Description

Description

George Weston Limited (“WN” or “Company”) is a Canadian holding company controlled by the billionaire Weston Family. The Company has a long history having traded on the TSX since 1928. The Weston family owns 53% of WN. 

WN’s three key assets are shown below: 

Source: 2019 George Weston Annual Report

Negative Enterprise Value

With both Loblaw and Choice Properties being separate publicly traded companies, valuation is relatively straightforward. 

The Weston Foods’ stub trades at a negative valuation of ~-$16 per share or ~-$2.5 billion implied enterprise value. 

Notably, this is a new phenomenon.  Weston Foods has been trading at a negative stub value for about a year now, versus trading at a positive value historically. 

Note: Chart does not include net debt + prefs for simplicity, shift upwards by a few dollars per share to adjust for that

I think going long Weston Food stub (i.e. long WN and short L and CHP in their respective share ratios) is an attractive risk-adjusted trade. The stub is trading near its historical lows despite Weston Food nearing the finish line of its multi-year transformation plan. 

What is Fair Value?

I estimate that WN offers a 17% return to just the publicly traded assets, ascribing zero value for Weston Foods. Furthermore, this is overly conservative as it deducts all of the Net Debt present at the holding company.

If I utilize a 7.7x multiple on Weston Foods’ 2021E adjusted EBITDA, the math works out to a 30% return. The 7.7x multiple is based on trading comps from Grupo Bimbo, Aryzta, and Flowers Foods.

Weston Foods Background

Weston Foods is a leading North American bakery with well-known brands including Wonder Bread, D’Italiano, Gadoua, Country Harvest, Ace Bakery and Casa Mendosa. Weston Foods is one of two fresh commercial bakeries in Canada, the other being Canada Bread owned by Grupo Bimbo. Fresh commercial bread requires significant scale as it is a DSD (direct-store delivery) business, thereby requiring depth in your logistics and distribution. 

Like many other Canadian markets, I would not characterize fresh commercial bread as “competitive”, allowing the two market players to enjoy substantial profits. 

In 2017, the company began a 3-year transformational program to improve its supply chain, simplify the business and reduce overhead costs. The goal of this program was to deliver $100 million of adjusted EBITDA improvements. While 2020 was expected to be the final year of the program, the benefits have likely been pushed into 2021 due to Covid-19 (foodservice business, comprising 20% of sales, was down 50% in the first four weeks of Q2/20). If their plan comes to fruition, adjusted EBITDA could push towards $300 million beyond 2021. I would also expect capex to moderate once the transformation plan is completed (CIBC estimates maintenance capex is ~$100 million annually), further benefiting unlevered free cash flow in 2021 and beyond. 

What sort of value would you put on an oligopoly consumer staples business with an estimated 40% market share generating $200 million of unlevered free cash flow? Open for debate, but presumably, the range of values would positive.

Source: 2019 George Weston Annual Report

Weston Foods has been experiencing relatively strong sales momentum recently with 3.3% and 3.7% growth in Q4/19 and Q1/20, respectively. 

Prior to withdrawing guidance in Q1/20 as a result of Covid-19, Weston Foods had provided the guidance below. While Covid-19 has definitely pushed the realization of their alignment program to the right, I think it is a reasonably low risk bet to assume that foodservice bread demand will come back given its nature (it’s a staple, often given away for ordering an entrée, easily transported with little diminishment in quality when ordering for pick-up or delivery, etc).  

Source: 2019 Annual Report

How to Surface Value?

The Weston family has undertaken actions in the past in order to surface hidden value and reduce/eliminate market implied discounts on their assets.

• July 5, 2013: George Weston and Loblaw IPO’d Choice REIT, which largely consisted of Loblaw-focused retail and industrial owned real estate. Since then, Choice REIT has diversified itself including by acquiring CREIT in 2018, which created a proforma REIT with a $16 billion enterprise value.

• November 1, 2018: Loblaw spun out its 61.6% stake in Choice REIT to George Weston in exchange for shares in WN.

On the Q4/19, George Weston CFO, Richard Dufresne, stated:

“All told, George Weston had a successful year in 2019 executing against its plan, delivering operational stability and supporting each of its businesses in making steady progress against their strategic frameworks. Having completed our first full year of direct ownership in Choice Properties, we marked an important milestone in our transformation toward a more balanced portfolio with three strategic complementary businesses in retail, real estate and consumer goods. Today, we are focused on improving the financial flexibility of GWL to support investments in our existing businesses as opportunities arise. We used such flexibility as part of Loblaw's acquisition of Shoppers Drug Mart in 2014 by contributing $500 million of cash and allowing our ownership position in Loblaw to be diluted below 50%. At that time, we clearly stated our objective to return our ownership to over 50%. Now that our ownership in Loblaw is at 52%, we have achieved that objective and our focus is turning to building financial flexibility. For this reason today, we announced our participation in Loblaw's Normal Course Issuer Bid program. This means GWL will be selling Loblaw shares into Loblaw's NCIB program with the objective of maintaining our ownership position at 52%. Assuming Loblaw buys back about $1 billion worth of stock on an annual basis, this will generate approximately $400 million of additional cash on an after-tax basis for GWL annually. We currently hold about $700 million of cash and we'll seek to accumulate approximately $2 billion in total over the next few years. We have no specific plans for this cash today but remain optimistic about the opportunities in each of our businesses. Of course if it turns out that we cannot effectively deploy the cash, then we would consider a range of alternatives including returning capital to shareholders.”

The billionaires club in Canada is tightknit, especially the wealth that is multi-generational. As a result, the families take note of what others are doing. On December 13, 2019, the Desmarais family announced a reorganization of Power Corporation of Canada and Power Financial. The Desmarais outlined a number of reasons for the reorganization including simplifying the corporate structure and NAV accretion. 

Source: Reorganization Presentation dated December 13, 2019

The presentation deck also highlighted the fact that Power Corporation and Power Financial were both trading at significant discounts to NAV.  

Source: Reorganization Presentation dated December 13, 2019

On the call, the CEO of Power Corporation, Jeff Orr, stated: “And so I think that will help with the NAV discount. I think the liquidity will help with the trading. And then Tom, ultimately it's going to be, what do we do to execute? And as we execute and successfully build businesses, realize value for the businesses, return value to shareholders, I think all of that is going to contribute to a narrowing of the discount.”

Having witnessed the Desmarais family taking action recently to (successfully) reduce the NAV discount in its holding companies, I believe the Weston family may look to undertake a similar action.  

Conclusion

Weston Foods’ stub trades at ~-$16 per share for an entity that generates positive unlevered free cash flow, is nearing the end of is multi-year transformation, and is controlled by a family that has a history of undertaking actions to unlock shareholder value. 

Recommendation: Long Weston Foods’ stub

Buy 1.0 shares of WN CN

Short 1.215 shares of L CN

Short 2.872 shares of CHP-U CN

Borrow for the short legs in L and CHP-U are close to GC rates and readily available.

Catalyst

Catalysts

-Weston Foods completes its transformation plan in 2020 and starts reaping the benefits in 2021.

-Weston family undertakes a proactive action(s) to address the NAV discount (a reorganization in some capacity).

Risks

-Trade utilizes a significant amount of capital and could be dead money for a period of time.

-Stub owners are subject to negative carry with respect to dividends.