Description

Seneca Foods (“SENEA) is a small cap, fruits and vegetable processing company that is not covered by the sell-side and is deeply discounted to intrinsic value.  The company’s GAAP earnings have declined from approximately $14.00/share to $4.00/share in the last 2 years. While this looks like a large drop, the decline is driven by accounting in a rapid inflationary environment and therefore is not indicative of normalized earnings.  We believe one can invest in SENEA today at 5.0x free cash flow and 4.0x EV/EBITDA on normalized profitability. Regardless of the peer used for valuation purposes, we believe upside ranges from ~40-190%.

Source: Company Filings, Internal Analysis

While there is plenty of upside to the stock, the downside protection makes this even more appealing from a risk reward perspective. At first glance, public filings currently show a book value per share of approximately $76. However, we believe this is understated because LIFO based accounting has a reserve of $39 per share against the inventory value on the balance sheet. Using FIFO based accounting, as is standard in the industry, the company’s book value per share would be closer to $115. Moreover, replacement cost economics (as shown below) could support the stock price well above that level due to the legacy cost base of the assets.

SENEA has been around for ~70 years and is a leading provider of packaged fruits and vegetables with 26 facilities in the US. They dominate the private label (“PL”) can industry in the US; canned vegetables represented 83% of sales, frozen vegetables represented 8% of sales, fruit products represented 6%, and chip products represented 1% of the total food packaging net sales. We estimate SENEA currently holds a 45-50% market share in the PL industry. Their PL business represents ~80% of sales, with the remainder of the business from branded and contract manufacturing for the likes of Del Monte (“DM”) and Green Giant (“GG”). Since peaking at nearly $70 per share, the shares declined significantly this past year. The drop can be attributed to three factors: a) concerns around normalized earnings, b) poor FCF generation and c) the removal of SENEA from the S&P 600 Index. 

Much of the underperformance in the shares can be attributed to the big drop in earnings power from $13.72 per share in 2021 to $4.20 per share in 2023.  We believe this significant decline has led many investors to improperly assess the true earnings power of the business. Most of this decline can be attributed to the company’s use of LIFO accounting in a rapidly inflationary environment. As we will expand upon below, this accounting policy can distort the company’s normalized profitability in times of rising inflation. For comparison, LIFO is seldom used in the CPG space and makes the earnings power look much more volatile than it is. When adjusting LIFO to FIFO, we can see the earnings power of the business is much less volatile than GAAP would suggest (See below).

Source: Company Filings, Internal Analysis

Secondly, investors have expressed skepticism surrounding the expansion in gross margins as compared to pre-COVID levels. While we initially shared this concern, we posit that there have been three significant changes in the industry that lead to stronger sustainable margins in the future.

1. SENEA excited the fruit business in 2018/2019. That business was money losing and the exit of that business alone improved gross margins by ~230bps (see section below for more detail).
2. Del Monte (“DM”) decided to exit the private label (“PL) business. More on that below, but we estimate that Del Monte had roughly ~30-35% market share of the private label market and walked away from $400mm of revenue. This not only led to market share gains for Seneca but higher margins due to reduced competition. For example, from 2018 to 2023 Del Monte grew their Americas business ~6% as compared to Seneca which grew revenues by approximately 30%. The operating leverage is worth ~100bps in margins to SENEA.
3. Pricing Power Returned to Industry.  Once Del Monte exited the private label business, they started raising pricing on branded products. In fact, management’s strong pricing initiatives enabled Del Monte to expand margins by ~900bps from 2018-2023 despite sales up ~6%. This created a pricing umbrella as it enabled Seneca to raise prices as well. While it’s difficult to quantify, we estimate Seneca’s margins structurally expanded by 500-800bps assuming 60-90% of the pricing increases Del Monte put in place flowed through to SENEA.

When you put it together, we believe normalized gross margins should be 17% to 20% vs. the ~9% they did pre-covid.

Source: Company Filings, Internal Analysis

Free Cash Flow Concerns:

While SENEA’s margins are likely sustainably higher due to the industry and competitive factors noted above, SENEA has not performed well with respect to FCF generation in 2023. They lost $280mm of FCF with inventory accounting for a $400mm drag. However, it is worth noting that this happened to its largest peers as well. Ultimately, we estimate normalized FCF to be $7.74-$13.37/share which assumes zero benefit from working capital.

Inventory Issues:

According to Nielsen, ~2.4bn units of private label canned fruit and vegetables were sold in the US in 2021. This represents a ~48% private label share as a percentage of the total canned fruit and vegetable market on a unit basis, but a ~33% share on a revenue basis. Generally speaking, the category has not seen much growth as the consumer has shifted towards “fresh” options over time.  However, we believe private label is better positioned due to continued market share gains over time. While we do not view the category as a growth market by any means, we do believe it to be a steady end market and a recession beneficiary as consumers trade down.

