|Shares Out. (in M):||214||P/E||na||10x|
|Market Cap (in $M):||1,980||P/FCF||na||na|
|Net Debt (in $M):||1,270||EBIT||82||420|
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We believe a long position in Pilgrims Pride (PPC) offers 40% upside under reasonable scenarios and a chance to more than double under a best case scenario. In terms of risk, there is good downside protection in the form of an expected buyout and a recent liquidation value appraisal while in bankruptcy 25% higher than current enterprise value. With a JBS road show on the come, and no sell-side coverage, there are plenty of catalysts over the next few months. Furthermore, after one of the worst chicken cycles experienced in recent memory, the industry is behaving rationally in regards to supply and is on track for a strong year.
PPC is an under the radar, special situation with a near term catalyst. PPC is a long because it appears to trade at 8x 2011 fully taxed EPS with ¾ synergy potential baked in, but could be as cheap as 5x if one uses bankruptcy projections margin estimates with full synergy credit baked in. Peers (TSN, SAFM) trade at 10-12x 2011, suggesting as the PPC story becomes more widely known there could be 40-100% + upside if it carried a similar multiple. It is highly likely PPC will be acquired over the next 6 months by their majority stakeholder, JBS USA, who is quite enthusiastic about the opportunity for synergies and could hype them in their road show.
How realistic are our assumptions? Our base case seems highly conservative and the best case which uses bankruptcy projections & synergies are not a stretch; management noted in their recent conference call that the business was tracking in line with bankruptcy estimates, but to not take them as guidance. Bankruptcy estimates do not include synergies.
In addition, PPC has a 1B NOL that is worth ~ $1.25 per share, or ~15% of the equity, not included in EPS above.
Pilgrim's Pride is the largest producer of poultry in the US with ~ 20% market share. Pilgrims went into Ch.11 bankruptcy in 2008 and emerged in Dec 2009. While in bankruptcy, JBS SA, A Brazilian beef producer acquired 64% of Pilgrim's equity for 800m, with the right to buy the rest post a US IPO. The JBS infusion provided Pilgrim's with the liquidity to exit bankruptcy. JBS is currently in the process of raising ~2B via an IPO of their US beef operations and the 64% equity stake in Pilgrims, which is expected to price in next 6 months. They plan to take the proceeds to purchase the rest of PPC. They've outlined 200m in synergies in their S1 from the PPC merger that will mostly take place within Pilgrims, however there is potential for 75m more longer term we're not baking in that will come from exporting chicken to Brazil; a way for JBS to capitalize on a weak dollar.
The majority owner of Pilgrim's, JBS USA, is in the process of raising a $2B IPO of their 64% PPC stake + their US beef operations. Given this structure, we think it is highly likely that JBS will hype their PPC stake and synergy potential during road shows over the next few months in order to raise enough cash to buy the remaining 36% stake. In other words, JBS is incentivized to encourage an over valuation of the minority 36% equity stake that we can buy publicly because they are raising ipo proceeds on the majority stake they already own.
Proforma capital structure:
Trades at 8x 2011 EPS with ¾ synergy credit. Full synergy + BK projections trades ~5x:
Although chicken is a highly cyclical industry given the 9 month lifecycle of poultry, we believe normal EBIT margins in the industry were around 5.5% historically. However, a brief study of the chicken industry will show the last 5 years have had very little "normal" about them as supply has been less rational and feed prices experienced much inflation. It's a very tough industry and has operated below normal for many years. Given these risks, we're being a bit chicken ourselves in the base case and using a 4.5% EBIT to account for unknowns. This would imply 65 cents of fully taxed earnings so we are paying ~ 14x 2011' earnings and get all the synergies for free. 200m of synergies if all flowing through to PPC would take fully taxed earnings to $1.20, or 7.5x PE.
But, our 4.5% base case negates the fact that PPC restructured while in bankruptcy and it is likely that margins are significantly higher than 4.5%, though hard to be precise. Most notably, SGA historically ran 350-375, yet SGA in 2009 was 300 - and run rate is ~280.
