|Shares Out. (in M):||98||P/E||0||0|
|Market Cap (in $M):||686||P/FCF||0||0|
|Net Debt (in $M):||459||EBIT||0||0|
|TEV (in $M):||1,145||TEV/EBIT||0||0|
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SunOpta has been written up here two times previously. Hopefully, the third time’s a charm.
SunOpta, Inc. (“SunOpta,” “STKL,” or “the Company”) is in the early stages of a multi-year turnaround that is expected to drive growth, improve profitability and unlock shareholder value. Although turnarounds are not for the faint of heart (especially when accompanied by an elevated amount of financial leverage: net debt/Adj. EBITDA of ~6.9x), SunOpta’s management and board have a proven track record of executing successful turnarounds in the industry. Notably, SunOpta’s new CEO, David Colo, was instrumental in cleaning up Diamond Foods (as COO) before that company was sold to Snyder’s-Lance. Meanwhile SunOpta’s new chairman, Dean Hollis, recently oversaw the significant value creation at AdvancePierre Foods (as chairman) on behalf of Oaktree Capital, which is a large investor (~20% stake) in SunOpta with a strong board presence. In fact, Oaktree has called AdvancePierre Foods one of the “standout” investments in its 22-year history (AdvancePierre was a 23-bagger). In my view, shares of SunOpta could increase by twofold in the near term (2-3 years) as its turnaround begins to gain traction, but shares have the potential to appreciate much greater over a longer-term horizon as it capitalizes on the powerful tailwind of consumers’ heightened focus on health and wellness. In the U.S., the market for organic (~$43 billion) and non-GMO labeled (~$24.3 billion) foods is growing rapidly (high single-digit/low teens % rate) and these growth rates are expected for the foreseeable future thanks, in part, to tastes/preferences of millennial consumers. SunOpta’s results in the near and mid-term will likely continue to be uneven. However, I believe that investors with a long-term horizon will likely be rewarded by investing alongside a proven and accomplished management team/board that is heavily incentivized to boost shareholder value.
Why Does This Opportunity Exist:
At current levels, shares of SunOpta are trading over 30% below its recent 52-week highs and roughly 50% below its 5-year high of ~$14 reached in $2014. There are a number of items that are likely currently weighing on shares including challenging recent results/slower expected turnaround in one of the Companies larger businesses (frozen fruit), and decisions by management to exit unattractive businesses (STKL recently exited its flexible resealable pouch and nutrition bar operations and has incurred costs to shut theses businesses down), that are masking tangible progress in the Company’s turnaround efforts. In addition to the recent earnings pressure, other factors include:
History of SunOpta:
SunOpta was founded in 1973 in Ontario, Canada, and was originally known as Stake Technology Ltd. Stake held patented technology that converted forestry byproducts (wood chips, Corn Stalks, and straw) from low-grade wasted biomass into usable products. The Company’s first commercial venture was its proprietary “steam explosion” technology that converted hardwood trees into food or cattle, sheep and goats.
Stake’s foray into the food industry began in 1999, when it acquired Sunrich Inc., a supplier of specialty grains and premium food ingredients to major food producers. Sunrich, which had about $30 million in sales in 1998, had a product line that included non-GMO, organic, and identity-preserved varieties of corn and soybeans, soy powders and concentrates, and organic starches. Subsequent to the Sunrich acquisition, the Company would embark on an aggressive acquisition spree that bolstered its presence in the natural and organic foods industry. In 2002, Stake acquired Opta Food Ingredients, which was located in Bedford, Massachusetts, and was a supplier of food ingredients to more than 350 food companies, including 12 of the largest U.S. consumer packaged food companies and 3 of the world’s largest QSR restaurant chains. In 2003, the Company changed its name to SunOpta, combining the names of the SunRich Food Group and Opta Food Ingredients. Commenting on the name change, Jeremy Kendall, SunOpta’s chairman/CEO at the time, stated, “We believe the name SunOpta reflects our environmental and organic commitment to products nourished in the ‘sun’ with ‘optimal’ nutritional value and environmental responsibility. The inclusion of ‘Technology’ in our name is no longer appropriate to our focus in the growing integrated natural and organic food business.” In total, some 37 transactions were completed between 1999 and 2015.
