Investors in the JSE’s food producers index have had a serious case of indigestion.
The food index year to date is down 16%, while the all share index is ahead 3.3% at the time of writing. On a three-year basis the food sector is even more sickly, declining 10% versus a 47% increase in the Alsi. Much of this underperformance has been led by rising distribution and input costs of raw materials which — with the implementation of erratic load-shedding — have hit profit margins of all food stocks.
An inability to fully recover higher costs from constrained consumers has slammed earnings, leading to the sector’s underperformance.
Tiger Brands CEO Noel Doyle aptly stated recently in the company’s underwhelming results that the South African consumer’s spending elastic has been snapped. This has led to constrained industry-wide volume growth and squeezed profits that have blighted what was normally considered a defensive sector.
They say everybody has to eat. That is true, but consumers can opt to eat less, trade down from trusted brands to cheaper, lower-priced house brands or even go for product substitution. A consumer’s purse can only stretch so far in an economy beset by soaring food price inflation, rising interest rates and unappetising GDP growth.
Year to date, the share prices of JSE heavyweights AVI and Tiger Brands are down 14% and 22% respectively. In the mid-cap food sector Libstar has slumped 35%, RCL Foods 10% and RFG Holdings 15%.
None in the sector has been immune. Poultry giant Astral Foods is down 8% and the only bright spot is fishing counter Oceana, ahead 14% so far in 2023.
IM has had a negative stance on food producers for more than two years, preferring the agricultural sector which has benefited from excellent weather and bumper harvests allied to robust soft commodity prices. This has been the correct call.
In mid-2022, IM turned positive on the fishing sector, with Oceana and Sea Harvest our preference in the food producer basket. Oceana has fared well, but Sea Harvest disappointed with a year-to-date performance down 15%. However, we remain confident the attractions of Sea Harvest will return as it recovers from one-off hits beyond its control, which slammed earnings in the 2022 financial year.
With the food producer sector suffering investor food poisoning, any bad news from a counter has led to an immediate and hard sell-off.
Weak interim results from sector giant Tiger Brands slammed the stock 17% as it reported a 16% rise in revenue for its first-half 2023 reporting period, but margin declined from 8.9% to 7%. This led to flat headline earnings of 731c a share — a shock to the market as the company had guided improved earnings in earlier investor updates.
Many food producer stocks are now trading at 52-week lows as battered investors reach for their Imodium pills in what is considered a defensive sector
Many food producer stocks are now trading at 52-week lows as battered investors reach for their Imodium pills in what is considered a defensive sector.
Despite the stomach-turning sentiment, there is potential opportunity not in immediate earning recovery, but in the possible permutations of mergers & acquisitions activity.
With market valuations at compelling ratings, it is rational to believe any corporate financier or private equity player would be looking at their calculators for opportunities.
The food sector is no stranger to deals. In 2019 the country’s largest dairy company, Clover Industries, was snapped up for R4.8bn by an Israeli consortium. US-based PepsiCo bought South Africa’s second-largest integrated foods company Pioneer Foods for R26bn in March 2020. In July 2020, unlisted Country Bird Holdings made an unsuccessful R1bn tilt for JSE-listed Quantum Foods. Latterly, majority shareholder African Equity Empowerment Investments made a minority R416m buyout offer for Premier Fishing and Brands.
IM sees nothing as immune to a possible M&A opportunity. With its basket of top grocery brands and a wide free float despite its bargain-basement, 20-year relative low, Tiger Brands has a market valuation of R29bn and a share price of R162.65. At its 2018 peak the company was valued at R81bn, and its present valuation highlights how the market has unwound food producers’ defensive premium.
The company would make an attractive acquisition for any global fast-moving consumer goods player wishing for exposure to the Southern African branded grocery market.
In dollar terms, Tiger Brands is worth $1.5bn, less than the $1.7bn PepsiCo paid for smaller Pioneer Foods. But IM sees the best feeding ground within the mid-cap food sector.
With a market valuation of R2.6bn for Libstar and R3bn for RFG, both counters are trading below their IPO listing prices. RFG listed in 2014 at R12.50 with a R3.2bn valuation, with its peak at R7.7bn. Libstar listed in 2018 also at R12.50, with a market value of R8.4bn. It has been on the slide ever since.
