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Morningstar | Saputo's Profitability Remains Depressed in 2Q, but Shares Still Aren't a Bargain

While narrow-moat Saputo's revenue trajectory largely aligned with our expectations (up 19%, versus our 21% estimate, thanks to contributions from acquisitions), its profitability faltered, with adjusted EBITDA margin falling around 210 basis points to 9.3%, or about 90 basis points below our full-year outlook. We attribute this contraction to pressure from both market pricing and input costs. In Canada (31% of sales) and the United States (47% of sales), lower international selling prices for dairy ingredients, as well as higher warehousing and transportation costs, curbed profitability. Adjusted EBITDA margin in Canada fell 190 basis points to 10.0% and adjusted EBITDA margin in the U.S. fell 290 basis points to around 8.3%. From our vantage point, this provides further evidence of Saputo's limited ability to take pricing to offset unfavorable dairy market conditions, which makes sense given the limited differentiation and price-elasticity of consumers in the category. However, we believe the company's efforts to extract costs from its operations should help offset these pressures longer-term; our forecast calls for high-single-digit average operating margin over the next five years (comparable to the 9% achieved in fiscal 2018). We aren’t anticipating a material change to our CAD 33 fair value estimate as we incorporate these results, as we had already incorporated modest margin contraction in fiscal 2019 into our outlook.

The company also recently announced the acquisition of F&A Dairy Products, a U.S.-based cheese manufacturer; the deal is expected to close by the end of 2018. The purchase was made for approximately CAD 111 million, or roughly 0.5 times sales, which supports our contention that Saputo has been a largely prudent consolidator. We expect the Saputo's penchant for acquisitions to continue longer-term, and that the firm will use these deals as a means to broaden its distribution network and gain exposure to faster-growing international markets.