Seaboard Corp SEB S
May 09, 2007 - 9:02pm EST by
ThatDu04
2007 2008
Price: 2,584.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 3,259 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT
Borrow Cost: NA

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Description

Short Seaboard Corp
Originally written up by Mark778 in August 2005 (which I highly recommend reading as well ), Seaboard Corp owns a wide variety of businesses including pork production/processing in the US, container shipping in Latin America, commodity milling and trading in Africa, sugar and citrus production in Argentina, electric power in the Dominican Republic, and jalapeno peppers in Honduras. While the variety businesses looks intimidating from an analytical perpective, pork and marine are the critical divisions to understand as together they comprise 82% of the 2006 EBIT and their strong results have been the major drivers of the company’s recent outperformance. For the last 3 years, margins in both the pork and marine business have been far above the trend for the rest of the last decade. If one believed that current results were sustainable, then SEB would probably be fairly valued at 8x current EBITDA. However, I believe it is likely that both pork and marine margins are unsustainable. Furthermore, I believe that pork margins will decline significantly in 2007, driven by rapidly increasing feed costs (corn). This pork margin decline should lead to a drop in overall earnings, removing the earnings momentum from the stock and driving it to a more appropriate valuation, even if marine earnings stay strong. Assuming only my expected decline in pork profitability and continued strong marine performance, I would argue that the stock is worth no more than $1,850 at 12x EPS, a 28% decline from today. However, if the marine business also reverts back towards normal profitability, then I would argue that SEB is worth $1,390, a 46% decline from the current share price.
Short Positives
- Major businesses are extremely cyclical commodity businesses that have recently operated well above historical norms. Normalization should bring significant margin downside
o Pork and marine division operating margins far above historical norms during last 3 years.

1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Pork OPM
7.2%
-0.2%
6.6%
8.7%
8.9%
-2.2%
3.0%
15.3%
17.8%
13.8%
Marine OPM
8.8%
5.6%
-0.6%
4.0%
6.2%
4.3%
1.4%
12.8%
14.2%
14.3%
- Pork outperformance has been driven by abnormally strong margins in more volatile pork production segment which is very exposed to rising corn prices.
o Hog production division at competitors expected to see significant margin decline in 2007 due to rising corn prices
- Questionable corporate governance with a history of related party transactions
- Valuation ludicrous on previous margin achievements. If margins normalize, downside could be significant.

1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
P/E
125.7x
122.3x
-282.9x
389.4x
73.9x
275.4x
111.9x
18.8x
12.2x
13.2x
EV/EBITDA
39.7x
43.5x
52.8x
30.7x
18.0x
30.6x
23.0x
9.7x
7.9x
8.3x

BUSINESS DESCRIPTIONS
Pork
Seaboard’s pork division is a vertically integrated pork producer (=raise) and processor (=kill). The company produces and sells fresh, frozen, and processed pork products to further processors, foodservice operators, retail outlets, and distributors throughout the US and internationally. SEB owns hog breeding and production facilities in OK, KS, TX and CO and can produce approximately 3.8mln hogs annually, internally supplying 80% of the company’s processing needs. For processing SEB can process 16k hogs in its core Guymon, OK facility and owns two bacon processing plants in UT and MT. SEB also markets related pork products for Triumph Foods LLC for a per head fee.

Competition
Seaboard is the #3 pork producer and #7 pork processor in the nation with ~4% mkt share in each segment. Pork production is a very fragmented industry with the top ten producers controlling only 1/3 of the market. This fragmentation (combined with the high fertility rate of hogs) has led to significant pricing volatility and cyclicality in this industry. Pork processing is a more stable and concentrated market (although lower margin) with the top ten processors handling over 90% of pork in the US. Smithfield Foods is the mkt leader in both pork production and processing and has widened its mkt lead by buying competitor Premium Standard recently.

