Description

We believe that SunOpta, with a new management team, a refocused business plan and activist involvement represents an attractive investment opportunity at the current stock price.  SunOpta Inc. is a $600 million market cap Canadian food company focused on the trend towards healthier natural and organic products.  The Company, with estimated 2016 revenues of $1.4 billion, has two business segments – a) sourcing, processing and marketing organic and non-genetically modified ("non-GMO") ingredients and b) manufacturing private-label healthy food and beverage products. 

After several years of disappointing shareholders with flawed execution, the Company has recently been restructured and refocused.  It has constructed new manufacturing capacity to provide nationwide capabilities, divested itself of its non-core holdings, grown its private label business organically and through acquisitions and appointed a new CEO. 

Catalysts include the presence of a couple of activists including a 25% shareholder pushing for the sale of the Company, and recent M&A in the space – fellow almond milk producer WhiteWave (WWAV) was recently sold for 20x EBITDA, more than double SunOpta’s multiple.  Even without M&A, we see potential for earnings to double as newly completed capacity at their Allentown plant is utilized and various startup and restructuring costs are behind them. The stock price could have 50-100% upside as earnings power increases and the multiple converges with other food processors and private label manufacturers.

History

SunOpta was founded in 1973 and is based in Ontario, Canada.  Until recently, the Company was primarily focused on the lower-margin sourcing and processing business, specializing in seeds and grains, primarily organic and non-GMO soybean, sunflower and corn.  There were non-core ownership positions in Opta Minerals, a producer, distributor and recycler of industrial materials (recently sold), and a biofuels company (now largely written off).  While the core sourcing business was a solid foundation, the Company has spent the last several years making a push into higher margin, value-added consumer products and manufacturing, targeting the “private label” market.

Companies focused on the growing healthy living / organic foods trends have been rewarded with high valuations, and this was true of SunOpta as well for a while, with its stock trading at over $12 in 2014, a multiple of over 15x EBITDA, and still above $10 as recently as August 2015.  A series of operational missteps, slower than expected growth in the consumer products segment, a pricey acquisition and a botched financing to help pay for it, all contributed to a significant sell-off of STKL stock in late 2015. 

The acquisition was that of Sunrise Growers, a supplier of private label frozen fruit with about $300 million in annual sales, for which SunOpta paid $450 million (about twice its own multiple), financed with debt and an equity issuance, neither of which went well.  The equity offering of 16.67 million shares was completed at $6, increasing shares outstanding by about 25%.  The Company also took out $330 million of expensive second lien loans. These loans will convert into term loans at an interest rate of 9.5% in October 2016, if not refinanced.  The transaction leaves SunOpta with pro forma leverage of around 5.5x.  In addition to the negative surprises on financing, the Company announced operational issues leading to recalls on some aseptic beverage products and sunflower kernels and the stock sold off further bottoming out below $4.

Industry Dynamics

SunOpta’s end markets of natural / organic food and beverages are very much on-trend as demonstrated by the growth of stores like Whole Foods, Sprouts Farmers Market and the shift in focus of peers like Kroger, as well as the increased emphasis on organic ingredients in restaurants and food service.  Demand is increasing by double-digit percentages per year in categories such as frozen fruit and vegetables, nuts and seeds where SunOpta has consumer product offerings.  Despite this, organic foods are currently estimated to only be 5% of the total US food market, leaving many years of potential growth ahead.  Domestic demand for organic produce continues to outstrip supply growth, which makes SunOpta’s international sourcing network a significant advantage and a strong foundation for its move into private label manufacturing.

The Turnaround

Several fundamental changes over the last six months piqued our interest in the Company.  First, the management: Rik Jacobs, formerly the Company’s COO, replaced the old CEO.  Mr. Jacobs has previous experience with Tetra Pak, and brings useful experience in consumer packaged goods.  Secondly, the Company finally seems to have acknowledged the operational mistakes - at the 2016 analyst day, management laid out their execution plans in some detail, speaking to full integration of the many recent acquisitions and targeting significant improvement in operating metrics over the next 2-3 years.  Targets include acceleration of organic growth to 10% p.a. from mid-single digits and expansion of gross profit margins from around 11% to 15%.  While these would represent an improvement over recent performance, when benchmarked to private label and organic peers, we see these as reasonable and achievable targets.

Capital allocation – while the Sunrise Growers acquisition looked expensive to us, management has committed to reducing leverage by 1 - 1.5x over the next year by paying down debt and increasing cash flow, so we don’t see this as an issue.  Secondly, management is having its feet held to the fire by an activist investor group, who owns 9.9% of the shares, with exposure to another 14.8% through cash-settled swaps, who wrote a letter to management in May emphasizing their belief that operational targets are not aggressive enough (they spoke of $1.60 in EPS as a realistic target) and requesting that management engage an investment bank to look at a potential sale of the Company.  (http://investor.sunopta.com/secfiling.cfm?filingID=902664-16-7222&CIK=351834)As a result, SunOpta has retained Rothschild Inc. to look into strategic alternatives. To add a little more outside scrutiny, Engaged Capital filed a 13D with a 7.5% stake just this week. With multiple sets of eyes looking over their shoulders, we are optimistic that management will be focused on getting results sooner rather than later.

