Special invitation of this magazine丨Wang Xiance
If this is an opportunity to bet purely on the reversal of the cycle, is it a bit too simple? The market is very smart and emotional at the same time, why do we make money? The author believes that the reversal of the cycle is only part of this opportunity and may provide a potential catalyst, more about buying the company's underlying business and cash flow in a good position.
Since 2023, pig prices have fluctuated at a low level, and the market expects that 2024H2 may open a new round of pig price upward cycle, the cycle of supply decline is expected to begin, and the reduction of production capacity is expected to be completed. In this industrial chain, companies with low valuations are expected to usher in upside opportunities under the catalysis of the pig cycle.
The downward and upward path of the pig cycle is taking place
The slaughtering/pig raising segment has typical cyclical attributes, especially in the upstream pig farming sector, where the cyclical attributes are very obvious. The attached chart is a pig return/profit chart that Iowa State University has been tracking and counting, and it is clear how the pig cycle is depicted at a glance.
After experiencing the downward trend of the overseas pig cycle in 2023, the author believes that we will inevitably usher in an upward cycle. Judging from the magnitude of the losses and the duration of the losses, as of November 2023, this downward cycle has been more severe than most of the downward cycles since 2002. Towards the end of the year and looking forward to 2024, farmers' willingness to raise pigs is also declining.
WH Group's main business consists of two parts: A-share listed Shuanghui Development (70%) and US-based food company Smithfield (100%). The entire industry is shutting down, including Smithfield, and the industry's willingness to raise pigs has fallen to a freezing point.
Pig companies have been under cyclical pressure in 2023, with pig prices in the U.S. market declining, while raw material prices such as feed are at a relatively high level, and the pig business has suffered significant losses. Taking WH Group's U.S. business - Smithfield as an example, the financial report shows that in the first nine months of 2023, WH Group's operating profit will be about US$1 billion, and yoy will drop by 36%; In terms of sub-markets, the operating profit of the Chinese market was US$790 million, an increase of 1.7% in YOY; Operating profit in the U.S. market was $120 million, down 84% from YOY.
However, as the Iowa State chart's chart shows, a downward and upward path is already taking place. When the supply is cleared and the pig price recovers, the sharp decline in performance in 2023 will also usher in a corresponding sharp rebound.
That's because business prospects are hard to predict accurately
It is only then that the underestimated opportunity emerges
In the case of hog price uncertainty, how to give the company a definitive valuation?
The author believes that there are similarities between hog prices and oil prices, and although prices fluctuate greatly with the cycle, related companies still have investment value. In investment, the important thing is "vague certainty", Buffett is likely not able to split the detailed models and average monthly sales expectations of BYD in a certain year, and there is a high probability that he did not compare the parameters of the competing models with the same positioning, but he made more money on BYD than most people (of course, he has architectural advantages, etc., this is a topic for a future).
As for WH's business model, the author believes that part of the slaughtering/breeding must be for its own meat products business, so it will cause intra-company transactions; The historical spread between U.S. pig prices and domestic pig prices does provide arbitrage opportunities for companies to earn money by importing cheap U.S. pork and selling it domestically.
Of course, the company can also engage in some gray financial massage based on this special structure, and even in the farce of the entanglement of father and son, the content exposed by the son also contains things related to this.
But on this point, the author believes that we have no way of knowing from the outside whether this situation really happened. In addition, it is a well-known fact that domestic companies are generally poorer in governance than in mature markets such as the United States.
Most of the controlling shareholders or shareholders who can actually influence the company's behavior do not have the interests of the minority shareholders in mind. If you want to strictly follow the standard of Buffett's pursuit of company quality in the middle and later stages of his career, Moutai can't invest, because the cash on Moutai's account is a typical inefficient capital allocation method vs the money on the account is the shareholder, and the shareholder is the owner of the company and should have the power to decide how to distribute the funds. Not only can Moutai not invest in the traditional sense, but most of the enterprises do not meet the requirements. As a result, we see that most of the money made by domestic stocks is driven by growth. And most companies that have not grown much will never think about giving back to shareholders through dividends or buybacks, but how to make new investments in the next step, open up new areas, or how to transfer the company's money to their own pockets through gray means.
