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Morningstar | Saputo Acquires Dairy Crest as Thirst for Deals Continues; Shares Remain Expensive

Narrow-moat Saputo announced its acquisition of Dairy Crest, a United Kingdom dairy producer, for GBP 6.20 a share, or around GBP 975 million in aggregate (approximately CAD 1.7 billion), a 12% premium to the last closing price and a 34% premium to the 90-day volume-weighted average price. The deal, which is expected to close in the second quarter of calendar 2019, should enable Saputo to expand its international presence, marking its first foray into the U.K. market. We posit that acquiring an established player with a solid asset base should allow Saputo to more quickly drive growth in this region than building out a platform organically. Further, while specific cost savings were not quantified, we surmise that the firm will not deviate from its strategic playbook of extracting costs from the companies it acquires.

The price represents a multiple of 2 times trailing revenue and 16 times trailing adjusted profit before tax (both for the year ended March 31, 2018), which strikes us as slightly lofty, given the commodified nature of the industry. We had similarly viewed the prices paid for Warrnambool in 2014 (for approximately 11 to 13 times EBITDA) and Murray Goulburn in 2017 (16 to 17 times adjusted EBITDA) to be elevated. However, we appreciate the solid margin profile of Dairy Crest; we estimate an adjusted profit before tax margin of 13.6% for the year ended March 31, 2018 (versus 8.2% for Saputo over the same time frame) and 10.2% for the following six-month period (versus 5.7% for Saputo over the same time frame). We expect to reassess the assumptions underlying our discounted cash flow model, but don’t anticipate a material change to our CAD 33 fair value estimate. We continue to view shares as expensive, particularly given a 4% uptick in shares on the announcement.

We’re not concerned about the leverage the firm will take on to finance the deal, as it has historically been able to maintain a strong balance sheet even while pursuing several bolt-on acquisitions; we estimate its net debt/adjusted EBITDA ratio has remained well below its 2 times leverage target over the last several years. At the end of calendar 2018, the company’s net debt/EBITDA stood at 1.96 times.