John Kingham | May 24, 2019 11:49
Cranswick (LON:CWK) is one of the UK’s leading food producers. It manufactures a wide range of premium fresh and cooked meat products, from pork chops to sausages, handmade pastries and much more.
With its share price at 2800p, Cranswick also has a dividend yield of just 2%, and a yield that low usually means the market is very optimistic about a company’s dividend growth potential.
But is the market right to be so optimistic about a company that makes sausages?
Let’s start by looking at the past as that’s often the best place to begin thinking about a company’s future.
The chart clearly shows that Cranswick has grown substantially and relatively smoothly over the last decade. Breaking that down in order of importance, Cranswick has produced the following annualised growth rates over the last ten years:
Capital employed (the company’s productive assets funded by shareholders and debt holders):
Revenues (money paid into the company by customers):
Earnings (what’s left from revenues after all expenses are deducted):
Dividends (payments to shareholders of cash which cannot be successfully reinvested within the business):
That’s a fairly impressive track record and it gives Cranswick an overall (average) growth rate of 8% per year over the last decade.
That’s better than the average of UK companies and it also exceeds my growth rate rule of thumb:
Rule of thumb: only invest in a company if its overall ten-year growth rate is above inflation (approximately 2% per year).
Cranswick has consistently proven itself capable of expanding into growing market segments, such as cooked meats, food-on-the-go and meat foods where the meat source can be traced 100% from farm to fork.
This last point is a consequence of the 2013 horse meat scandal. Horse meat turned up in burgers and other meat foods because the supply chain for meat can be very fragmented. In simple terms it usually involves:
These activities may all be done by different companies in different countries across the world. Keeping track of exactly what goes into a lasagne or burger proved to be difficult, and in 2013 a significant portion of some meat products were found to be horse.
We don’t eat horses in the UK, at least not intentionally, so this was a problem for the meat industry as a whole.
For Cranswick though, this was a positive development. As a UK-based food manufacturer, it already had a relatively vertically integrated business (vertical as in up and down the supply chain).
It didn’t rear pigs, but it was already focused on premium UK meats, processed in the UK. So most of its pigs came from UK farms, and were slaughtered, cut up and processed in its UK facilities.
This more traceable supply chain proved to be a great asset, and following the horse meat scandal Cranswick took this a step further by purchasing East Anglian Pigs, a company focused on breeding, rearing and finishing (i.e. growing to full marketable size) pigs. Around 17% of Cranswick’s sales are now generated from pigs reared in its own facilities.
In 2016 Cranswick acquired Crown Chicken, which allowed it to take this successful vertically integrated model into the world of chicken meat.
All companies need assets in order to provide customers with products and services, and in Cranswick’s case it needs quite a lot of expensive assets.
These are large-scale assets like meat processing plants, food manufacturing facilities or pig farms. The 2019 annual results highlight this years’ record capital investment of £79 million, stating that:
The year saw the commissioning of the new Continental Foods site at Bury and commencement of the construction of the new Poultry facility at Eye in Suffolk.Cranswick 2019 annual results
This investment in new productive assets is of course necessary if Cranswick is to continue to expand its production of pigs, chickens, sausages and pies.
But are these investments worthwhile, or should the cash have been returned to shareholders instead?
It’s a valid question, and one we can answer by looking at the company’s net return on capital employed (ROCE).
If the return on those capital assets is less than the return we can reasonably expect from an index tracker (i.e. about 7%), then the investment may have more to do with CEO empire building than the maximisation of shareholder returns.
Here’s a chart showing Cranswick’s net return on capital employed, along with its net return on sales (ROS, and I’ll explain why net return on sales is there in a moment):
First, Cranswick’s ROCE is consistently around the 12 to 14 percent mark.
This is quite good as it’s above the return you could reasonably expect on an index tracker. It’s also slightly above my minimum standard for ROCE, which is 10% averaged across the last ten years.
Rule of thumbOnly invest in a company if its ten-year average net return on capital employed is above 10%.
This consistently above-average profitability shows that Cranswick is able to fend of pressure from competitors, either by producing a better product or service or by being more cost efficient, or both (I think it’s probably a bit of both).
Net return on sales is in that chart because it’s another useful way to look at profitability, pricing power (i.e. a company’s ability to raise prices in line with or ahead of costs) and efficiency.
Companies with thin profit margins can be risky and problematic, so I look for companies with net margins of at least 5% (that isn’t high, but it does rule out the most obvious basket cases).
Rule of thumbOnly invest in a company if its ten-year average net margin is above 5%.
It isn’t clear from the chart, but Cranswick narrowly fails this test with an average net margin of 4.6%. Unfortunately for Cranswick, food manufacture is typically a low margin business and food manufacturers are rarely able to generate more than a few pennies of profit from each pound of revenue.
But all is not lost. If Cranswick was a highly cyclical business with lots of debts and thin margins, like some construction companies for example, then I’d be worried. The combination of volatile revenues, thin margins and high debt costs is a potential nightmare.
However, Cranswick operates in a very defensive industry, and people will still eat pork pies and sausages in even the worst recessions. Also, and quite sensibly, Cranswick has almost no debt. This combination of defensive revenues and small debt obligations means that Cranswick’s thin margins are probably not a major concern.
