value and opportunity

Cranswick is now my biggest position with around 6,3% of the portfolio (Performance 85% including dividends). The stock had a great run since I bought it in June 2012 as we can see in the chart:

Competitive situation UK supermarkets

One of my “Mental models” which so far worked well for me was the following: Unless you are a professional liquidator, if your customers have big problems you as a supplier will get problems as well.

It is no secret that UK Supermarkets are in a very tight spot. I have written about Tesco already, but all the others are struggling as well .A few days ago, Tesco started a new round of price cuts as part of their turn around plan.

Just out of curiosity, I checked how their online offer for pork looks like. There sem to be already quite a lot of pork products on offer. For instance this one is a 33% discount on British pork chops which most likely are from Cranswick.

Just as a refresher, without giving names, this is how Cranswick discloses its biggest customers:

Customer concentration
The Group has three customers which individually account for more than 10 per cent of the Group’s total net revenue. These customers account for 26 per cent, 24 per cent and 11 per cent respectively. In the prior year these same three customers accounted for 28 per cent, 23 per cent and 10 per cent respectively.

I do not fully understand the dynamics of the UK pork market, but with this competitive situation and the weakening EUR, Cranwicks competitive position does not improve, rather the opposite. Also their move into branded products is risky as Aldi and Lidl are famous for their generic branded stuff which will further squeeze branded meat.

Change in business model

One other thing I noticed: Last year, Cranswick changed its business model and “reintegrated” pig rearing, i.e. increased the vertical business chain. When I analysed the business model of Cranswick I actually liked that it was not integrated as this insulated them from the low margin, low ROC business of pig rearing which for some reason they now seem to find attractive. This has already added significantly to working capital.

Valuation

This is how the initial valuation and the current valuation compare:

Market Cap 390 mn GBP / 687 mn GBP
P/E: 10.3 / 16,6
P/B: 1.6 (P/B tangible 3.1) / 2,2 (Tangible 4,0)
P/S: 0.5 / 0,7 / 10,1
EV/EBITDA 6.8
Div. Yield 3.9% / 2,3%

Roughly speaking, multiple expansion has added 50-60% of share price appreciation.

Special case: Neil Woodford

Michael Woodford, former star fund manager of Investec left the firm in 2013. Among his funds, he owned around 25% of Cranswick. Since then, he opened up his own fund company, which is a lot smaller. Surprisingly, Investec kept the 25% position and Woodford, with new money bought another 5% with his new fund. I guess this explains part of the outperformance in 2014 of Canswick. here is clearly the risk that if Investec ever decides to sell, the stock could be in trouble.

Back testing my initial thesis

That is how my valuation looked back then:

If Cranswick would manage to deliver 20% ROE going forward, my Boss model would indicate a fair value of around 2.000 Pence per share or an upside of 160%. If we assume going forward 15% ROE, Cranswick would still be a double with an Intrinsic value of ~1.550 pence per share. I think this is definitely possible over a time period of 3-5 years without any P/E expansion.

Based on 2013/1014 comprehensive income, ROE is ~13-14%, so the shares are more or less fairly valued now on that basis.

Don’t get me wrong, I still think Cranswick is an above average” company with good management, good business model and a great track record. But in my opinion, at the current price level and with the changed competitive environment, the risk/return relationship looks less attractive than 2,5 years ago.

Consequences & portfolio management

As a consequence, in a first step, I will half my Cranswick stake. Additionally, in order to keep my UK exposure, I will reinvest the proceeds 50/50 into Admiral and Ashmore, which I think have a much better return/risk profile at current prices.