November 26, 2013

SunOpta (STKL) is significantly undervalued relative to other natural food peers.  Meanwhile, the company is sitting on two non-core assets that could be worth as much as 30% of the current stock price, with the value likely to be realized over the next two years.  The company also has several growth opportunities over the next 1-2 years.  Given the popularity of natural and organic food companies over the past few years, it is rare to find one that almost nobody has heard of.  Based on management projections and my estimate of the value of the non-core assets, I believe that STKL could be worth as much as $26 per share, or almost 200% above current levels.

SunOpta Inc. (STKL) is a Canadian company focused on natural, organic, and healthy foods.  STKL is one of the largest suppliers of internationally-sourced organic ingredients, and is the:

• #1 producer of natural and organic fruit snacks in the U.S.
• #1 processor of confection sunflower in the world
• #1 organic soybean processor in the U.S.
• #1 producer of oat fiber in the world (for food industry)
• #1 processor and packager of organic aseptic soymilk in the U.S.

In addition, 100% of STKL’s food business is non-GMO.  The company employs a “field to table” business model, whereby they source, process, and package natural and organic foods for over 12,000 companies around the world, including Starbucks, Hain Celestial, Whole Foods, Wal-Mart, Kraft, Target, and Annie’s.  No customer accounts for 10% of sales.  The company was founded in 1973 as a technology company named Stake Technologies.  Stake purchased the organic seed and soymilk supplier SunRich in 1999 for $4.25 million.  Sales in the year ended 2012 were $1.091 billion.

Over 90% of the company’s revenue comes from its organic foods operations.  Organic foods has been one of the most successful parts of the food industry over the past decade, and should continue to be going forward.

The organic foods operation is divided into four segments: Grains & Foods, Ingredients, Consumer Products, and International Foods.

• Grains & Foods (48% of 2012 revenue).  Specializes in marketing organic, identity preserved (IP), and non-GMO grains, ingredients, and packaged goods and processing services, with emphasis on soybean, sunflower, and corn products.  Products include seeds and whole grains, ingredients, packaged foods (marketed under the Sunrich Naturals brand), and animal feed and pet food products.  Management is targeting long-term operating margins of 6-8% for this segment (6.3% in 2012).
• Ingredients (8% of 2012 revenue).  Focused primarily on fiber products and specialty fruit ingredients.  Fiber, derived mostly from oat, pea, soy, and rice, is used commercially to increase the fiber content of cereals, breads, cookies and crackers; to increase yield and enhance texture in ground and processed meat products; and to add strength and reduce breakage in baked products.  Value-added fruit ingredients are used in yogurts, ice creams, cheeses, smoothies, shakes, frozen desserts, bakery fillings, health bars, beverages, dressings, marinades, dips, and sauces.  In 2011, this unit lost a significant customer to an alternative form of fiber, which caused management to pursue their own forms of alternative fiber.  These alternative fibers, particularly rice and the newly launched corn, have a large target market in gluten-free foods.  Management is targeting long-term operating margins of 12-15% for this segment (4.2% in 2012).
• Consumer Products (17% of 2012 revenue).  Provides natural and organic consumer packaged food products to major global food manufacturers, distributors, and supermarket chains with a variety of branded and private label products.  Also offers conventional and organic beverage processing and re-sealable pouches in a variety of products including shelf-stable and refrigerated juices, frozen fruits and vegetables, specialty beverages, vitamin waters, electrolyte waters, energy drinks, soups, baby food, and healthy fruit and vegetable snacks in flexible pouches.  Finally, offers natural and organic fruit-based snacks in bar, twist, rope, and bite size shapes, plus a range of baked and extruded nutrition bars.  Management is targeting long-term operating margins of 8-10% for this segment ((0.5%) in 2012).
• International Foods (16% of 2012 revenue).  Includes the European and North American based operations that source and supply raw material ingredients and trade organic commodities.  Sources raw material ingredients from over 60 countries and is one of the largest suppliers of a wide range of organic commodities to the food industry in Europe, North America, and Asia.  Management is targeting long-term operating margins of 5-6% for this segment (4.3% in 2012).