SunOpta’s revenues from its consumer products business surpassed 50% off overall revenues for the first time in 2015 as a result of three acquisitions completed during the year (Sunrise Growers, Niagra Natural Fruit Snack Company, and Citrosource). In 2016, SunOpta sold its Opta Minerals business, a move that positioned SunOpta as a pure play foods company.
SunOpta is a leading global company focused on organic, non-GMO, and specialty foods. SunOpta specializes in the sourcing, processing, and packaging of organic and non-GMO food products, integrated from seed through packaged products. SunOpta’s two primary business segments, global ingredients and consumer products, generated $1.3 billion of revenues during 2017. The Company generated 78% of its 2017 revenues from the U.S., with Canada (3%) and Europe and other (19%) making up the balance. The Company’s products are sold by a number of widely recognizable retailers, including Whole Foods, Starbucks, and Amazon. The following provides a further details about the the Company’s two segments:
Competitive Advantages - Sourcing and Low-Cost Provider:
The Company’s integrated “field to table” business model involves the sourcing of raw materials, especially many hard-to-find organic and non-GMO ingredients, in 65 countries from a network of 5,000 suppliers that encompasses approximately 10,000 growers. SunOpta is believed to possess the world’s largest vertically integrated organic raw material supply chain. A key competitive advantage of the Company comes in the form of the long-term relationships it has maintained with its growers/suppliers, many of which have existed for over 25 years. These relationships have enabled SunOpta to enter into exclusive agreements with growers and/or processors of key strategic commodities to control the reliability of its supply chain. In addition, SunOpta also leases certain farmland that it subleases to fruit growers helping to ensure access to key inputs. SunOpta transforms the inputs it sources into ingredients and consumer products for its 3,300 global customers via its 21 manufacturing operations. The Company’s sourcing capabilities coupled with its processing and packaging capabilities provides the consumer products segment with a low-cost advantage over its peers.
In 2016, the Organic Trade Association estimated U.S. organic retail sales at approximately $47 billion, with approximately $43 billion coming from organic food sales. Organic retail sales in the U.S. have generally experienced double-digit growth during most years since 2000, when the USDA set national organic standards. Organic food, which increased at an 8.4% growth rate during 2016, now represents about 5.3% of total retail food sales in the U.S., a market share figure that trails those seen in other leading consumers of organic food. For example, during 2014, the organic market share in Denmark and Switzerland was 7.6% and 7.1%, respectively. The natural foods (non-GMO) industry is much larger, and in 2014 it represented about $200 billion of sales at retail, a figure expected to reach $330 million by the end of 2019. During 2016, sales of food and beverage products specifically labeled as non-GMO increased at an 11.9% growth rate to $24.3 billion.
Consumers’ increased awareness of the benefits of a healthy lifestyle, especially among the millennial generation, should help to sustain the strong growth rate experienced by organic and natural products. One of the industry’s challenges is keeping up with the pace of organic demand, as the amount of farmland dedicated to organic products is well below the current demand. Nevertheless, the premiums garnered by farmers of organic products, despite the lower yields, are enticing farmers to convert their farms to organic, a process that takes 3 years. The fact that 81% of consumers are willing to pay more for products that are healthier or that contain natural or organic ingredients, according to data from NPD, should also help encourage farmers to make the conversion to organic farms.
Millennial parents are the largest group of organic purchasers in the U.S., with 52% of millennial parents buying organic products. Millennial parents also over-index, compared to older generations, in stating that choosing organic products is an integral part of living green. It is interesting to note that natural and organic products have a 3x greater share online, which may be one of the motivations for Amazon’s recent purchase of Whole Foods. I would not be surprised if Amazon/Whole Foods became an increasingly important customer, if not a potential suitor, of SunOpta given that company’s organic/healthy ambitions, in the coming years.