Source: NielsenIQ/PLMA                                                                        

Given the nature of the industry, there is significant seasonality in packing/production cycles. Typically, you grow the crops, harvest, and then pack all at once. Therefore, companies must have a strong view on the next 12 months when they make packing decisions. This can lead to significant working capital volatility. When you combine this with supply chain bottlenecks and a rising commodity environment, it’s easy to image how SENEA got themselves into trouble. In 2023, inventory adjusted for LIFO was up ~69% vs sales up ~9% which led to a significant FCF drain on the business.  Interestingly, the company would have generated $13/share of free cash flow assuming flat working capital, placing the business at near a 25% FCF yield. Simply put, the company misestimated demand post COVID, but we believe this to be more than reflected in the share price. As we further analyzed this period of cash drain, there are two things that do give us some comfort:

1. There is very little inventory obsolescence risk in the canned food business due to the long shelf life of the products (typically 3+ years). 
2. This is not a SENEA specific issue. Del Monte experienced a ~60% increase in inventory as compared to a ~3% increase in sales (see below).  When comparing the inventory and revenue growth between the two companies, it suggests this was in fact an industry issue rather than something Seneca specific.   

Source: DM / SENEA Financials

Use of LIFO Accounting:

In 2008, the company decided to switch from first-in, first-out (FIFO) accounting to last-in, first-out (LIFO). While the decision to use FIFO v LIFO is made by the management team at each company, LIFO accounting is used less and less by CPG companies. For example, we looked at 14 CPG peers (JJSF, Del Monte, HSY, SJM, THS, MKC, CAG, POST, TWNK, CPB, K, KHC, FLO, and GIS) and only one company uses LIFO (GIS). A lot of companies prefer FIFO for practical and optical reasons. Practically speaking, you typically sell your first bought inventory first. When it comes to food, you don’t want obsolesce and the first batch of food you make is the first batch of food you sell. Optically, in a rising price environment (as is the case globally), FIFO accounting will result in higher margins as compared to LIFO. Conversely, some would argue LIFO is a better reflection of the real-time operating environment as LIFO inventory reflects the current cost of goods sold in today’s market.

Regardless of the logic of using one vs the other, companies using LIFO can exhibit significant margin degradation in a rising inflation market. Rapidly rising manufacturing costs are immediately run through the income statement while revenues may reflect a pricing environment of the past, thereby pressuring margins. Ultimately, Seneca exhibits significantly more earnings volatility than many others. For example, the rapid rise in costs in FY2023 led to a $100mm difference between LIFO and FIFO after oscillating from -$28mm to +$41mm in the seven years before. Therefore, a more accurate way of looking at the business during this period is on an adjusted EBITDA basis that normalizes for this volatility (the difference between adjusted EBITDA and EBITDA is the LIFO Charge). In fact, if SENECA was a FIFO based company, its earnings would have been $13.48/share vs the $4.20/share reported for FY2023.

Source: Company Filings, Internal Analysis.

Exit of Del Monte Foods:

Today, Del Monte is one of the largest producers, marketers, and distributors of processed foods in the US. The company has about $1.7bn of sales in the Americas (most of that the US) with the majority of its revenue tied to its branded products. As of FYQ1’23, they have approximately a 29% market share in canned vegetables, 37% market share in canned fruit, 29% market share in fruit cups and an 8% market share in canned tomatoes (source: DM filings). Their products typically tend to be the highest price point in canned goods in stores. For example, at a local market the DM canned vegetables are ~$1.50 vs. Green Giant at $1.10-$1.30 and private label in the $0.50-$0.75 range. While today Del Monte is a branded business, that was not always the case. In 2017/2018, nearly 30% of Del Monte’s sales came from the private label business. At that time, we estimated they had 30-35% market share of the private label business. In 2018, new management came on board and made the decision to exit private label. The logic was simply that private label has been a bit of a race to the bottom with excess capacity. DM’s margins in private label were thin and the company wanted to focus on its higher margin Del Monte brand.

Ultimately, this proved to be the right decision for Del Monte and the industry. In 2018, DM Americas generated $1.65bn of sales with a ~15.7% gross margin. In 2023, DM Americas revenues are similar ($1.74bn), but profits are up approximately 60% as gross margins expanded by ~900bps. They eliminated nearly $400mm of private label sales which a) improved its mix, and more importantly b) tightened up the entire private label industry enabling increased pricing of branded products. We cannot underscore the impact this had on the entire private label industry which benefitted from a competitor representing nearly a third of the market exiting the business.

DM Americas

Source: DM Financials

Replacement Economics:

Book value per share is something to be mindful of with respect to assessing the value of a company. In the case of Seneca Foods, the adjusted book value (adding back the reserve against inventory from the use of LIFO accounting) per share currently stands at ~$115, or 0.5x price/book value. As noted at the beginning of the write-up, Seneca is 70 years old and has fully depreciated significant amounts of its PP&E such that the value of the assets are understated on the balance sheet. 