These four divisions can be further refined into three key go-to-market segments: raw materials, value-added ingredients, and consumer packaged products.  Beginning with the 4Q13 report, the company will begin reporting new segment results along these three go-to-market segments, which should help to clarify the story for investors.

STKL is focused on three core strategies:

1. Focus on becoming a pure play natural and organic foods company.
2. Aggressively grow the value-added packaged foods and ingredients portfolio.
3. Leverage their integrated platform.

Historically, STKL has focused on their raw materials business, which is lower margin.  Over the past year, they have shifted focus to consumer packaged food products, which they believe can be higher margin.  Consumer packaged food is expected to become 60% of the sales mix (from 25% historically and 40% currently).  The company is targeting 3-year organic revenue growth of 8-10% per year with eventual EBITDA margins of 10%.  This is in line with revenue growth projections at both HAIN and UNFI.  I intend to show that even if STKL is unable to transform from a raw material ingredients supplier to a consumer packaged foods company, the stock is still deeply undervalued.

As part of STKL’s effort to become a pure play organic food company, divesting non-core assets and recycling the cash into value-added ingredients and consumer packaged products has become part of the focus over the past two years.  To this end, the company has made three key divestitures:

• In June 2012, the company sold Purity for $14 million.  Purity is a Canadian natural health products distribution business.  The sale completed STKL’s exit from all non-core distribution businesses.
• In April 2011, STKL sold its frozen fruit processing assets in Mexico for $5.65 million.
• In June 2010, the company sold its Canadian Food Distribution assets to UNFI for $68 million.

Recent key acquisitions include:

• In December 2012, SunOpta acquired a grain handling and processing facility in Bulgaria for ~$4.2 million.  The facility has been a supplier to SunOpta of non-GMO sunflower kernel since 2011.  The facility is located near a protected and chemical free agricultural area, which produces organic sunflower, flax seed, corn, barley, and soybeans.  It should allow the company to expand its capabilities from sunflower into other organic products grown in the region.
• In August 2011, STKL acquired Lorton’s Fresh Squeezed Juices for $2.5 million.  Lorton’s is an integrated producer of a variety of citrus based products in both industrial and packaged formats.  The company is focused on expanding the extraction operations at Lorton’s.
• In December 2010, the company acquired Edner of Nevada for $4 million.  Edner produces a variety of portable foods such as nutrition bars and grains-based snack bars.
• In November 2010, STKL acquired Dahlgren for $46.3 million.  Dahlgren is an integrated processor and global supplier of confection sunflower seed products.

In addition to these recent acquisitions, the company is finding plenty of quality internal growth initiatives to invest in:

• SunOpta recently finished constructing a cocoa processing facility in the Netherlands that will specialize in the processing of organic and fair trade cocoa beans into derivatives such as organic cocoa powder, butter, and liquor.  All cocoa beans are expected to be internally sourced through the International Foods division.
• In November 2012, the company completed the expansion of the aseptic non-dairy beverage processing and packaging plant in Modesto, CA.  Capacity was increased by 10%.
• In September 2012, the company completed the commissioning of two flexible re-sealable pouch filling lines at their Allentown, PA facility.  Installation of two more lines was completed in 3Q13.
• In December 2011, the company completed the installation of a new aseptic processing line at their Pacific Fruit Processors plant.

Perhaps one of the most exciting opportunities facing the company is the non-GMO opportunity.  Many people believe that at least some of the health issues in the U.S. are due to the genetic modification of our food throughout the last century.  It is estimated that up to 80% of packaged foods in the U.S. are genetically modified (aka containing GMO).

