Description

We believe that John B. Sanfilipo & Son Inc. (JBSS), the leading private label and number two branded (Fisher Nut) processor, packager, marketer and distributor of shelled and in-shell nuts, is a compelling investment opportunity. The stock is only trading at only 0.80x book value due to temporary execution problems with respect to inventory management and headwinds from rising nut prices over the last two years. As we describe below, the company is at an inflection point in terms of gross margin improvement, which should result in material upside (>45%) to the stock in 12-months. Furthermore, we believe that the stock has downside protection due to its tangible net asset value, which is comprised of real estate, inventory, and accounts receivable.

(12/31/05)
Cash 3,245
Accounts receivable 47,208
Inventory 209,488
Other 5,163
Current assets 265,104

Land 10,353 (a)
Buildings 66,442 (b)
Machinery and equipment 106,977
Furniture and leasehold improvements 5,582
Vehicles 3,078
Construction in progress 26,752 (c)
219,184
Less: Accumulated depreciation 116,709
Net 102,475
Rental investment property 28,365 (d)
Development agreement 6,802 (e)
Other 4,564
Tangible asset value 407,310

Liabilities
Revolving credit facility 27,817
Current maturities of long-term debt 72,073
Accounts payable 75,142
Other 27,454
Long-term debt 5,275
Other long-term 18,104
Total liabilities 225,865

Net asset value 181,445
Tangible book value per share $17.00
Book value per share (incl. intangibles) $18.25

Notes:
(a) New Elgin facility.
(b) Includes 2 owned facilities in Chicago that will be sold for $20 million as part of the consolidation project.
(c) Work on new Elgin facility.
(d) Renting a portion of Elgin facility to third party.
(e) Original 83-acre plot of land for Chicago area consolidation project. Expected to be sold by end of 2006 for at least $7 million.


Mismanaged Contracts
The company’s gross margin has deteriorated from the 17% range during FY’01-FY’04 to 13.5% in FY’05 and 8.4% in the most recent quarter. In FY’05, the company was forced to buy almonds in the spot market to fulfill its industrial sales contracts, which were based on prior year crop costs. The company didn’t anticipate a rapid increase in the price of almonds and pecans during the year and made a bet that it could buy inventory at stable prices. Through the first have of FY’06, gross margin has been under pressure as management bought almonds upfront, thinking that prices would continue higher, but the market softened. We believe that management will do a better job at aligning inventory costs and contract prices. In a normal environment (i.e. more predictable), the company should earn a gross margin of roughly 17%, in our view.

Rising Nut Prices
The other factor affecting gross margin has been higher nut prices, resulting in declining volume and lower capacity utilization. The company lost some private label business in the latter part of FY’05 with customers that would not accept price increases. However, we believe that the company is in a position to win back these customers as nut prices are expected to decline going forward. Additionally, consumers’ preferences have shifted to branded snack nuts and away from private label as the price differential has narrowed. We expect gross margin to improve slightly beginning next quarter and more meaningfully over the next 2-3 quarters. Cashews, peanut, and pecan prices are declining (representing a combined 60% of sales), which should drive volume and improve capacity utilization. The company has less than 100 days of cashews, peanuts, and pecans in inventory, so it is in a good position to take advantage of declining prices.

Chicago Area Consolidation
The company is currently consolidating six Chicago area facilities into a single location through the construction of a new production facility in Elgin, Illinois. The new facility is expected to reduce costs through the elimination of redundancies and improved manufacturing capabilities. While we are not factoring any margin improvement from this facility into our model, we believe that it could add 1-2% to gross margin.

The company has already reached full capacity at its Chicago area facilities. The new facility will initially increase capacity by 25-40% and will support increased capacity needs for future growth. The facility is slated for completion by the end of 2008, but the company will gradually shift certain functions to the facility before then. We expect the company to finance the remaining construction at the Elgin facility with the proceeds from the sale of the two Chicago area facilities for $20 million and the sale of the 83-acre plot of land for $7+ million.

Valuation
We believe that the stock is undervalued, with a tangible book value per share of $17.00 and total book value per share of $18.25. Our 12-month price target is $22 per share, based on 10x our FY’08 EPS of $2.29. Importantly, we are only forecasting 16.5% gross margins and a ROIC of 9.8%, which is in-line with historical norms. This is a conservative estimate since it does not consider margin improvement driven by the Chicago area facility consolidation project. Furthermore, we anticipate that FCF per share will exceed EPS beginning in FY’07, as the company will have much lower capex needs following the completion of its Elgin facility. Finally, we expect the company to pay down some debt using a portion of the $30 million in proceeds from the sale of its two owned Chicago facilities and 83-acre plot of land.

Catalyst

Earnings.