Activist Involvement and Oaktree Engagement:
SunOpta’s historical operations were characterized by low capacity utilization at key facilities, which resulted in SunOpta’s delivering profitability levels that have trailed those of its industry peers by a wide margin. The Company’s poor performance and various operational missteps (product recalls, late deliveries, etc.) ultimately caught the attention of several activist investors and prompted the Company to pursue strategic alternatives.
SunOpta’s growth potential, coupled with its operational and capital allocation missteps, attracted the attention of activist investor Tourbillon Capital, which had established an ~10% position in STKL shares in 2016. Tourbillon implored the Company to pursue value-enhancing initiatives such as a sale of the Company in light of its view that the Company operations remained underoptimized, with revenue growth and profitability well below industry averages. At that time, SunOpta’s revenue growth since 2011 (of 7% with acquisitions) was well below the industry’s 13% growth, while its then 6% EBITDA margin was well below the levels of its industry peers. In a letter to SunOpta’s board dated May 27, 2016, Tourbillon stated:
“It remains our firm belief that if the Company were to fix its operational missteps, refocus and reprioritize its sales efforts, and effectively deploy capital, the Company would be worth several times what it is worth today. According to the plan that management laid out in April 2016, the Company should earn close to $0.80 of EPS in 24-36 months. Furthermore, based on our due diligence, if the Company is able to correct the operational issues entirely under its control – underutilization, cost of nonperformance, low yields, etc. – we believe that SunOpta can earn over $1.60 of EPS over the same time period. At the current price, SunOpta shares would be trading at 4.8x and 2.4x earnings, respectively, while peers trade around 20x earnings.”
The pressure from the activist investor prompted the Company to announce its decision to explore strategic alternatives in June 2016. In October 2016, 3½ months after it had begun to evaluate alternatives with the help of advisors, the Company announced that it had entered into a partnership with Oaktree Capital, securing an $85 million preferred investment from that firm that was used to pay down debt. In addition, SunOpta agreed to add three new board members, among them two Oaktree appointees, Dean Hollis and Dr. Albert Bolles, both of whom boast meaningful experienced with packaged foods companies. The third new board member, Brendan Springstubb, is from Engaged Capital, another activist shareholder that targeted the Company during its strategic review process. A third activist, West Face Capital, which is based in Canada, also targeted SunOpta during its strategic review process and was believed to be poised to push for board and management changes if SunOpta failed to sell itself.
Oaktree has a successful track record in the food industry, and investments have included AdvancePierre Foods, Campofrio Food Group, and Diamond Foods. Notably, the sale of AdvancePierre Foods to Tyson for $4.2 billion in 2017 enabled Oaktree to earn 23 times its invested capital. It should also be noted that Dean Hollis, who was recently appointed to the SunOpta board by Oaktree (Hollis became chairman of SunOpta shortly after joining the Company’s board), oversaw the significant value creation at AdvancePierre Foods for Oaktree while serving as AdvancePierre’s chairman. In announcing the SunOpta partnership with Oaktree, Dean Hollis stated:
“During Oaktree’s due diligence, it became apparent that SunOpta is in the right space with the right assets to build a highly profitable sustainable platform capitalizing on the favorable industry dynamics, growth of private label solutions and the Company’s deep global sourcing capabilities. However, the investments in capital and acquisitions intended to reposition the Company over the last couple of years, while strategically valuable, have clearly strained the operational resources, causing SunOpta to be undervalued in the market today. This Partnership with Oaktree provides SunOpta with key strategic, operational and financial resources support and flexibility that will accelerate this company’s value enhancing initiatives to the benefit of all shareholders and position the company for long-term sustainable success.”