In addition, JBS has outlined 200m of synergies in their filings to take place over the next 18 months (start 2010). In our base case, we assume 150m of synergies flow through to PPC. JBS has a majority of board seats so we expect these synergies to take place with or without full JBS takeover.
If we assume 200m of the synergies flow through to PPC and we use the 2011 bankruptcy projections of $1.30 in EPS pre-synergy (which assume 7.6% EBIT) it translates into ~$2 in EPS, or roughly 5x 2011. While it should be noted that Bankruptcy projections were developed by Agristat, the industry's leading consulting group and are not technically PPC's guided figures for exiting bankruptcy, in their recent conference call the management team did say that under current industry supply / demand / feed outlook margins are tracking in-line with the bankruptcy projections.
How to think about EBIT vs. peers and valuation:
A quick look at historic results shows that EBIT margin correlations are all over the place vs. each other - mostly due to hedging and timing of sales contracts. Correlations aside, in general, SAFM has out earned TSN and PPC by a wide margin due to their superior management team and focus on high margin "big birds" whereas TSN and PPC EBIT margins were more in-line when one backs out the uqnie years (2008 for example PPC locked in high feed prices - which put them out of business). To further complicate the matter going forward, PPC has restructured greatly while in bankruptcy, but has offered limited disclosure. To us, the recent quarterly results versus the peers offers some clues.
Here's what we know: The recent quarterly results for PPC Jun 09 and Sep 09 were well ahead of TSN. 300bps to be exact over the 6 month period. However, PPC Dec 09' quarter was much weaker than TSN, which is a bit confusing, and brought the 9 months average outperformance to ~ 100bps in EBIT for PPC. If you speak with management it will become evident that the Dec 09' quarter was kitchen-sinked. We think part of this was to clear the slate for the next couple quarters where JBS will be trying to show how strong PPC's results are, and part of the underperformance was PPC going all out to win back contracts they lost in bankruptcy. In light of this, hedging and forward buying aside (everyone is naked right now), we think PPC will earn between 100-300bps higher than TSN before JBS synergies. The street is using 4.5% EBIT for TSN Chicken segment in 2011 and we are using 4.5% for PPC 2011 in our base case, before synergies, but if the street is right for TSN, and PPC has indeed become more lean than TSN than the appropriate PPC range should likely be 5.5% or greater for 2011 EBIT.
At 7.5B in 2011 sales a quick table below on fully taxed earnings power before synergies
EBIT = EPS
4.5% = $0.65
5.5% = $0.85
6.5% = $1.05
7.5% = $1.25
If synergies come out to 150m of the expected 200m + this translates into an extra 0.40 EPS (full tax)
It's easy to see how even under conservative assumptions one could get a $12.80 price target, or 40% up. Assumes 11x EPS of $1.05 (0.65 + 0.40) = $11.55 + $1.25 in NOL value per share = $12.80.
100% + upside looks like this. 11x EPS of $1.65 (1.25 + 0.40) = 18.15 + 1.25 NOL = $19.40
As crazy as it seems, chicken producers do not tend to get highly discounted multiples as cycles heat up.
200m in synergies appear to be conservative with potential for an additional 75m from exports
In our conversations with JBS, the 200m of synergies appear conservative. 2/3rds of the 200m savings will come from SGA; including a mix of staff cuts, logistics synergies.
JBS has been described to us in research calls to the industry as ruthless cost cutters. A quick check of the JBS USA S1 (backing out PPC results) shows SGA as a % of sales have averaged about 1.5 to 1.75% for the last couple of years. Whereas PPC is currently running ~ 4% SGA and TSN is running at 3%.