In today’s age of transparency, there is a definite trend toward knowing what is in your food (horse meat in ground beef, anyone?).  Think about when fast food restaurants were forced to start offering nutritional information.  Today, over 50 countries require all GMO food to be properly labeled, including China, Japan, India, and all of Europe.  Absent on that list is the U.S.  However, Proposition 37 was very close to passing in California in 2012 (ultimately lost 51.5% to 48.5%).  Prop 37 would have required companies to label all GMO foods.  The opposition spent over $45 million, or five times more money than the support.  More recently, in Washington state, I-522 was defeated 55% to 45%.  Similar to Prop 37, I-522 would have required the labeling of foods that are made with genetically altered crops as well as the labeling of genetically engineered seeds and seed products sold in the state.  A consortium led by General Mills, Nestle, Pepsi, Monsanto, and DuPont spent ~$22 million to defeat the proposal, versus just $8 million raised by supporters.  Oregon will be the next battle ground.  Meanwhile, Sen. Barbara Boxer (D-CA) and Rep. Peter DeFazio (D-OR) recently introduced the Genetically Engineered Food Right-to-Know Act in Congress. 

Whole Foods Market recently announced that it will require GMO labeling in its stores by 2018, while Target is introducing a new natural health brand called Simply Balanced.  The initial Target rollout will include a selections of foods that are 40% organic.  GMOs will be phased out of the ingredients by the end of 2014.  The brand is replacing two subsets of the current store-brand Archer Farms: Archer Farms Simply Balanced and Archer Farms Organic.  I believe it is a matter of when, not if, all foods will have GMO labeling.

This is important, because STKL’s food business is 100% non-GMO.  Not all natural food companies can say that.  If/when GMO laws get passed in the U.S., food manufacturers will likely seek non-GMO suppliers in order to avoid labeling their products as GMO.  STKL already has existing relationships with many of these companies, which will likely work to their advantage.  The organic and natural foods industry is so small compared to non-organic that even a small change by these giant companies would have a significant sales impact on non-GMO suppliers like STKL.

The most recent quarter was choppy due to start-up costs for the new cocoa processing facility as well as retrofit costs for the premium juice facility in California.  The cocoa commissioning costs will spill over a bit into 4Q13, while the juice factory will experience elevated costs into 1Q14 due to equipment and permitting delays.  These unexpected costs caused the stock to sell off following the quarterly report, but I consider this blip to be short-term in nature.

Meanwhile, a few weeks ago, Plum Organics voluntarily recalled several SKUs of baby food pouches manufactured by SunOpta due to spoilage issues.  There have been no reported illnesses as a result of this issue.  At this point, STKL has not said anything about the recall other than “if it was material, we would have to issue a press release.”  The company is currently trying to determine the nature of the problem.  STKL’s aseptic pouch business is less than 5% of total sales and Plum accounts for 50-60% of pouch sales.  While this may cause a bit of a short-term disruption, I am not worried about current or future business going elsewhere, because STKL is essentially the only company with these capabilities.  In contrast to, say, applesauce pouches, STKL sources the organic ingredients, works with the customer to formulate the product, manufactures the product (in this case organic baby food), and packages the product in an aseptic pouch.

These exciting things happening in the main organic food business as somewhat masked by the company’s partial ownership of two unrelated businesses: Opta Minerals and Mascoma.

Opta Minerals

Opta Minerals (OM) is a producer, distributor, and recycler of environmentally-friendly industrial materials.  OM provides custom process optimization solutions and related materials that are used in the steel, foundry, loose abrasive cleaning, and municipal water filtration industries.  The company’s principal product lines include:

• Blends of industrial minerals used primarily in heavy industrial applications
• Silica-free abrasives
• Specialty sands, filtration media, and other products and services

OM is publicly traded on the Toronto Stock Exchange and is 85% controlled by two companies (66% STKL; 18% Oakwest Corporation), which likely depresses its public market value.  After the strategic review that ended in February 2012, management decided to build the company further by making two opportunistic acquisitions.  I believe this shows management’s focus on long-term value creation. 

The first of these purchases came in early 2012 when OM bought Babco Industrial Corporation for $18 million.  Babco is an industrial processor and supplier of petroleum coke, synthetic slag, ladle sand, and crushed graphite.  Babco had revenue of $13 million and net income of almost $2 million in 2011.  The second purchase came in July 2012 when OM bought WGI Heavy Minerals for $14.6 million.  WGI’s principal business is the processing and sale of industrial abrasive minerals, and the sourcing, assembly, and sale of ultra-high pressure water jet cutting machine replacement parts and components.  WGI had revenue of $38 million in 2011.

