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Avian Flu Update After Talking with Industry Professionals

Takeaway: Just when we thought AI was taking a break another outbreak was reported.

The Avian Flu (AI) has been wreaking havoc on the egg and poultry industry this year.  As I was researching our previous note on AI on Tuesday (printed on 5/27/15) it was looking that poultry farmers were getting a break with no reported infections for five days.  But that optimism was short lived as another outbreak was detected in Nebraska and Iowa, affecting 293,200 chickens and 20,700 turkeys respectively in each state.

 

Wholesale egg prices continue to rise, nearly doubling versus pre-AI prices. As we previously reported companies are looking elsewhere for eggs, mainly international and alternative egg-substitutes.

 

INTERNATIONAL SUPPLY

Importing eggs is more complicated than it seems, and given the U.S.  has always been an efficient producer, few countries are pre-approved for egg importing. French and Dutch farmers are acting fast to try to take advantage of the U.S. AI outbreak, working with their embassy’s in the U.S. to expedite the approval process.

 

You may be thinking, what is the difference between a U.S. and a European egg? When you travel to Europe you will notice in a majority of supermarkets that the eggs are not refrigerated, while in the U.S. they are always refrigerated.  This is because eggs have a natural protectant on them called a cuticle, which acts as a shield to keep bacteria out. In Europe they are required to not clean the eggs and leave the cuticle intact, while in the U.S. all eggs must be washed in 90⁰F water and sprayed with sanitizer. Given this difference there will have to be a change in process to export the eggs to the U.S. but European companies want to take advantage of this opportunity.

 

After speaking with industry professionals we have determined that the egg prices in Europe are usually priced at about a 20% premium in a non-AI environment, and that to do all the additional cleaning and ship the fresh eggs across the pond would cost an additional 20% on top of that.  We have provided our math in the below chart for a visual:

 

Avian Flu Update After Talking with Industry Professionals - Avian Flu Chart 1 5.28.15

 

COMPANY UPDATES

POST provided an update on the recent AI outbreak that is affecting their business.  They are now stating that a third of company owned chickens in Nebraska has tested positive for AI.  Bringing the total affected supply to ~35% of the company’s volume commitments.  Post management has determined that this amount of loss constitutes a force majeure event for the Michael Foods egg business.  They have started to take drastic measures to minimize the financial impact such as, discontinuation of certain products and price increases. 

 

HRL has stated that their Jennie-O turkey supply has been greatly impacted by the AI outbreak in Minnesota and Wisconsin and could inhibit their ability to fully meet orders, and will assuredly raise prices.  Thanksgiving feels far away but when you calculate the time to clean facilities and get birds to a mature size, it doesn’t seem possible that they will be able to fully rebuild their supply.

 

OUTLOOK

As the summer approaches we will begin to see a slow down as the AI and all flu’s for that matter don’t survive well in high temperatures.  One concern is when migrating birds from northern states start to fly back south in the fall we may have a relapse of AI, but not to the same extent we are seeing now.


The Macro Show Replay | May 28, 2015

 


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BULLISH TRENDS

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BEARISH TRENDS

 

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KORS: Adding To Long Idea List

Takeaway: It’s not broken. It’s not COH (it’s more like RL). The cash flow offers tremendous support. Downside risk here is low relative to upside.

We’re adding KORS to our Core Ideas list as a Long. The truth is that we think both KORS and KATE should be bought on the massive selloff we saw following KORS’ print and guide. Let’s be clear – these are two dramatically different companies that are in different stages of their maturation curve.  But horrible market sentiment towards what is perceived to be the ‘luxury handbag space’ is unabashedly shellacking anything touching the category (except, interestingly enough, wholesale distributors like Macy’s). We think that has left both names flat-out cheap, with catalysts to the upside as the year progresses. While KATE remains one of our Top Ideas, we’re officially adding KORS to our Long Idea list. (Note: Longs, in order, RH, KATE, NKE, WWW, KORS. Shorts, KSS, HIBB, FL, TGT).

 

KORS: Adding To Long Idea List - kors financials

 

Here’s a couple of quick bullets on what we’re thinking on KORS…

 

KORS

  • We recently issued an Idea Vetting Book on KORS [Materials: CLICK HERE, Replay: CLICK HERE], where we came away concerned about the return trajectory, but more positive about what was priced in over the near-term. With today’s correction, we think the catalyst for the shorts has been outed, downside support is material, and there’s upside to the name if KORS even comes close to hitting numbers.
  • KORS is not ‘going the way of COH’. Coach is a one-trick pony that built a business for one consumer, in a singular category, in one primary channel, in one geography. That’s not scalable. KORS built a high-end brand serving multiple consumers, in numerous categories, in several different channels of distribution, in most regions of the globe. Unfortunately, the business size and margin structure is similar, but that’s happenstance. These are different models. Are we enamored by the ‘jet-set’ KORS consumer? It’s not as appealing to us as KATE’s. But we’ll take it over COH any day.
  • There’s still a lot of growth here – just not in the US. If the US business stays flattish over 3-years, then we still get to a consolidated top line growth rate of about 9%. Is that KATE-like, no such luck. But the punchline is that this brand trajectory looks a lot more like Ralph Lauren (global growth) than it does Coach (stagnant in US).
  • There’s no question that margins are coming down. But when we model HSD top line and 22%% EBIT margin by 2018 compared to 29% last year, we get to $4.40, $4.80, $5.13, and $5.50 through 2018.
  • Not impressed with high-single digit EPS growth – even at 10x current year earnings?  Then you should probably look at the cash flow.
  • KORS should generate $2.85 per share in free cash flow this year – assuming the midpoint of company guidance – which we think this very reasonable. It’s got a 5% free cash flow yield today, and 10.4% on 2018.  This company could repo 5% of its stock this year, a number that goes up to 10% within 3-years assuming muted modeling assumptions.   
  • Sentiment has come close to bottoming out for KORS. We’ve seen several Sell-Side analysts capitulate – adding to elevated short interest levels (that seemingly picked up today).

KORS: Adding To Long Idea List - 5 27 KORS Sent


A MAJOR MOVE IN THE ORGANIC SPACE

Takeaway: Last night Hormel Foods announced it will acquire Applegate Farms for $775mm.

There is no shortage of “old line” food manufacturers looking to acquire growth brands.  

 

Last night Hormel Foods announced it will acquire Applegate for $775mm.  The strategic fit make sense given Applegate's strong brand position in the natural and organic prepared meats category, a segment in which Hormel has limited exposure.

 

Hormel expects the acquisition to be neutral to FY15 EPS and accretive by $0.07-0.08 per share in FY16.  The accretion will likely come from revenue synergies and not cost savings.  Hormel will likely improve the top-line growth profile, as Applegate will benefit from expanded sourcing and increased distribution.

 

Not surprisingly on the back of this news we are seeing a positive reaction to some of the other names that could also be in play: LNCE, WWAV, JJSF and PF.  We would also note that HAIN is not responding as favorably to recent M&A news. 

 

We continue to believe that HAIN is not a target, due to the structure of the company and collection of brands that do not participate in the “organic category.”

 

Below is a one page summary of the Hormel/Applegate deal:

A MAJOR MOVE IN THE ORGANIC SPACE - HRL acquires Applegate chart 1



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