12/23/2005 12:00 am EST
Irwin Michael, founder of ABC Funds, is a leading value investor and contributor to Internet Wealth Builder, an exceptional newsletter published by Gordon Pape. Here’s his latest value play and potential takeover target—an out-of-favor seller of nuts.
"The major North American economic and political problems remain, such as the twin deficits, a depressed dollar, the Iraq war quagmire, and rising interest rates. Yet in spite of all these well-known negative factors, the stock market has continued to climb a formidable wall of worry. Either the stock markets are impervious to these issues or else they are largely factored into stock prices. We believe it is the latter case and this opinion is the backbone of our generally bullish equity market outlook for the next 12 months.
"We have had good success investing in small capitalization, under-followed US companies recently. Onerous Sarbanes-Oxley reporting requirements have encouraged several takeouts and privatizations. We have discovered another potential candidate, poised for a turnaround, that has fallen out of favor with investors and it’s our latest pick of the month— John Sanfilippo & Sons (JBSS NASDAQ)
"JBSS can trace its history to 1922 when Italian immigrants started a pecan shelling company in a small Chicago storefront. By 1959 they had diversified into other nut types and new products including oil roasting nuts for the ice cream industry. Through various acquisitions, JBSS has grown to be the second-largest nut company in the US, with an estimated 10% share of this very fragmented market. The company sells all major nut types including peanuts, pecans, cashews, walnuts, and almonds to consumers (mass merchant, grocery, and drug chains), industrial (bakeries, diary), food services (airlines, schools), and export.
"The company remained private until 1992, when it issued stock to the public at $12 a share. Post IPO, the stock failed to gain traction. The price languished below $10 for most of the 1990s, often trading at a fraction of its book value. During this time however, JBSS impressively increased sales and grew its book value per share. But it wasn’t until 2002 that investors began to take notice. Due to the widely successful marketing of high protein/low carbohydrate diets such as Atkins and South Beach, Americans began consuming peanuts, cashews, and almonds like never before.
"In 2003, JBSS earned $1.61 per share, which was twice the amount it earned in 2002. In 2004, earnings reached $2.32 per share. Investors watched the stock rocket though $50 a share in 2003. By the end of 2004, however, it had become apparent that interest in Atkins and South Beach had waned. To make matters worse, tree nut prices, the company’s largest cost, were soaring. For the first quarter of fiscal 2006, JBSS reported its first loss since 1999. With that announcement in October 2005, the stock plummeted 22% in a day, closing at $13.44.
"The stock now appears to be a bargain. It is trading at a 26.5% discount to its book value of $18.42 and at about eight times next year’s estimated earnings of $1.65 a share. Book value is likely understated given that JBSS owns quite a bit of real estate, most of which was purchased in the 1980s and early 1990s. The company is planning to consolidate its operations by building a new, larger central facility, and the cost savings could be materially accretive to earnings in a couple of years.
"As far as tree costs are concerned, management expects prices to fall as newly-planted crops are harvested in the coming years. Finally, given the company’s low stock price, the costs and time required complying with Sarbanes-Oxley, and the favorable prospects for the company, the Sanfilippo family could take the company private. If it did, we feel it would be worth considerably more than what the stock is trading for in the market. Our advice is to buy at current levels."