2023-07-11 10:29:02 ET
Summary
- Seneca Foods' stock has declined 40%+ ytd, and is trading at a cheap multiple and at a significant discount to its NCAVPS.
- This opportunity exists because Seneca was recently removed from the Russell 2000 index which caused forced selling.
- Despite the stock's decline, Seneca's financial results have remained solid, with revenue and adjusted earnings continuing to grow.
- I see Seneca trading at $61 per share by the end of 2023 as the earnings multiple expands.
- There are economic risks that could cause a decline in earnings, but Seneca's liquidation value provides a solid margin of safety.
Seneca Foods Corporation ( SENEA ) is not a high quality business nor is it necessarily an exciting business. As such the stock has not provided great returns over time as it’s up about 200% since the turn of the century and it’s about flat over the past 10 years. All of this is to say, the stock is not one that I would buy and hold for a long period of time as earnings compound.
This doesn’t mean that there will never be a good time to buy the stock. There have been many peaks and valleys with the stock price, and trading in and out of those would have provided fine returns. One of those periods was in Q4 of calendar year 2018. Seneca recorded a large LIFO charge that quarter and gross margin decreased from 8.1% in the prior year’s quarter to (0.4%).
This LIFO charge of $25 million was due to higher cost increases incurred for higher steel costs and lower yields for peas and corn. This led to the big drop in gross margin and the stock price gradually fell about 25% to about $22 per share.
At this point, the stock was trading at a discount to its net current asset value per share (NCAVPS) which was, including the LIFO reserve of $160 million, $34 per share. Along with this discount, revenue and earnings growth started to inflect upwards which caused the stock to rise and by the end of 2019, it was 70% above the low of that year.
I am discussing this story because I believe a similar dynamic is at play today. The stock has recently had a steep decline and is trading at a steep discount to its NCAVPS. I think this discount provides a margin of safety for an investment in the stock today. If earnings rise from where they currently are or if the earnings multiple rises closer to its average over the past few years, the stock should appreciate nicely. If not, the margin of safety from the value of the assets prevents further downside risk. In this article I will go into more detail about the business, its past financial performance, its valuation, and why the current opportunity exists.
Business Overview
Seneca is mainly a provider of packaged fruits and vegetables. They manufacture and sell private label products, branded products, and products for repackaging which are also used as ingredients by other food manufacturers. The company breaks its business down into 5 segments: canned vegetables, frozen vegetables, fruit products, snack products and other. The largest segment in canned vegetables, accounting for 83% of sales in fiscal year 2023. Seneca sells its products both domestically and internationally, but 93% of revenue came from domestic sales.
The packaged food industry is highly competitive but Seneca is one of the larger companies in the industry. According to the most recent annual report, Seneca is aware of at least 13 competitors in the U.S., some of which are privately owned.
Past Financial Performance
Seneca’s financial results from the past decade are nothing to write home about. Since 2013, revenue and operating income has been essentially flat. Despite this, the company has been repurchasing shares and the share count has dropped from 11.2 million to 7.6 million so earnings per share have increased.
In terms of quality, Seneca is not a great business. ROIC has not been consistent as earnings and cashflow have large fluctuations depending on the year. These fluctuations generally have to do with inventory positions of general commodities which experience price volatility based on external factors. Many investors don’t like owning businesses whose earnings are so effected by inventory prices as it makes it much more difficult to predict earnings over time. This makes investors less willing to pay a high earnings multiple for the stock. It also makes it even more important to invest in the stock at the right time, for example when the company has a low cost of inventory on hand and the prices of commodities start to rise.
Valuation and Why the Opportunity Exists
The investment thesis is relatively simple and it’s very similar to the situation from 2019 that I outlined in the first paragraph. However I think the current opportunity exists not only because Seneca’s GAAP gross margin and profitability have been declining for the past few years, but also because the stock was removed from the Russell 2000 index. This removal has led to forced selling from funds that track the index and has created the opportunity that exists now.
Seneca is currently trading for about $35 dollars per share and is down 44% year to date. I have calculated NCAVPS to be about $57 dollars.
This high liquidation value that is well above the current stock price provides a large margin of safety for investors.
Additionally, the GAAP results make earnings look worse than the economic reality of 2023 financial results. The lower gross margin was due to a $100 million non-case LIFO charge in 2023 which was driven by higher prices for steel, commodities, labor, ingredients, packaging, fuel and transportation. Adding back this non-cash charge leads to $106 million of adjusted earnings using FIFO accounting, or $13 per share.
In 2021 and 2022, the stock traded between 4-5.5 times trailing adjusted earnings using FIFO accounting. If the stock were to currently trade in this range using the $13 earnings per share I mentioned above, the stock would trade between $52 and $71 per share. This is right about where the stock traded before being removed from the Russell 2000. Taking the midpoint, I estimate Seneca will be trading about $61.5 per share by the end of the year. Interestingly, this happens to line up well with my calculation of NCAVPS of $57.
As I mentioned above, this is not a stock I would buy and hold for a long time so I think it makes most sense to begin selling shares if the stock gets to $52. Buying shares of Seneca now feels like more of an opportunistic trade than an investment and I would treat any appreciation of the stock as a chance to trim or sell all shares.
Risks
The main risk is that inventory levels have recently been replenished despite the recent higher input costs. If there is economic weakness that leads to reduced demand, the combination of higher cost inventory and lower revenue would hurt margins and profits.
This is also a microcap stock which generally means there is more volatility in the stock price, but average volume per day is about $2 million per day so there is not a big risk due to illiquidity.
Final Thoughts
There is currently an opportunity to purchase shares of Seneca due to its removal from the Russell 2000 index and the forced selling that came along with that. Despite this selling, financial results have remained solid. Revenue has continued to grow and while GAAP margins and profitability have declined, these declines don’t necessarily reflect the economic reality of the business as there was a $100 million LIFO charge in 2023 that reduced GAAP earnings.
Adjusted earnings per share in 2023 with the LIFO charge added back and subsequent tax adjustments subtracted was about $13. This puts the stock at 2.7 times trailing earnings. Over the past two years the stock has traded at between 4 and 5.5 times adjusted earnings and if this range were applied to 2023 adjusted earnings, the stock would trade between $52 and $71. I estimate the stock will be trading at the midpoint of these numbers by the end of the year, or $61.5 per share.
If the earnings story does not end up panning out from either a drop in earnings or a lack of investor attention, the stock’s current discount to its NCAVPS creates a solid margin of safety for owners. While this discount provides a high liquidation value, it is highly unlikely Seneca will liquidate its assets. This discount simply creates more of a floor for the stock price if financial results worsen over the next year in my view.
For further details see:
Seneca Foods: In Deep Value Territory