Maple Leaf Foods was written up in 2012, and we thought we would contribute these updated thoughts as we think investing in the Company today remains compelling.  

As a review, Maple Leaf Foods is the dominant meat processor in Canada.  Partially vertically integrated, it raises and slaughters about 30% of its own hogs and produces hot dogs, sausages, bacon and other processed meats. While mostly a pork processor it has a smaller non-pork meat business.  Its brands, including Schneiders Hot Dogs and Maple Leaf Bacon, command market shares that aggregate to about 40%.  Its market cap is $2.8 billion (Canadian).  Its longtime CEO Michael McCain owns 33% of the company.

Maple Leaf is undergoing a significant corporate transformation.  It has divested assets to manage down its relatively high level of leverage even as it executes a comprehensive overhaul of its aging meat processing manufacturing footprint with a goal of substantially expanding margins.  On the disposition front, in the summer of 2013 Maple Leaf sold a meat rendering and a pasta business that cut leverage in half.  Most importantly, in October 2013 it announced its decision to consider strategic alternatives for its second largest business, Canada Bread.  The latter is one of Canada’s largest bakers and investors never understood the logic of owning it alongside the meat business.  In February 2014, Maple Leaf finally announced the sale of Canada Bread to Groupo Bimbo of Mexico for $1.830 billion, which easily met investor expectations.

The Canada Bread deal closed in the 2^nd quarter of 2014.  Post the close of the deal, Maple Leaf, trading at approximately $19.50/share in recent days, has no debt and $4/share in cash.  At some point a substantial portion of this cash will be returned to shareholders through a special dividend or a share buyback.  The precise level of cash return will depend on the leverage level Maple Leaf puts on the meat business and the acquisition strategy of the company.  Assuming no significant acquisitions and a leverage level of 2x EBITDA, we believe there could be an additional $4/share of cash available for distribution to shareholders.  

In addition to the ability to drive value through the set of corporate actions described above, Maple Leaf is also compelling as a turnaround investment.  Maple Leaf was essentially a roll-up company, spending many years consolidating the highly regionalized and fragmented Canadian meat processing industry.  As such, it has many older, inefficient facilities spread all over Canada and mediocre margins reflected the suboptimal nature of this manufacturing footprint.  To repair this problem, Maple Leaf embarked on a five year $800 million capital program to completely overhaul its manufacturing and distribution network.  2014 is the final and most important year of that program.

The overhaul is designed to achieve EBITDA margins of 10% in 2015, up from 5% in 2012.  Key accomplishments of the program, some of which have been achieved, include reducing SKUs by 800,  shuttering 17 of 19 distribution facilities, and most importantly, consolidating the meat processing functions from 26 plants to 8.  The five most important new plants have been opened in the last year and Maple Leaf is ramping up those facilities to optimal manufacturing efficiency that will drive the largest portion of margin expansion.  Specifically, achieving optimal efficiency will allow Maple Leaf to permanently shutter the older facilities which must be kept running alongside the new plants until high volumes of product can be reliably supplied from the new plants.  Management expects this to take place throughout this year with the biggest impact in the fourth quarter.  Associated overhead and transition costs will also fall away as the renovated plants displace the legacy plants.

We have spent considerable time with Maple Leaf management and accept as reasonably feasible their 10% EBITDA margin target starting in either q1 or q2 of 2015.  Indeed, given their strong consumer franchises we believe they might even do better given margins at peer companies.  Importantly, however, the fortress balance sheet and ability to return capital to shareholders gives us confidence in our downside scenario should management miss their targets which, given the massive nature of the overhaul, is a distinct possibility. 

At today’s share price we get to create Maple Leaf at 7.5x its target EBITDA post its restructuring.  This compares to peers that trade anywhere from 9x to 11x with much higher multiples for companies like Hillshire Brands with strong consumer franchises.  The likely capital return and the possibility of higher than 10% margins could even argue for a larger multiple.  It is also important to note that the meat industry is undergoing global consolidation.  Last year, Shuanghai Holdings of China bought Smithfield Foods and the latter, prior to its sale, was rumored to be a possible buyer of Maple Leaf.  Most recently, Hillshire is being acquired by Tyson for 13-15x EBITDA (lower multiple includes synergies).  Assuming 10x multiple on management’s target EBITDA of $300mm and 145mm fully diluted shares outstanding gets you to $21/share.  Add to that the $4/share net cash on the balance sheet gets you to $25/share or 28% upside from current levels. 

This upside excludes management’s ability to use the cash on the balance sheet along with additional leverage of 2x EBITDA for buybacks.  Cash on the balance sheet along with leverage at 2x EBITDA will add up to a number close to $1.1-1.2bn, which can easily buy back more than a third of the company. 

If Michael McCain ever decided to sell the company and move on (he LBO’d the company 20 years ago), Maple Leaf could fetch $30+/share even assuming the low end of the Hillshire multiple.  This would be 50+% upside from current levels.