In addition to Oaktree’s preferred investment (which is convertible into 11.3 million STKL shares at a price of $7.50 a share), Oaktree has purchased shares of STKL on the open market. Oaktree was granted the right to purchase up to 3 million shares pursuant to the terms of its preferred investment (3 million shares purchased at an average cost of $6.90 a share in March 2017), but it received approval in 2017 to purchase additional shares of SunOpta stock (beyond the 3 million specified in its agreement with SunOpta) after petitioning the board. During 2017, Oaktree deployed nearly ~$60 million in the acquisition of 8.1 million shares of SunOpta on the open market at a price of $7.36 a share, increasing its stake in SunOpta to ~20%, up from ~11% (assumes conversion of preferred stock). It should be noted that Oaktree acquired 3.7 million shares in December 2017 from Tourbillon. (Tourbillon owns ~5% of the outstanding STKL following the sale to Oaktree.) Given Oaktree’s keen eye for value in the food industry, I believe that its investment and involvement should not be overlooked. During SunOpta’s 3Q 2016 earnings call, Dean Hollis stated, “I have done numerous and successful transformations in my career, and I am more excited and more confident in the long-term value creation of SunOpta than perhaps [at] any other time in my career.” In my view, this statement is a strong vote of confidence in SunOpta’s potential in light of the 23-bagger that Dean Hollis presided over while at AdvancePierre. In March 2018, three SunOpta insiders made open market purchases of STKL shares including $176k deployed by Mr. Hollis in the purchase of 25k shares at a price of $7.02 a share.
The Value Creation Plan:
In November 2016, SunOpta formally unveiled its value creation plan, intended to unlock long-term shareholder value. In announcing the plan, Kathy Houde, a SunOpta director who had been serving as the Company’s interim CEO, stated, “The successful implementation of the value creation plan will deliver value for all stakeholders. For our customers, it will lead us to the most trusted reliable supplier of natural and organic ingredients as well as private label solutions supported by timely and on trend innovation.” The value creation plan is supported by four key pillars: portfolio optimization, operational excellence, go-to-market effectiveness, and process sustainability. The following provides merely a summary of the plan’s key highlights:
In addition to providing a solid foundation for future growth, SunOpta’s value creation plan aims to address a whole range of issues that have previously plagued the company (quality control, fill rates, on-time deliveries, etc.). The plan is also expected to generate a meaningful amount of near-term financial benefits, including $31 million in annual EBITDA enhancements and $20 million in working capital improvements. During 2017, the Company implemented ~$13 million of profitability improvements with the remainder ($18 million) expected in 2018. The annual savings are being derived from a number of different areas including including manufacturing, procurement, and logistics. The savings the Company generates in the near term are bding reinvested in the business.
Management expects to realize additional EBITDA improvements over time. The Company’s value creation plan is expected to be completed over three phases. Phase I is expected to last about 12-18 months, while phases II and III are expected to take up to 18-36 months to complete after the completion of phase I. During phase I, the emphasis will be on gross margin expansion, with sales growth likely to materialize during phases II and III. While the initial focus of the plan is on profitability improvement, management noted during its 3Q 2017 earnings call that it was having good success in building its pipeline of future sales opportunities.
During 2017, SunOpta invested ~$60 million into its business, though just $8 million was in areas of recurring expenses, including sales, customer marketing, and engineering resources. The Company terms the remaining $52 million as non-structural costs, such as incremental capital expenditures (~$15 million), and a variety of one-time costs, including consulting, severance, recruiting, and plant closure costs, that amounted to around $37 million.