A great example of the value of Seneca’s assets can be gleaned from looking at a recent plant opened by another company. In the summer of 2022, Conagra (“CAG”) opened a 240K square foot facility in Waseca, MN. This facility can process 120 million pounds of cut and cob corn, 45 million pounds of peas, and more than 20 million pounds of rice.

While this is a facility that processes fresh vegetables for frozen foods, there are lots of similarities to SENEA’s plants. One has boilers, the other freezers. One uses aluminum cans and tops, the other uses plastic bags. SENEA has 5 Minnesota facilities with a combined square footage of 2,441K square feet within an hour and a half drive of this CAG facility. Nonetheless, we have to assume this is a state of the art facility. Therefore, if we assume an 85% discount to this replacement cost, it would imply Seneca’s Minnesota capacity alone is worth $458mm or ~55% of total EV. Let’s then assume the rest of the capacity of the network should be at an arbitrary 20% discount to the MN capacity. In this hypothetical case, the replacement value would be $153 per share, suggesting ~200% upside to the stock. However, if we are wrong and SENEA’s facilities should be valued at a 65% discount to Conagra, then the shares should be worth $433 or nearly 9x. Ultimately, the main takeaway is that it is clear to us that the company is trading at a significant discount to its replacement cost.

Source: Company Filings, Internal Analysis

Exit of Fruit:

In FY’18, Seneca made the decision to exit certain fruit operations, most notably its Modesto facility in California. At the time, Modesto was the largest peach cannery in the world and operated substantially below capacity. While the company kept its cherry operations (which makes up the majority of the fruit segment), they exited pears, peaches, apricots, and apples. The industry faced “shrinking consumer demand and competition from lower priced imports.” Moreover, when combined with a) rising processing costs of fruit in CA and b) the farmer’s propensity to shift supply to nuts and other products, it became apparent that that losses in this division were irreversible. The exit of fruit alone improved Seneca gross margins by ~230bps on average using 2018/2019 financials.  While this resulted in decreased revenues, it improved margins and profitability over time and should be properly assessed when comparing how the business has changed over the years.

Discontinued Operations

Source: Seneca financials.

Value Proposition of Private Label:

The significant inflation today within grocery coupled with expanding margins over the past decade due to pricing actions within the consumer product space does appear to be impacting consumer spending patterns.  While we do not have canned vegetable data specifically, other categories within grocery are seeing rapid share shifts towards private label.  For example, private label is up 7.9% in CSD over the past four weeks of data while the category is down 3.5% (source: Nielsen data ending September 2023).  The same can be said for salty snacks and potato chips where private label has grown 11.8% and 13.9% as compared to a category that is down 1.1% and 1.4%, respectively.  These types of datapoints may point to more robust earnings power for Seneca than what the stock currently reflects. 

So Whats it Worth?

There is no perfect comp here other than Del Monte and there are no other large scale private label competitors to analyze (Del Monte is private). However, we looked at a few peers that we think are relevant to the comparable valuation analysis:

• THS – Largest public private label focused CPG company
• CPB – Branded canned soups
• BGS- Levered, declining brands
• GIS – Sleepy and losing share to PL within CPG

We firmly SENEA’s business is better today than in the years past and its multiple should indeed be higher.  Seneca Foods maintains a dominant position in its industry, is not facing any new competitive threats, and currently trades below 4.0x EBITDA and 5.0x earnings.  It would not be unreasonable to see its multiple re-rate to that of its lowest valued peers, representing well over 100% appreciation in the stock. If one uses the group’s average, equity upside expands to well over 200%.

Lastly, we think management understands this as well with approximately 9% of shares repurchased in FY 2023.   

Source: Bloomberg, Butler Hall Estimates

Model:

Disclosure: At the time of publication, the author of this article holds a position in SENEA.  This article expresses the opinions of the author. The author has no business relationship with any company whose stock is mentioned in this article.

The author of this article has a long position in the company covered herein and stands to realize gains in the event that the price of the stock increases. Following publication, the author may transact in the securities of the company, and may be long, short or neutral at any time.  The author of this report has obtained all information contained herein from sources believed to be accurate and reliable.  The author of this report makes no representation, express or implied, as to the accuracy, timeliness or completeness of any such information or with regard to the results to be obtained from its use.  Any projections, forecasts and estimates contained in this report are necessarily speculative in nature and are based upon certain assumptions. Accordingly, any projections are only estimates and actual results will differ and may vary substantially from the projections presented. All expressions of opinion are subject to change without notice, and the author does not undertake to update or supplement this article or any of the information contained herein.  This is not an offer to sell or a solicitation of an offer to buy any security.

Catalyst

2024 earnings