In summary then, we have a company with very consistent growth, which hasn’t been driven by wild acquisitions or reckless borrowing. It has above average profitability, and its thin margins probably aren’t a major problem given its defensive nature and rock solid balance sheet.
From this point of view it’s easy to see why the market is relatively optimistic about Cranswick’s future.
But there are risks, and I can think of a few which might derail Cranswick’s future to varying degrees.
In 2015, red meat (which includes pork) and processed meat (which includes sausages) were classified as carcinogenic by the World Health Organisation.
“According to the most recent estimates by the Global Burden of Disease Project, an independent academic research organization, about 34,000 cancer deaths per year worldwide are attributable to diets high in processed meat.”World Health Organisation Q&A on the carcinogenicity of the consumption of red meat and processed meat (2015)
This is not exactly great PR. The risk is that consumers move away from pork and processed meat products towards poultry, fish or plant-based foods instead.
To some extent, that does seem to be happening in the UK, with multiple sources citing declining pork sales, although it’s hard to separate out any trend from the underlying variability of pork consumption.
Going in the other direction, as expected, are sales of chicken. Also growing rapidly are the number of vegans and flexitarians, as this report from the Agriculture and Horticulture Development Board explains:
With red meat listed as a cancer risk, the government’s Department of Health would like some consumers to eat less meat. Specifically, the suggestion is to eat less than 70 grams of red meat per day. That isn’t a lot, seeing as two typical sausages and two rashers of bacon add up to 130 grams.
And health isn’t the only reason the government might want people eat less pork and other red meats. We also have climate change, with key scientists and government advisors suggesting a reduced red meat diet is necessary if we’re to hit the target of net zero emissions by 2050.
I have no idea how this might pan out, but something like the “five-a-day” suggestion for fruit and veg may be used for meat, such as a “one-a-day” upper limit.
Technological disruption isn’t usually something that’s thought of as a risk for food manufacturers, but that doesn’t mean the risk isn’t there.
In the case of meat, I think a major long-term risk comes from cultured meat, more informatively known as lab-grown meat.
It’s hard to see a downside to a world in which the production of cultured meat vastly exceeds the production of animals for food.
And while this may seem like science fiction, Just, the seller of plant-based egg alternatives, is hoping to get its cultivated meat products (starting with chicken nuggets) into the shops in 2019.
Of course, it’s early days yet and those chicken nuggets are likely to be very expensive, but ten or twenty years of growth and economies of scale will fix that.
So how will this affect Cranswick’s business?
On balance I think not too much, but there’s a lot of uncertainty.
On the plus side, Cranswick is vertically integrated, so pig rearing and processing is only one part of its business (17% of the pigs it processes come from its own facilities). When cultured pork largely replaces pig farming, Cranswick will be able to buy cultured pork from the supply chain instead of pigs. And then it can work its magic, turning animal-free pork into lovely sausages, pork pies and all manner of other tasty foods.
On the negative side, Cranswick benefits from being vertically integrated, rearing, slaughtering, cutting and processing pigs all in the UK, with a more transparent and trusted supply chain and, potentially, better animal welfare. This is important because it helps Cranswick charge higher prices and earn better returns on sales and capital.
But with Cultured meat these advantages disappear. Cultured meat will be much easier to trace from production facility to the consumer’s plate, there won’t be any incentive for suppliers to sneak in cheaper meat (because animal meat will be more expensive) and we’ll also know that animal welfare isn’t an issue.
Ultimately it means a lot of uncertainty and I guess we’ll just have to wait to see how this change affects companies like Cranswick.
Listing out the risks faced by a company is always going to sound a bit negative, but despite all those risks, I’d still invest in Cranswick.
It’s a market leader, it’s profitability and growth are good and its balance sheet is rock solid. As a food producer it has been and should continue to be quite defensive, so it’s just the sort of dividend-paying company I’d like to see in the UK Value Investor portfolio.
The risks from changing consumer tastes, government intervention and technological disruption are real, but I don’t think they’re enough to completely derail Cranswick, at least not in the next ten years.
What they do derail, in my opinion, is its current share price of 2800p.
I don’t think the current price is outrageously high, but I do think it’s a bit on the optimistic side and requires everything to go perfectly well for Cranswick for a very long time.
For example, if the company grows its dividend by an impressive 7% every year for the next ten years, its dividend will double. And if the share price stays the same for ten years, it will have a dividend yield of 4%.
The FTSE 100 currently has a yield of 4.3%, so a 4% yield is it a realistic possibility for Cranswick, and that means a flat share price for ten years is also a realistic possibility.
In fact, when I bought Cranswick in 2012 it had a dividend yield of 3.8%, so yes, a 4% yield is a very real possibility (I subsequently sold Cranswick in 2015 after its shares shot up following the horse meat scandal).
So I like Cranswick, but I don’t like the idea of watching its dividend grow rapidly year after year, only to see its share price remain unchanged for a decade.
I would rather wait for its PE10 and PD10 ratios to go down a bit, and its dividend yield to come up a bit.
But I don’t think it’s massively overvalued. For example, if its share price falls by 28% to 2000p, it would have a more reasonable dividend yield of 2.8%. That doesn’t sound like a big difference, but it’s almost 50% higher than the current yield.
At 2000p Cranswick would also be comfortably inside the top-30 stocks on the UK Value Investor stock screen, and at that point it would be a serious investment candidate.
Written By: John Kingham
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