While a sale of the company could be at a large premium, we believe that the stock price could potentially double on operating improvements alone.  We believe that the greatest opportunity is through sales growth and the utilization of the excess aseptic beverage capacity at the Company’s Allentown, PA facility.  When the facility was completed, it gave SunOpta the ability to serve customers nationwide.  We estimate that incremental profit margins on sales from the facility are as high as 35%, more than three times the corporate average.  The Company is aiming for a mix of new products, new customers and greater penetration to get to full utilization over the next couple of years.  Indeed, product innovation is an opportunity across the entire consumer products platform and a key selling point to customers.  SunOpta has a dedicated innovation group to drive these efforts, headed by Jim Gratzek, formerly of General Mills, devoted to new product development. 

On the cost side, sales growth will help to leverage fixed operating costs as will consolidation of production facilities, and the Company has committed to bringing SG&A levels down to below 8% of sales.  Finally, there is the balance sheet opportunity of the high-cost term loans.  If SunOpta is not sold, we would expect these to be refinanced at lower rates, though probably in 2017 rather than 2016.  At a minimum, the Company has a high yielding opportunity to invest its free cash flow just by paying down the debt.

In summary, we see a lot of self-help opportunities for SunOpta, with a tailwind of double-digit industry growth and a management team that is finally focused on internal organic growth and improvement rather than overpriced external M&A.  While there are clearly execution risks, we believe that it will not require heroic performance to achieve management’s margin and growth targets. There’s also the option that the Company will be sold if it cannot be turned around in a timely manner.

Valuation

Management’s targets for 2018 are laid out by segment in the investor presentation http://files.shareholder.com/downloads/STKL/2845617510x0x800768/e503e5dc-e3fc-46c1-ad0f-ee15f9065687/SunOpta_Investor_Presentation.pdf

Standalone: Based on the performance targets for 2018 which seem reasonable, SunOpta is trading for around 9x P/E, ~7.5x EBITDA and 0.7x EV/Sales.  Comparing multiples for private label food companies and processors, an appropriate blended sum-of-the-parts multiple would be around 1x sales and 10x EV/EBITDA, the latter would imply a share price of $11-$12.  This would also equate to a reasonable 15x 2018 P/E.  Even allowing for potential hiccups in execution, there should be meaningful upside from the current valuation.

M&A: The recent purchase of competitor WhiteWave Foods (WWAV) by Danone for 2.8x 2016 sales and 20x 2016 EBITDA estimates shows the premium prices that consumer goods companies with exposure to the healthy living / organic trends can fetch.  Other healthy living companies such as Boulder Brands and Annie’s have also fetched multiples of over 20x EBITDA. To be sure, WhiteWave is a larger company with a range of consumer brands against SunOpta in private label, but there is meaningful product overlap, and it highlights the opportunity in SunOpta trading at just over 0.8x 2016 Sales – 30% of WhiteWave’s multiple – for a consumer goods company.  Conservatively comparing SunOpta’s ingredients business to non-organic processors and the consumer products division to lower-growth non-organic private label peers such as Treehouse Foods, we believe the value to an acquirer could be as high as $15/share at a blended multiple of 1.0x estimated 2018 sales.

Risks:

The company has a pretty checkered history regarding execution and the most recent quarter was no exception. Some of this is outside their control (crops, producing for third parties who lose customer contracts) and some of it is. However, the management’s focus now appears to be on execution and filling existing capacity, and while quarter to quarter results will be noisy, the outlook medium to long term appears healthy.

Balance Sheet –  we expect to see leverage and interest costs come down in the next year. The company is not faced with any near-term covenant issues however – from the Q2 call:

“From a liquidity perspective we ended the quarter with approximately $75 million of available capacity on our asset backed credit facility and this is at our peak usage. So we expect availability to increase over the back half of the year.

In addition I would like to remind listeners that due to the excess availability we have under our credit facility we’re not currently required to maintain compliance of any specified financial ratios under that credit facility. We remain focused on debt leverage, reduction and expect noticeable improvements in these metrics by the end of the year.”

Disclaimer: This report is neither a recommendation to purchase or sell any securities mentioned. The author or affiliated funds  presently has a long position in securities of this issuer and may trade in and out of these positions without notice. The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates.  No representation or warranty is made as to the accuracy of the data or opinions contained herein. Readers should conduct their own verification of any information or analyses contained in this report. The author undertakes no obligation to update this report based on any future events or information. Please do your own work.

Catalyst

New contracts filling up Allentown capacity, healthy incremental margins, getting past startup costs

Refinance/paydown of debt