The following is a link to SunOpta’s recent earnings press release that details achievements of its various initiatives (see Value Creation Plan Update):
Experienced and Proven Leadership with Meaningful Equity Incentive:
In February 2017, David Colo was appointed to serve as CEO of SunOpta. Mr. Colo is an experienced food industry executive (~30 years in general management, operations and supply chain management) who most recently served as chief operating officer of Diamond Foods in a similar turnaround situation that was also another Oaktree investment (Diamond Foods was sold to Snyder’s Lance in 2016 for $1.9 billion.) During SunOpta’s 4Q 2016 earnings call, CEO Colo stated, “We will make decisions with a long-term focus, even if those decisions do not maximize near-term earnings.” It should be noted that Mr. Colo’s food industry experience includes turnarounds in both packaged and food ingredients companies. In addition to Mr. Colo, a number of key positions have been changed out as part of an upgrading of talent at all functions and all levels of the Company. Over the past year, SunOpta’s base of salaried employees has risen to 550, up from 500 (out of ~2,000 total). Notably, 350 of the 550 salaried positions have been filled by new Individuals.
Mr. Colo has a meaningful equity incentive to see through a successful turnaround of SunOpta. Among Mr. Colo’s equity awards are 474k performance-based stock options (special stock options) and 278k performance stock units (special stock units). Mr. Colo also has 150k of restricted stock units, 50k of which he received after purchasing $1 million worth of shares on the open market during 2017 (145k shares were purchased in March 2017 at an average price of $7.06 a share). Notably, the vesting of the special stock options and special stock units is subject to stock price performance conditions during the 3-year period ending February 6, 2020. A third of these awards vest upon achieving an $11.00 stock price, a third upon achieving a $14 stock price, and a third upon achieving a stock price of $18.00.
During SunOpta’s April 2016 investor day, prior leadership (former CEO resigned in November 2016), provided detailed targets for its business segments. Following the announcement of the value creation plan, management has generally stuck with its prior targets:
In April 2016, SunOpta stated that if it achieved its mid-term targets, then it would be able to experience an expansion of EBITDA to 8.5-10.5% of sales, which management has targeted as growing at an approximate high single digit growth rate. However, new management has communicated a slightly higher goal and is targeting an EBITDA margin of between 10% and 11% of sales.
I’ve looked toward precedent industry transactions as a guideline. There have been a number of transactions in the consumer products industry over the years. Branded consumer products companies have typically garnered low double-digit (teens) EV/EBITDA multiples, while acquisitions of private label firms have commanded high single-digit multiples, on average. In 2012, private label manufacturer Ralcorp Holdings Inc. was acquired by ConAgra for 1.5x sales and 11.9x EBITDA. At that time, Ralcorp’s EBITDA margins were in the low teens range, which is comparable to the targeted profitability for SunOpta. Recent multiples for branded consumer packaged goods companies have occurred at even healthier multiples, including Campbell Soup’s acquisition of Snyder’s-Lance at a nearly 20x EBITDA (12.8x post synergies), McCormick’s 2017 acquisition of Reckett Benckiser’s food business for 19.6x, and Keurig’s pending 2018 offer to acquire to Dr. Pepper Snapple Group at a 16.8x EV/EBITDA. Given SunOpta’s organic/non-GMO focus, I believe that transactions in the healthy natural space might also be a good precedent. As illustrated in the following table, recent transactions in the healthy/natural space have occurred at an average of ~16x on an EV/EBITDA basis.
Although the Amplify transaction listed in the foregoing table occurred at just 7.2x EBITDA in 2014, the Hershey Company announced in December 2017 that it had agreed to acquire the business (which was taken public in 2015) for $1.6 billion, or ~14.8x EBITDA. (TA Associates acquired its majority stake in amplify for $320 million in 2014.)
Assuming SunOpta can grow its revenues at an ~8% annual rate over the next ~2-3 years and achieve an EBITDA margin of 9.5%, which is below the Company’s targeted 10-11% range, I project STKL can generate ~$151mm in EBITDA. Applying a 10x multiple, representing a discount to precedent industry transactions, to this projection results in a ~$12 valuation. As the Company’s turnaround gains traction, I believe the Company’s earnings power could be materially higher and enable it to command a significantly higher valuation. With many branded consumer products companies seeking growth to counter adverse industry trends, I believe SunOpta could prove to be an attractive acquisition candidate at some point down the road as its operational issues are addressed and growth potential is restored.
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