Outlook
The pork business has been extremely strong during 2004-6, driven by a booming export market. According to the US Meat export federation (www.usmef.org), US pork exports have increased at an 67% from 2003-6, driven by strong demand from Mexico, (28% of exports, up 62% 2003-06) South Korea (9% of exports, up 378%) and Japan (27% of exports, up 25%) as those countries dramatically decreased their beef consumption (US beef exports down 49% 2003-6) following the outbreak of mad cow disease in the US. In 2007, Japanese and Korean export demand for US pork has remained strong. However, in recent weeks, both Japan and Korea have begun to take steps towards easing their restrictions on US beef, suggesting that the continued substitution of pork for beef may have less of an impact on exports going forward. Furthermore, pork export tons fell 2.4% in February 2007, only the second month to be below the year earlier since August 2003, suggesting that previous surges in pork exports may not continue.
More importantly, the pork business faces a significant threat from the recent large, ethanol-driven increase in corn prices. As corn equals ~50% of the total costs of raising a hog (feed costs= ~75% and corn is 66% of feed costs), the almost doubling of corn prices in early 2007 should dramatically pressure prices. This theory has been supported by agricultural economists who worry that rising corn prices will dramatically hurt pork producer profitability.  (http://www.farmdoc.uiuc.edu/marketing/livestockoutlook/html/041007/041007.html)
SEB will gain some relief from increasing hog prices, but according to the USDA, live hog prices have only increased 8% in Q1 07 vs. Q1 06, not enough to offset the dramatic increase in corn prices. Furthermore, hog producers continue to increase production (USDA expects pork production to increase 2% in 2007, limiting pricing gains.
While SEB does not break out hog production and hog processing separately, by looking at competitor Smithfield’s breakdown, it becomes quite apparent that a large driver of pork division margin outperformance over the last few years is due to the hog production division (SFD hog production has generated OPMs from the high teens to the low 20s over the last 10 quarters while processing margins have been low to mid single digits). However, hog production margins should decline significantly due to the significant increase in raising costs driven by dramatic increases in corn prices. Competitor Premium Standard Foods (recently acquired by Smithfield), said that hog production operating margins declined from 12.2% to 3.9% for Dec qtr 06 vs. Dec 05, primarily due to a 31.5% increase in the cost of corn. Smithfield’s margins declined to 1.1% in the Jan 07 qtr vs. 14.9% in the Jan qtr 2006 and management commented on the most recent CC that high corn prices were going to pressure future margins. During Q1 07, SEB’s pork margins declined from 12.3% to 8.7%, with the company blaming high corn prices for the drop in margins. I believe that this margin decline will continue throughout 2007.

Pork Segment
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Sales
532
500
571
725
772
646
736
962
1,024
1,003
% Growth

-5.9%
14.1%
26.9%
6.6%
-16.4%
13.9%
30.7%
6.5%
-2.1%
Operating Income
38
(1)
38
63
69
(14)
22
147
183
138
Operating Margin
7.2%
-0.2%
6.6%
8.7%
8.9%
-2.2%
3.0%
15.3%
17.8%
13.8%









Marine
SEB’s marine division provides containerized shipping between 25 countries in the US, Caribbean, and Central and South America. The company’s fleet consists of 11 owned and 28 chartered vessels. The segment time charters or the majority of its fleet and is profitability is impacted by containership rates, charter hire rates and fuel costs, among other things.
While not much information exists about the company’s marine segment Mgmt has commented on the likely unsustainable profitability in the Marine segment:
“Although management cannot predict changes in future
cargo rates, fuel related costs, charter hire expenses or to what
extent changes in competition and economic conditions will impact
net sales or operating income, it does expect this segment to
remain profitable in 2007 although lower than 2006.”
Furthermore, given the expected 15% increase in containership capacity for 2007, it is quite possible that container shipping rates will weaken going forward. However, I have not assumed any significant weakness in marine margins going forward as I do not believe I have enough information to forecast a margin decline in this business.

Marine
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Sales
309
311
308
365
385
383
409
499
638
742
% Growth
#DIV/0!
0.5%
-1.0%
18.6%
5.5%
-0.4%
6.7%
21.9%
28.0%
16.2%
Operating Income
27
17
(2)
15
24
17
6
64
91
106
Operating Margin
8.8%
5.6%
-0.6%
4.0%
6.2%
4.3%
1.4%
12.8%
14.2%
14.3%

Commodity Milling
SEB markets grain and oilseed products mainly in Africa, South America, and the Caribbean with locations in 15 countries. The division sources, transports and markets over 3mln tons of wheat, corn, soybean meal, and other related commodities for use as food and animal feed. SEB also owns 25 grain processing locations capable of producing 1.5mln tons of finished product/yr.
As segment sales are significantly affected by fluctuating prices for various commodities including wheat, corn and soybean meal, a dramatic increase in the price of grains could hurt the company’s sales and or margins as the company attempts to pass on these higher input costs. Thus, I would argue that rising grain prices could lead to lower 2007 operating profit in the commodity milling division.
Commodity Milling
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Sales
314
306
260
359
476
652
668
1,067
836
736
% Growth