Qualitatively, we know JBS has 330 personnel in their corporate offices on 15B in sales. 330 was cut down from 600 over the years while PPC on the other hand has 1100 personnel in their corporate offices on 7B of sales. A former senior executive of PPC with whom we spoke also believed there was a lot of fat to cut. PPC has 320/340m in logistics costs, which JBS thinks they can save 15-20% on by consolidating with their US beef operations, which translates into 55-75m savings. The remaining synergies will come from labeling, packaging, & other.
While details are less clear, there is a potential 75m in additional synergies (on top of the 200m) over time from exports. JBS wants to take advantage of the weak US dollar and export chicken down to Brazil. Currently 20% of the PPC volume is exported at 10% of the revenue. JBS plans to take it to 30% of volume and 18% of revenue and thinks they can get a 5% EBITDA margin improvement on exports. This translates into roughly 100bps of EBITDA improvement, or 75m on 7.5B in sales. The export initiatives will come over a few years.
Current chicken supply / demand is in balance and margins appear to be normal to above normal:
We track the chicken industry closely and believe capacity is currently well balanced with demand, leading to normal to above normal margins. Calls to the industry participants also suggest 2010 should be a good year.
Since the poultry cycle is 9 months, we have decent visibility into the supply coming through the pipeline. As long as demand does not fall considerably, USDA pullet placement data suggests constrained supply till at least 3Q 2010.
JBS owns 64% and wants to buy rest post their US IPO:
JBS has not hit the road yet for the IPO but in our conversations with the company it is clear that they view the pilgrim's acquisition as an opportunity of a lifetime and wants to purchase the rest of PPC. Please confirm via your own work, but in our industry calls we have heard that the CEO of PPC has already bought a home where JBS USA is headquartered in Greeley, CO JBS bought their 64% equity stake at $5.90. JBS wanted to buy the whole company in bankruptcy, but shareholders felt they were getting it too cheap. The solution was to create a mandatory exchange clause that JBS USA secured via their 800m liquidity infusion to get PPC out of bankruptcy.
The mandatory exchange seems fair and will use market prices. Specifically, JBS has the right to buy the remaining stake at the 30 day trailing stock market price for PPC as long as two conditions have been met:
Both PPC and JBS USA must have filed their first public results post exiting bankruptcy / IPO
We estimate if JBS USA road shows in April with an IPO shortly thereafter, this would allow them to buy the rest of PPC as early as May-July, if the two conditions above have been met.
JBS IPO will attempt to raise ~2B. Incentivized to hype PPC synergies during road show:
Given the structure of the deal, we think PPC synergies could be hyped significantly. JBS USA has filed an S1 in the US and hopes to raise 2B in an IPO. JBS USA will be > 50% owned by JBS SA, the Brazilian parent.
The IPO earnings profile will have the following distribution: Under normal margins with synergies, ~ 50% of the IPO value is PPC and ~ 50% US beef operations. IR said beef business can do 5% EBITDA and sustain it for the next couple of years. His margin equates to 770m of EBITDA on 08' sales. PPC should be able to achieve ~650m in EBITDA in 2010 under conservative assumptions with 2011 EBITDA going to 700 assuming 4.5% margins and ¾ synergy credit baked in. In better scenarios PPC is more like 75% of the value. JBS USA will IPO with a net cash balance sheet. If JBS were to buy PPC at $14, it would equate to 1.1B.
A note on replication cost:
While in bankruptcy true liquidation value at 100% recovery was assessed to be 4B, pre-fees vs. current EV of 3.2B. For pure PPE value, we use 30 cents / lb, which yields ~2.5B in production replication value. However, this ignores other assets like relationships with customers, access to distribution networks, etc.
DISCLOSURE: We and our affiliates are long Pilgrim's Pride (PPC), and may long additional shares or sell some or all of our shares, at any time. We have no obligation to inform anybody of any changes in our views of PPC. This is not a recommendation to buy or sell shares.
JBS USA IPO roadshow. Hypes PPC synergies & PPC value.
March 10' Earnings. We expect them to be strong.
Sell-side coverage. None currently.
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