returns from investing in such firms, evidence that I detailed in a previous article on Seeking Alpha. Since the People’s Republic of China has, for all intents and purposes, legally captured Hong Kong, WH Group is now based in a province of an illiberal nation. Consequently, this makes it subject to the concerns I have about investing in firms in illiberal nations.

As relevant to Chinese firms generally, readers should be aware that due to the variable interest entity [VIE] structure of most Chinese stocks, non-Chinese investors cannot own shares of the actual Chinese company; they can only own shares in a shell company based in the Cayman islands that has a financial relationship with the real company. Investing in VIEs is generally associated with greater risk for investors, and based on language stating that WH Group is incorporated in the Cayman Islands , it too is likely engaged in riskier VIE structuring.

Further, there are the ethical concerns to consider. Legally, every Chinese company is at the beck and call of the Chinese government and must cooperate with the Chinese security apparatus. When investing in any Chinese stock, investors must consider, for example, whether they are comfortable giving capital to a firm in a country whose government can, at any time, instruct the firm to direct its capital and revenues toward funding the government’s military projects and other activities for illiberal purposes. Indeed, many Chinese firms doing business abroad, particularly in America, have been found to have under-the-radar links to China’s military, including BYD ( OTCPK:BYDDY ) ( OTCPK:BYDDF ), Huawei , ByteDance (parent company of TikTok), and others.

Aside from the inherent risks of invested capital being used to fund the activities of a relatively hostile geopolitical adversary , there is also the risk of underperformance by WH Group compared to other large meat producers like Tyson. China’s government could, on a whim, interfere with market forces and industry dynamics in ways that hurt WH Group’s performance, as seen with China’s crackdown on Ant Group , China’s decimation of its gaming industry , and China's destruction of its private education sector . Any industry, including the food industry, could be the next victim of the Chinese government’s capricious attitude toward business ventures in the country, especially since the government legally controls them all.

All these issues have earned Chinese companies increased scrutiny from American regulators, and have triggered threats of mass delisting of Chinese stocks from American stock exchanges, though this risk has eased in recent months . As a firm that is traded on the OTC Market and the Hong Kong Stock Exchange, WH Group is relatively safe from these US delisting threats, but the possibility of increased scrutiny and adverse actions being taken still remains so long as geopolitical tensions between the West and China persist.

As for risks specific to WH Group itself, the company found itself embroiled in public scandal in 2021 regarding accusations surrounding questionable managerial decisions, questionable business decisions, and possible deceptive business practices, per Fortune . The fallout from this scandal saw the departures of WH Group’s founder and his eldest son, the latter of whom was the one who made the accusations against the firm and management. If true, the shady operations of WH Group may eventually be investigated by Chinese regulators or other regulatory entities, resulting in not just negative publicity for the firm, but also various punishments if the accusations are found to be true in subsequent legal or regulatory proceedings. None of these outcomes bode well for the company if things don’t play out in its favor on this front.

Why I Think the Benefits Might Outweigh the Risks

Despite the significant risks of investing in WH Group, I think the benefits of investment may be greater than the risks, possibly substantially, greater.

First, the new wave of swine flu in China stands to keep pork supply low and keep WH Group’s revenue high, bolstering the company’s financials overall.

Second, regarding geopolitical and ethical risks, WH Group might be lower risk than the average Chinese firm, due to its sale of an uncontroversial product. Pork meat can only be used for one purpose: to feed people. While the Chinese government could force the company to direct funds and food toward its military, or toward other entities in its pursuit of geopolitical power, it can’t direct the company to use its products to spy on foreigners, steal trade secrets, collect customers’ user data, or engage in other such activities; this is obviously a possible risk with products from Huawei, ByteDance, etc. Thus, the risk that capital given to WH Group will be used by the Chinese government for espionage or military purposes is reduced compared to other Chinese companies, mitigating ethical concerns of investing in the name and reducing the likelihood that WH Group faces subsequent adverse regulatory actions from China’s geopolitical rivals.

Third, regarding the public WH Group scandal, there have been no substantial updates since 2021, and the business appears to be operating smoothly with no clear signs of mismanagement or deception. Since there is no apparent investigation or pending litigation against the firm related to the allegations, I will assume that no news is good news, and that the allegations were either a nothingburger, or will be overlooked by the relevant authorities for the foreseeable future. Either way, regulatory risk on this matter can perhaps be ignored for now, though investors may want to keep in mind the allegations raised, just in case similar claims against the company spring up again, establishing a possible pattern of corporate behavior.

Conclusion

WH Group Limited is a firm with some substantial risks and substantial benefits. It is a consumer staples company producing large volumes of a desirable and popular product domestically and internationally, and it is significantly undervalued while offering a safe, sizable dividend yield backed by solid financials. Despite being headquartered in an autocratic country, which should ordinarily make investment a nonstarter, I think WH Group is one of the safest such companies that investors could bet on for the long term.

For long term investors looking for sustainability and safety, as well as large production numbers, revenues, and margins, WH Group should be considered as part of their portfolio. Accounting for all the risks and benefits, I therefore rate WHGLY and WHGRF a speculative buy.

For further details see: