How to wing it when the feathers fly

Fi­nan­cial fig­ures in the next six to 12 months may be tough to digest

Financial Mail - Investors Monthly - - Front Page -

The lo­cal poul­try sec­tor is no place for the lily-liv­ered in­vestor. Higher feeds costs have pecked away at once fat mar­gins, cheap im­ports (now aided by a stronger rand) are scratch­ing away at mar­ket share and con­sumer de­mand is on the ebb. Some in­dus­try play­ers have pointed out that chicken is now often sold at prices well be­low what it costs to pro­duce a bird.

That sit­u­a­tion can’t con­tinue for too long — not with­out there be­ing a culling of the more in­ef­fi­cient poul­try pro­duc­ers.

How­ever, lest we for­get, the cy­cle al­ways turns, and poul­try pro­duc­ers pro­vide an af­ford­able pro­tein source for SA’s grow­ing house­holds and also have lu­cra­tive con­tracts to sup­ply the mul­ti­tude of fast food out­lets that are feed­ing into the bur­geon­ing mid­dle class.

Whether the worst is over for the lo­cal poul­try pro­duc­ers is dif­fi­cult to say.

How­ever, one thing is cer­tain: fi­nan­cial fig­ures in the next six to 12 months will prob­a­bly be tough to digest, and some com­pa­nies’ bot­tom line may even be coated in red ink.

This rather un­pleas­ant sce­nario of­fers in­vestors some in­ter­est­ing food for thought. The JSE’s “big bird” As­tral Foods has clawed its way back from a Jan­uary low of R90 to about R135 at the time of writ­ing. The share is still well off its R190 an­nual high, but the slow re­cov­ery has been sus­tained de­spite a dis­mal op­er­at­ing up­date is­sued re­cently. In short, As­tral in­di­cated that fac­tors to the detri­ment of the lo­cal poul­try mar­ket had turned out more se­vere than ex­pected.

Feed costs con­tin­ued to es­ca­late, fol­low­ing the im­pact of the drought on the lo­cal maize crop, and there were also record lev­els of poul­try im­ports, adding to the ex­ist­ing sur­plus of poul­try stock. As­tral has con­se­quently warned of in­sti­tut­ing marked pro­duc­tion cut-backs.

Smaller Uiten­hage-based com­peti­tor Sov­er­eign Food In­vest­ments, on the other hand, seems to be fly­ing above the dire trad­ing con­di­tions, its shares trad­ing at close to a 12-month high. The share price, though, is tied to a 900c/share buy­out of­fer tabled by un­listed ri­val Coun­try Bird Hold­ings (CBH).

CBH has al­ready ac­cu­mu­lated a 25% stake in Sov­er­eign by buy­ing shares from groups of smaller share­hold­ers.

The hitch, of course, is that, at this del­i­cate junc­ture, it seems highly un­likely that CBH will suc­ceed in its buy­out pitch. Sov­er­eign’s largest share­hold­ers — Pru­den­tial, San­lam, Old Mu­tual and RECM & Cal­i­bre — have to date backed the com­pany’s man­age­ment, and also its promis­ing ini­tia­tives in sup­ply­ing value-added chicken to Spar’s su­per­mar­kets.

It seems a rea­son­able bet that come mid-Septem­ber, when the buy­out of­fer ex­pires, CBH will not be hold­ing much more than its cur­rent stake in the com­pany.

If the buy­out of­fer falls away (re­mov­ing the pric­ing peg) and there has not been a mirac­u­lous re­cov­ery in the poul­try sec­tor’s prospects, it might be pos­si­ble to knock down Sov­er­eign’s share price with a feather. That might well suit CBH, with its neg­a­tive con­trol stake, though that’s a story for another time.

But Sov­er­eign’s sec­ond half of the fi­nan­cial year to end-Fe­bru­ary did show op­er­a­tional strain, with the sprightly earn­ings gains made in the first half pushed back in the lat­ter months.

There’s no doubt that Sov­er­eign, by virtue of its size and value-adding ini­tia­tives, will fly when the sec­tor turns. CBH must know this too; why else would it covet Sov­er­eign’s as­sets?

But in the short term, IM thinks Sov­er­eign’s mar­gins will be squeezed and profit growth staunched. We would opt for a short on the share.

While As­tral is clearly also go­ing to en­dure a lean pe­riod, the com­pany has the bal­ance sheet and strate­gic where­withal to profit in the longer term from poul­try in­dus­try car­nage.

As­tral has al­ready warned that a num­ber of mid- to large-sized in­de­pen­dent poul­try pro­duc­ers are in “se­vere fi­nan­cial dis­tress and are ei­ther cur­rently in the process of clos­ing down their busi­nesses, or are go­ing into busi­ness res­cue”.

The com­pany may well pick up choice pieces in the dis­tressed poul­try sec­tor, buy­ing only the bits where value can be en­hanced eas­ily with­out legacy li­a­bil­i­ties be­ing in­her­ited.

Sen­ti­ment might well fluff up for As­tral as in­vestors see the com­pany as the de­fault bet on a re­cov­ery in the poul­try sec­tor and take an early po­si­tion for gen­er­ous div­i­dend flows over the longer term.

IM choice would be to go long on the “big bird”.

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