Is Saputo Stock as Undervalued as Analysts Think?

Stock Market

Saputo (TSE: SAP) is a dairy processor and cheese producer that operates in Canada, the U.S., Argentina, the United Kingdom, and Australia. It sells products in more than 50 countries. In addition, Saputo is one of the top three cheese producers in the U.S. (48% of revenue) and one of the largest cheese manufacturers in Canada (27% of revenue).

Saputo appears to be undervalued, with the backing of analysts. However, its operational efficiency seems to be trending in the wrong direction.

Measuring Saputo’s Efficiency

Saputo needs to hold onto a lot of inventory in order to keep its business running. Therefore, the speed at which a company can move inventory and convert it into cash is very important in predicting its success. To measure its efficiency, I will use the cash conversion cycle, which shows how many days it takes to convert inventory into cash. It is calculated as follows:

CCC = Days Inventory Outstanding + Days Sales Outstanding – Days Payables Outstanding

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Saputo’s cash conversion cycle is 50 days, meaning it takes the company 50 days for it to convert its inventory into cash. In the past several years, this number has steadily trended upwards, indicating that the company’s efficiency has deteriorated. For context, it was 31 days in Fiscal 2014.

In addition to the cash conversion cycle, let’s also analyze Saputo’s gross margin trend. Ideally, I would like to see a company’s gross margin expand each year. This is, of course, unless its gross margin is already very high, in which case it is acceptable for it to remain flat.

In Saputo’s case, its gross margin has contracted in the past several years, going from 11.6% in Fiscal 2017 to 7.7% in the past 12 months. This is not ideal because it does not allow the company the opportunity to increase free cash flow or reinvest a larger percentage of revenue into growth initiatives.

Is Saputo Stock Undervalued?

To value Saputo, I will use a single-stage discounted cash flow (DCF) model because its free cash flows are volatile and difficult to predict. For the terminal growth rate (the long-term growth rate that the company can perpetually achieve), I will use the 30-year Government of Canada bond yield as a proxy for expected long-term GDP growth.

My calculation is as follows:

Fair Value = Average FCF per share / (Discount Rate – Terminal Growth)

C$29.07 = C$1.25 / (0.078 – 0.035)

As a result, I estimate that the fair value of Saputo is approximately C$29.07 under current market conditions. With a share price just above C$28, the company may be undervalued – but not by much.

Analyst Recommendations

Saputo has a Strong Buy consensus rating based on six Buys assigned in the past three months. The average Saputo price target of C$35 implies 24.1% upside potential.

Final Thoughts

Saputo doesn’t have very attractive efficiency trends, as its cash conversion cycle and gross profit margin have been deteriorating. However, the company appears to be slightly undervalued with the backing of analysts. Nevertheless, analysts may be a little too optimistic with their price targets.

Disclosure

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