Management’s strategy was to complete the integration of these two businesses, so as to establish the run rate for the business after synergies to show potential investors.  With the integration now complete, management has indicated that we could see movement on the sale of this business in the next 6-9 months.

Opta Minerals is publicly traded on the TSX with a current market value of $33 million.  I believe that the company could actually be sold for much more than that and that the limited float is weighing on its public market value.  Due to its ties to the steel industry, OM’s business can be pretty cyclical.  The business is currently going through a cyclical downturn, but according to management the potential acquirers are well aware of the cyclicality of the business.  I assume that OM will report revenue of $147 million in 2014 and the “normal” midcycle EBITDA margins are ~12.5%.  At 8x EBITDA, this business is worth ~$100 million to STKL or $0.86 per share.

Mascoma

Mascoma, founded in 2005, is a privately-held renewable fuels and chemical company.  Among other things, Mascoma is developing a proprietary technology called Consolidated Bioprocessing Platform (CBP), for the conversion of abundant biomass (non-food plants such as wood chips and grass) into energy.  STKL owns 18.65% of the company.

STKL owned a patented Steam Explosion Technology that was sued for a pretreatment process in the production of cellulosic ethanol.  After many years of trying to commercialize the technology, STKL decided to combine it with Mascoma’s downstream component to create a complete biofuels solution.

Mascoma is a private company, so the valuation is a bit more theoretical.  However, there are two past transactions we can use to triangulate a reasonable value.  Prior to the combination with Mascoma, a Blackrock-led consortium invested directly in the BioProcess Group in June 2007 for $30 million, taking a 13% stake.  This puts the pre-money value of the BioProcess Group at $200 million.  Let’s assume this is the peak value of Mascoma.  In June 2010, when BioProcess was combined with Mascoma, everyone had to take a haircut, and the value of Bioprocess was determined to be $51 million.  The BioProcess consortium received a 27.7% stake in Mascoma, for an implied value to STKL of ~$34 million.  Let’s assume this is the trough value of Mascoma.  Taking the simple average of these two values implies that STKL’s portion of Mascoma is worth almost $120 million or $1.72 per share. 

This brings the total value of non-core assets to $2.58, or ~30% of STKL’s current price of $9.00.  I expect something to happen with Opta Minerals in the next 6-9 months, but that Mascoma is likely a 2014-15 event at the earliest.  Mascoma recently filed a $100 million shelf IPO offering.

SunOpta Foods produced $964.4 million of revenue and $51.4 million of EBITDA in 2012.  With the emphasis on growing the value-added ingredients and consumer packaged products businesses, management has laid out three-year targets of 8-10% annual revenue growth and 10% EBITDA margins.  Assuming the low end of this revenue growth range puts 2015 revenue at $1,215 million, and a 10% EBITDA margin produces $121.5 million of EBITDA.  Assuming a 15x EBITDA multiple and $184.6 million of net debt, STKL stock is worth ~$24.  Including the non-core asset valuations we derived earlier brings the total stock price to ~$26 versus the current price of $9.00.

Put another way, after adjusting the current enterprise value for the non-core assets, STKL is currently trading at just 11.5x 2012 food division EBITDA.  This compares to peers trading at valuations of 15-18x EBITDA.  I believe that STKL is aspiring to be more like HAIN, with the emphasis on consumer packaged food products, which trades at a valuation of 18x EBITDA.

Meanwhile, United Natural Foods (UNFI) trades at a premium multiple to STKL, even though I consider UNFI’s business to be inferior to that of SunOpta.  UNFI is a distributor of healthy and organic foods.  Recall, SunOpta sold its Canadian distribution business to UNFI in 2010.  UNFI is growing revenue at an average of 12.5% over the last five years, partly through acquisitions of brand distribution agreements.  EBITDA margins at UNFI have consistently been 3.8% over the last five years.  LTM EBITDA was ~$230 million and FY2015 (ends July 31, 2015) EBITDA is expected to be ~$300 million, giving UNFI a valuation of 15.5x LTM EBITDA and 12.0x 2015E EBITDA.