-2.4%
-15.3%
38.3%
32.6%
36.9%
2.4%
59.7%
-21.6%
-12.0%
Operating Income
10
11
3
(4)
13
18
16
35
28
31
Operating Margin
3.0%
3.4%
1.0%
-1.0%
2.8%
2.8%
2.4%
3.3%
3.4%
4.2%
Other Businesses
Sugar and Citrus-SEB is also involved in the production and refining of sugar and the production and processing of citrus products in Argentina and markets these products mainly locally with some exports to the US, South America, and Europe. SEB’s mill currently has processing capacity of 200k metric tons of sugar and 4mln gallongs of alcohol per year. The company also owns 50k acres of sugar cane and 3k acres used for orange trees. During 2006, SEB benefited from rising global sugar prices, which more than offset the loss making citrus operations. This division is significantly impacted by local and global sugar prices. I expect continued strong performance out of this division as sugar prices are likely to remain high driven by ethanol demand.
Electric Power-SEB owns two floating electric diesel power generating facilities in the Dominican Republic with 112 megawatts of rated capacity. The company operates as an IPP sells electricity with 50% under contract to large commercial users under LT contracts and on the spot market to 3 govt controlled distribution companies as well as other customers. During 2006, SEB’s power production was restricted by the DR regulatory authorities, which schedule power production based on the amt of funds available to pay for the power produced and the costs of that power. SEB is also part of a consortium to build two coal-fired 305mw electricity generating plants in the DR. SEB has a less than 50% interest and expects to spend between 25 and 75mln.
Others- SEB produces jalapeno peppers in Honduras and has a equity investment in a Bulgarian wine business. These businesses are not that meaningful for overall results.
Other Revenues
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Sales
119
122
94
99
171
148
169
157
191
228
% Growth

2.4%
-22.6%
5.4%
72.5%
-13.6%
14.1%
-6.8%
21.5%
19.1%
Operating Income
2
2
(26)
(18)
12
31
28
20
24
29
Operating Margin
1.6%
1.5%
-27.8%
-18.4%
7.2%
21.2%
16.5%
12.6%
12.6%
12.8%
Negatives/ Risks
- Volatility of commodity divisions allows potential for significant upside surprises if pork prices dramatically increase or corn prices significantly fall
- No analyst coverage means that there is no own to talk sanity into these people
- Poor disclosure makes analysis difficult
- Insiders own 70% of the company.
Mgmt
SEB is controlled by the secretive Bresky family through their private Seaboard Flour company. The family makes ever effort who make every attempt to avoid publicity. However, a 1998 Time article (also noted by Mark) suggests that their level of ethics is not the highest. Most notable from the article, is the information about a 1990 lawsuit by shareholder Alfred Kahn, which alleges a high level of self dealing between Seaboard Corp and privately traded Seaboard Flour. “Robohm was subpoenaed in the Kahn lawsuit, and he recited a litany of business dealings in which, he said, Bresky had interests in companies that profited from inflated contracts with Seaboard Corp. According to his deposition, kickbacks were paid to officials in foreign governments; contracts were padded, with the excess money diverted to Swiss bank accounts; management fees were inflated; brokerage commissions ran 2 1/2 to five times the usual rate. And in the case of one Seaboard subsidiary, "there was a great deal of cash that was...unaccounted for." The Breskys settled the Kahn lawsuit for $10.8mln without admitting any wrongdoing.[i]
Conclusion
I think its best to give the CEO of SEB the last word about the cyclicality of the company’s operations:
“Since 2004, we have cautioned that these operating results are
extraordinary, and that going forward, we expect to return to
normalized levels of profitability which are more in line with
our commodity-driven businesses.”
“We have had a remarkable run over the last three years…since the beginning of 2004, our combined operating income has exceed our previous 25 years combined… and our stock price has appreciated over 500%. It would be nice to consider these highlights as reflecting a trend, but, realistically, it is more likely that they reflect a spike within a trend.”[ii]
Negatives/ Risks
- Volatility of commodity divisions allows potential for significant upside surprises if pork prices dramatically increase or corn prices significantly fall
- No analyst coverage means that there is no own to talk sanity into these people
- Poor disclosure makes analysis difficult
- Insiders own 70% of the company.

Catalyst

Continued decline in Pork division profitability pressures earnings
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