Description

The African Swine Fever that threatens China the world’s largest pork producer is wreaking havoc on the world protien markets has sent stocks like Tyson (TSN), JBS, Sanderson Farms (SAFM) and Pilgrim's Pride (PPC) rocketing higher as there is speculation that the tightness in pork will bleed over into chicken and beef.  This may be true but there is a better play that is not widely recognized because it is not widely followed. Long Seaboard (SEB) is the best way to play the African Swine Fever epidemic in China with 75% upside and limited & defined downside. As a vertically integrated pork processor with 100% ractomine free product and existing relationships with Chinese buyers, SEB will deliver record earnings over the next few years and book value will appreciate meaningfully. This opportunity exists because SEB is an opaque situation with zero investor and sell-side following. See the chart below comparing SEB which is up a little over 30% YTD vs. all of the tangential beneficiaries mentioned above which have had much more substantial rallies.

Seaboard Corporation was founded in 1918 and is headquartered in Merriam, KS. Majority owned by the Bresky family and managed by third-generation CEO Steven Bresky, Seaboard is one of the largest vertically integrated pork processors in the world. Originally a domestic milling operation, Seaboard operates today as a conglomerate comprised of pork processing, commodity trading and milling, shipping, and sugar divisions. The company also owns a 50% stake in the country’s largest vertically integrated turkey processing operation, known as Butterball. While the business lines can be volatile and are certainly commodity driven, over the years the company has proven to be a good steward of capital, compounding its value multiple times over. Sporting a ~$4,000 stock price, no sell-side coverage and zero investor relations engagement, fundamental changes in the company’s business (such as the ASF impact) go mostly unnoticed by the market and create the opportunity to gain an informational edge. We currently view Seaboard as one of the best long opportunities in the market with limited downside. The company is uniquely positioned to benefit from the fallout of the African Swine Fever(ASF) outbreak in China, a black-swan event for global pork and protein markets. It is hard to overstate the impact of ASF, as we’ll detail later in this thesis. Suffice to say, we believe we are in the early innings of a world-wide pork shortage which will result in significantly higher pork prices. The recovery process from the ASF outbreak will take years, positioning Seaboard for an extended period of elevated earnings. SEB has $600M of net cash on the balance sheet, enough total cash ($1.5B as of 12/31/18) to repurchase the entire public float 1.5x over, and a management team that executed its first share repurchase in 4Q18 since a $100M tender in 2014. Management is willing to buy the stock <1.25x BV, which provides a floor at $3,658 given their cash balance and the limited liquidity. On the upside we expect a prolonged positive pork cycle which will drive record earnings and a substantial increase in book value. We believe the upside for SEB is $8,000 or ~75% upside.

Background

Started by Otto Bresky almost 100 years ago, Seaboard has evolved from a simple Kansas-based milling business into one of the largest agribusinesses in the world. From shrimp farming to sugar production, Seaboard has been in and out of almost every agricultural business imaginable; and while the company retains its roots in the milling business, current operations are dominated by protein processing. Historically perceived to be a volatile and low-return commodity business, Seaboard has produced an impressive track-record of value creation since going public, compounding its book value per share at a CAGR of 11.2% since 1991.

Despite Seaboard being principally engaged in commodity pork production, the company has vastly outperformed the S&P 500 for the last twenty years. As the chart below indicates, Seaboard has appreciated 10X compared to just 3.3X for the S&P 500 with dividends reinvested.  Seaboard’s performance is a testament to the talent of the Bresky family’s stewardship of the company over the last twenty years.

Seaboard reports its results within six segments: Pork, Commodity Trading and Milling, Marine, Sugar & Alcohol, Power and Other. While contributions can vary depending on the year, Pork Processing represents roughly 25% of revenue and 70% of operating income. Commodity Trading and Milling contributes about 50% of total revenue, but only 15%-20% of total operating income. Marine is the company’s third-largest segment, representing 15%-20% of revenue and 10%-15% of operating income. Sugar & Alcohol, Power and Other have historically been rounding errors, and haven’t contributed meaningfully to the consolidated results, although in 2018 Power accounted for 10% of operating income. It is important to keep in mind that Seaboard reports its interest/income from the Butterball JV below the operating income line, under “Income from Affiliates”. In an average year, protein processing winds up accounting for roughly 80% of Seaboard’s total net income, the majority of which comes from the pork segment.