SunOpta, on the other hand, sources organic and non-GMO ingredients and manufactures the kinds of products that UNFI distributes.  STKL is growing revenue 8-10% per year organically.  EBITDA margin was 5.5% over the last 12 months and will continue to grow along with revenue as the company shifts the mix in favor of consumer packaged products and value-added ingredients.  Ultimately, the company is targeting EBITDA margins of 10% over the next 2-3 years, or over 2.5 times the margins at UNFI.  Yet, STKL trades at 12.5x LTM EBITDA and ~9.0x 2014E EBITDA.  Adjusting for the disposition of non-core assets, I estimate that STKL is actually trading for 10.0x LTM EBITDA.

1. There is a material shift away from organic and natural foods.  This industry was once viewed as trendy, and some may still see it that way, but I believe the evidence overwhelmingly suggests that natural and organic foods are a permanent part of American diets.
2. Macroeconomic weakness/recession.  During the latest recession, STKL’s revenue fell ~6% in 2009, so there is some economic sensitivity despite the overall trend in favor of organic and natural foods.  These types of food tend to be more expensive, so some consumers will trade down when money gets tight.

1. New segment reporting beginning in 4Q13.  Beginning with the 4Q13 and FY13 earnings report, the company will begin reporting segments that better align with their three key go-to-market segments: raw materials, value-added ingredients, and consumer packaged products.  This will help to clarify the opportunity and shed light on the growing consumer products segment.
2. The sale of either or both of the company’s non-core assets.  I expect the sale of Opta Minerals to happen in the next 6-9 months, while Mascoma is likely to IPO in 2014 or 2015.
3. Street coverage.  STKL is mostly covered by smaller Canadian brokerages.  Citi and Canaccord Genuity are the only decent-sized U.S. brokerages that cover the stock.  Given the popularity of the space, plus the likely capital market transactions over the next two to three years, I would expect more mainstream coverage of the stock.
4. Passage of GMO labeling legislation.  I believe it is a matter of when, not if, GMO labeling legislation gets passed in the U.S.  We are so far behind the rest of the world on this topic, including “third-world” countries like China and India.  This would be a major tailwind for a company like STKL, whose entire product portfolio is non-GMO.

While STKL has some nice option value in the form of non-core assets, it is cheap on its own merits versus the peer group.  Organic foods has been one of the most successful parts of the food industry for the past decade, and it is almost impossible to find an organic food company that nobody has heard of – until today.  I believe the core food business is worth $24, and including the estimated value of non-core assets, STKL stock could be worth as much as $26.  This represents almost 200% upside from current levels.

Disclosure: The author, his family, and funds the author manages and/or is associated with may or may not have a position in any of the securities mentioned in this write-up. Any of the aforementioned may trade in and out and around any of the securities mentioned without notifying you. The analysis presented is the author’s own and is believed to be accurate. Do your own diligence. This write-up constitutes analysis and/or market commentary and is not an investment recommendation and as such, should not be used in isolation to make an investment decision. The author undertakes no obligation to update this report based on any future events or information. Estimates are subject to numerous assumptions, risks and uncertainties which change over time.

1. New segment reporting beginning in 4Q13.  Beginning with the 4Q13 and FY13 earnings report, the company will begin reporting segments that better align with their three key go-to-market segments: raw materials, value-added ingredients, and consumer packaged products.  This will help to clarify the opportunity and shed light on the growing consumer products segment.
2. The sale of either or both of the company’s non-core assets.  I expect the sale of Opta Minerals to happen in the next 6-9 months, while Mascoma is likely to IPO in 2014 or 2015.
3. Street coverage.  STKL is mostly covered by smaller Canadian brokerages.  Citi and Canaccord Genuity are the only decent-sized U.S. brokerages that cover the stock.  Given the popularity of the space, plus the likely capital market transactions over the next two to three years, I would expect more mainstream coverage of the stock.
4. Passage of GMO labeling legislation.  I believe it is a matter of when, not if, GMO labeling legislation gets passed in the U.S.  We are so far behind the rest of the world on this topic, including “third-world” countries like China and India.  This would be a major tailwind for a company like STKL, whose entire product portfolio is non-GMO.