Description

Investment Thesis   

John B Sanfilippo & Son (“JBSS” or the “Company”) is a straightforward and timely short opportunity with an estimated +40% return over the next two quarters. Basically, the rise in commodity nut prices that benefited JBSS over the last several years on the way up is now going against it as prices have recently reverted much lower. The result: 1) a significant hit to revenue and earnings this year; 2) a likely re-rating as the market realizes the degree of commodity exposure in the business; and 3) structurally lower revenue and profitability going forward. The Company has limited institutional coverage and operates in an esoteric corner of the agriculture market with limited pricing transparency. The stock is currently GC.

Background

JBSS is a vertically integrated processor of nuts with a regional focus in the Midwest. The Company buys raw nuts from growers, shells and processes them and either sells the processed product or packages and sells them under one of its brands or a private label. Currently approximately 40% of its revenue is derived from private label, 20% from branded culinary and snack nuts (under the Fisher and Orchard Valley Harvest labels) with bulk processing and export accounting for the rest. The majority of the branded products JBSS sells are basic bags of shelled raw nuts with limited differentiation. As such, the space is competitive and pricing power with retailers is very limited (Wal-Mart represented 24% of JBSS sales in 2015). The Company is controlled by the founding Sanfilippo family out of Chicago.

Starting in 2009, JBSS began a restructuring that upgraded management, closed uneconomical facilities, consolidated and centralized operation and increased its investment in branded products. These initiatives were completed in 2012. While management has continued to execute and gain share, the majority of its subsequent financial performance has been largely driven by rising commodity input prices (raw nut prices represent 80% of JBSS COGS). As you can see in the table below, walnut and almond price increases accounted for ~60% of JBSS' total revenue increase since 2011. During that period, revenue per pounds sold grew 44% and EBITDA per pound has grown 41%.The improved profile story concurrently drove JBSS’s stock price from $10 per share and 5x EBITDA to close to a high of $70 and 12x EBITDA.   

Almond & Walnut Prices: 80% of the global almond supply is grown in California and harvested annually from November to January. In 2010 the average spot price for almonds stood at $1.10 per pound. Over the next five years prices increased over 400% to a record high of $4.70 last year. This was driven by perceived health benefits, increased Chinese consumption and partially by supply constraints (the CA drought and growers holding onto inventory with the hope of selling at even higher prices). The stronger USD and elevated almond costs led to substitution, slackened demand and a large drop-off in export volumes. Prices from the crop harvested earlier this year are now selling for $2.00 per pound, over a 50% year-over-year drop. The current price is also the 15-year average trading level for the commodity. Barring a weak crop, the industry anticipates prices to remain at this level through the 2016-2017 harvest. Walnut prices have followed a comparable trend with raw nut pricing declining 50-60% in the most recent harvest.

Financial Implication & Valuation  

JBSS does not provide guidance (this opportunity would not exist if it did) but recent commentary from competitor, Diamond of California, provides an insight on what is in store for the industry. Earlier this year, Snyder’s Lance (LNCE) closed its acquisition of Diamond Foods. On the May 20 earnings call, LNCE management stated, “our top-line outlook also reflects a significant negative impact to the net price realization at Diamond of California due to the commodity changes…the year-over-year impact due to walnut pricing is about $50 million to $60 million, negative.” This equates to an annualized impact of -$66M or a 17% hit to the Diamond nut segment topline.

Almonds and walnuts account for 33% of JBSS revenue. As noted, prices for these nuts dropped over 50% year-over-year in the most recently harvested crop. JBSS may eventually be able to make up for some of this price decline with higher volumes but so far retail has been keeping the margin and has only made minor price cuts (to drive consumer demand). Per commentary from Derco Foods, “domestic shipments [of almonds] were down 13% at 51m pounds in April..the lull in domestic numbers is mostly due to shipments that have been delayed, in part due to higher prices at the retail level. It will be a while until the relatively lower pricing is reflected on store shelves.” Even if retail does reduce prices, consumption would have to spike dramatically. Below is an estimate of the impact to its financial performance over the next four quarters. The revenue impact is comparable to what Diamond is forecasting and assumes JBSS is able to raise gross margins to 17%. LTM gross margins were 14.7%, so the outcome could certainly be worse. The Company’s nascent move into branded snacks branded (e.g. NutExactly) is demonstrably failing at grocery given the lack of perceived value/ price. It is also worth noting that the Company shut down its international segment this spring. Probably the right move in the long-term but will be another ding to the topline and may surprise investors. The below numbers only include the impact from almond and walnuts; the exit from import has not been included.

The only analyst that covers JBSS is way off and will have to take his numbers down significantly. He has gross margins growing 13% and earnings growing 27% over the next twelve months. He estimated JBSS will generate $86M in EBITDA when the Company will be lucky to break $50M. Under the best case scenario, EBITDA drops 25% over the next 3-4 quarters.

JBSS’s current market cap is $563M (11.3M fd s/o) and EV is $656M. The Company took a one-time hit to margins in the most recent quarter when it liquidated some remaining higher cost, prior year crop inventory. That has impacted the stock but it does not appear the market realizes the ongoing structural impact of lower nut prices. JBSS currently trades at 9.6x LTM EBITDA and 17.7x LTM adjusted EPS. The estimated forward EBITDA of $50M at the current trading multiple equates to $33 per share but its multiple will almost certainly contract/ stock will re-rate lower when the market reacts to the revenue drop and becomes aware of the Company’s commodity exposure. Much larger commodity agricultural/ food ingredients processors typically trade at 6-9x EBITDA. 7x EV/ forward EBITDA would be $23 per share, over 50% below current. Note JBSS traded at an average 4-5x EBITDA prior to 2014. If EBITDA reverts back to pre-2014 levels so too may its multiple.    

Risks   

• Take-out: LNCE’s acquisition of Diamond Foods almost certainly helped push up JBSS’s stock price. However, as the degree of commodity exposure in the nut sector becomes increasingly apparent, potential suitors will likely become averse to the space. On last month’s earnings call, LNCE management noted they had learned everything they now know about walnuts and almonds in the last several months, indicating they did not originally know what they were buying.

• JBSS has been paying an annual special dividend late in the calendar fourth quarter. The Company will likely do so again this year but shorts have five months before potentially having to bear this cost.    
  

Catalyst

1) Near-term hit to earnings and re-rating

2) Structurally lower financial performance

3) Sell-side guidance cut