Seaboard entered the pork processing business in 1990 when it acquired a pork processing plant in Albert Lea, Minnesota. Shortly thereafter, in 1992, the company began construction on a greenfield plant in Guymon, Oklahoma. In 1995 the company shuttered the Minnesota plant and brought Guymon online. Today the revenue generated by the pork division is derived from two shifts that run at the Guymon plant, as well as its 50% interest in the Seaboard Triumph JV which is reported using the equity method. Seaboard is vertically integrated with feed mills and hog farms across the southern Midwest that support the company’s processing capabilities. Given this vertical integration Seaboard is highly leveraged to the price of the pork cutout, which is the total value of all the different cuts of pork from one pig, and benefits from lower input costs of corn and soybean. Additionally Seaboard’s pork is ractopamine free, a growth hormone banned in China. The company exports 25% of its production, with China, Mexico and Japan being the three largest export customers. Seaboard has existing relationships with three Chinese buyers/distributors, with COFCO being the largest of the three.

The Pork Market

111 million metric tons of pork are produced annually across the globe. China accounts for ~50% (55.5mm MT) of this production, with the EU contributing 21% (23.3mm MT) and the US 11% (12.2mm MT). China is also the largest importer of pork in the world, a market that in totality represents 7.9mm MT annually. Of this amount China represents a 21% (1.66mm MT) share, Japan 19%, Mexico 14%, followed by South Korea at 8%. Global consumption of pork has increased by 2.1% per year over the past 30 years, driven by the growth of the middle-class in Asia and an increased appetite for the meat in Mexico. Mexico represents the fastest growing country in the top 10 consuming nations, growing at a 4.6% CAGR over the past 10 years.

China is the most important factor relative to global pork fundamentals. Small changes in the country’s production or consumption patterns can have a significant impact on the global supply/demand balance.

African Swine Fever

African Swine Fever (ASF) is a highly contagious viral disease which affects pigs. The disease is transmitted in a variety of methods: by live or dead pigs, through processed pork products, via contaminated feed, processing facilities, and transportation devices. There is no cure or vaccine for ASF. While the disease has a near 100% mortality rate for infected pigs, it poses no threat to humans via contact or consumption.

ASF Outbreak in China

The first report of ASF in China occurred in early August of 2018. At the time we were short SEB based on a domestic over-supply of pork production that had come online at the same time the Chinese/US trade war was heating up and Mexico imposed a 25% tariff on US pork exports. More reports of ASF began to come through during the month of August. Then on September 6th China reported finding ASF on four farms in a single day. We covered our short and began paying extremely close attention to the outbreak, which seemed to be intensifying by the day. By early November there had been 59 cases throughout 20 Chinese provinces.

The current numbers coming out of China are staggering. In March, the Chinese government announced that its hog herd was 19% lower y/y, and its sow population was down 21% y/y. These figures are likely severely under-reported. Reports surfaced during March that the herd population was down in excess of 30% y/y. On March 28th the Shandong Province reported its sow population was down 41% y/y. In 2017 the Shandong Province produced 47M hogs, representing ~7% of total Chinese production. The newest figures are pegging the current loss at 150M-200M. This is a loss of monumental proportion, and it will take years to restock the population.

As we noted earlier, it’s hard to overstate the scale of the ASF outbreak. China’s annual pork production is ~55.5mm MT. That figure is likely to be down in excess of 30% in 2019, representing a deficit of ~16.6mm MT. This amount is more than double the entire annual global export market of 7.9mm MT. There is simply not enough pork in the world to supplement this deficit. There is no easy fix for the problem, which continues to expand in scope. The 41% drop in sow inventory will create a production issue for many years, as it typically takes two years to raise a fully performing sow. Moreover, the disease is now spreading quickly through neighboring Vietnam. In mid-February

Vietnam reported its first case of ASF, and by late March 23 Vietnamese provinces were reporting ASF cases. Vietnam produces 35mm hogs annually, a figure which will be reduced in 2019 and beyond. The bottom line in that China will be required to significantly increase its pork imports in order to satisfy its appetite for pork. This was evidenced in April when China purchased 77,000 MT of US pork, the largest weekly Chinese purchase of US pork on record.

Below is the timeline of the ASF outbreak in China.