Both stocks had troublesome listings with periods of earnings and margin disappointment. Libstar issued a profit warning within months of its May 2018 IPO, and the market has never forgiven the stock. It now trades at 376c.
RFG has been unable to widen its operating profit margin, despite a slew of acquisitions. Some have been problematic to bed down and extract value from. RFG peaked at R29.50 in December 2016, and now trades at R11.25.
Both Libstar and RFG have major private equity shareholders and anchor financial institutions that will direct their futures
Both Libstar and RFG have interesting portfolios within supplies of branded and private label groceries, ready meals and bakery goods to mainstream retailers (especially Woolworths), alongside sizeable export divisions. Libstar has material exports in herbs and spices, and RFG in canned fruits and juices.
But both companies have assets shareholders decry as subpar. These dilute the overall portfolio and margin, yet management at both companies seems reluctant to address and rationalise.
Within Libstar, the Denny Mushrooms and home and personal care assets have consistently disappointed. At RFG, integration of the numerous lower margin pie businesses has been problematic and canned foods have been hit by high tin plate costs and a competitive environment.
Both Libstar and RFG have major private equity shareholders and anchor financial institutions that will direct their futures. At Libstar, private equity shareholder Actis owns a 37% stake, with the Public Investment Corp (PIC) at 11.9%. At RFG, Capitalworks private equity has 38%, with Old Mutual owning 18%. Both factions have received derisory returns on their investments since IPO.
IM is aware Libstar and RFG’s respective private equity ownership mandates may be up within two years. Founder management CEOs at both stocks have stepped down in the past year or two, with new appointees steering the ship in weakened consumer times. Shareholder activism has seen a resurgence on the JSE over two years as shareholders have shaken the tree at many underperforming companies, yet little activism has hit the food producers. Is that about to change as valuations slump?
IM’s top M&A plays are all in the mid-cap sector: Libstar (376c) and RFG (R11.26) with an outside bet on RCL Foods (900c) and Sea Harvest (R10.16). There have been market whispers on various rival companies’ interest in Libstar.
The brand portfolio has strong categories in dairy via Lancewood with leading market shares in cheese and yoghurt, a growing export business under Cape Herb & Spice and long-established grocery supply businesses to Checkers and Woolworths. Dealer own and house brands are 47% by value, 30% are Libstar’s own brands and the balance is in principal brands.
Libstar’s slumping share price would understandably attract suitors. IM believes both RCL Foods and Premier made overtures towards Libstar’s coveted foods portfolio. However, IM understands both approaches were rebuffed.
RCL Foods has been a simmering deal target for years as majority shareholder Rembrandt owns 80% of the underperforming R8bn hodgepodge foods business. The company recently exited Vector Logistics, and IM has long speculated its Rainbow Chicken division would be spun out. The core groceries business has potential and would be strengthened should Rembrandt merge its oils and fats business Siqalo Foods into RCL Foods.
IM has previously highlighted Sea Harvest as not just an acquirer of food assets to bulk up its Cape Harvest Foods unit, but also as a value unlock for its 54% majority shareholder Brimstone. Its impeccable BEE credentials would certainly be in the mix, should Libstar or RFG ever be in play or disassembled by a corporate raider.
Despite its lacklustre share price, RFG is IM’s No 2 M&A target. The stock has seen some recovery, with recent interim results showing good top-line growth and earnings recovery off a weak comparative base. Its prospects statement was less than encouraging, with talk of constrained volumes and pricing pressures.
Libstar is IM’s prime M&A target. The market is seemingly anticipating a weak first half in 2023 and that — alongside selling by its second-largest shareholder, the PIC — has caused the company to be the worst performer in the food producers index this year.
At 376c, institutions may be reluctant to sell their Libstar holdings to a protagonist given the lowly valuation of the stock, and would rather await recovery in the business. IM is aware the company is mulling over several strategic opportunities to resurrect itself and improve returns. Any external offer would have to be juicy to extract institutional support. IM believes it would have to be about 750c a share.
With a combination of management knowing it needs to improve the company’s valuation, allied to possibilities of the company being in the M&A crosshairs, IM places a special situations buy on Libstar.
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