WH Group has not done a particularly bad job in this regard, referring to WH Group's historical dividend record, the Shuanghui brand that consumers can reach and the Smithfield meat brand that can be reached in the United States, combined with our research and feedback in the industry chain, we believe that WH Group's business is generating real cash flow, and it is difficult to say whether the management will occasionally achieve some of its own self-interest at the expense of the interests of minority shareholders, but we are willing to accept it when there is a good price.
So the core factor is price vs value, what kind of valuation are we willing to accept these potential flaws? Or what kind of value/texture does the corresponding price enterprise have? As long as Mr. Market's "mental illness" is not cured, there will always be corresponding opportunities, and whether these opportunities occur in Moutai, which has an excellent business model, or in pork products that are so unsexy, depends on the price.
Many market participants have reported that WH Group's business is not transparent because it is difficult to accurately predict the data for the next quarter, and the author agrees that WH Group's business data cannot be accurately predicted compared to Internet companies or consumer companies.
But fortunately, our investment model does not need to accurately predict the data of the next quarter, we only need to know and understand that the meat products business has a relatively stable cash flow, especially the business pattern is very stable overseas, and there is a high probability that there will be no ChatGPT to "reform" the meat products industry in the short and medium term, so it is a relatively stable opportunity. In today's environment, constant is gold.
Moreover, the market gives us a price with a decent risk-reward ratio because of some factor that will not be repeated anymore or because of cyclical trends, which is enough for us. Perhaps it is precisely because investors who demand accurate forecasting data and do not participate in it give WH Group such a low level of attention.
A 10-15x valuation correction is predictable
The situation of each pig breeding enterprise is different, and WH Group's current strategy is to weaken the pig breeding business in the long term, and the phased reduction of production capacity is part of the long-term plan. With the recovery of the cycle, the company can still enjoy the positive impact of the narrowing of pig losses, but in the long run, with the reduction of the pig business, the company's cyclical nature may be relatively weakened.
In addition to the cycle reversal, Shuanghui and Smithfield themselves are also good cash flow businesses. Meat brands have a certain consumer mentality, the slaughter/meat product competition landscape in the United States is very solid, and the essential attributes of short- to medium-term food are still greater than many other categories.
For such a company and industry logic, the price offered by the market is attractive, and the following provides several objective data for readers' reference:
First, WH Group's current valuation is at the lowest level of the company's history since its listing, including 23E/24E; 8x/6x PE; 10%+ FCF yield, mid-single-digit dividend yield;
Second, Shuanghui Development currently has a market value of 80 billion+ RMB, with WH Group accounting for 70% (of course, Hong Kong stocks must have a holdco discount);
Third, as Smithfield's most comparable listed comparable company, Tyson Foods in the United States, the historical median trading is between 10-12x fwd PE vs WH Group's current 5-10x; Tyson's current FWD valuation is not a reference because the downcycle has caused Tyson's profits in 2023 to be almost completely swallowed up;
Fourth, Smithfield's operating profit is about 1/4 of Tyson's (but that's just a reference, because Tyson has a lot of beef business, while Smithfield is a pig-only business). Tyson's current market capitalization is about HK$140 billion; Finally, WH Group's current market capitalization is HK$60 billion to HK$65 billion.
Based on the above data, the author believes that the company's path from the current valuation to the historical high of 10-15 times PE is still predictable.
At the same time, value without catalysis can be a value trap. The catalysts I see include:
The first is the opportunity offered by the cycle reversal. The occurrence of cycles is not subject to the subjective will of people, but is caused by the objective law of supply and demand. History doesn't necessarily repeat itself exactly according to the script, but the probability of rhyming is still very high. Therefore, the most direct is the recovery of performance due to the contraction of supply due to the continuous loss of pig farming, and as of December 2023, such a state is already happening. Considering WH Group's volume and cash flow, it is difficult for WH Group to be liquidated, and it will survive in an upward cycle.
Second, there could be a potential surprise: The Wall Street Journal reported in October that WH Group was considering spinning off Smithfield to go public in the U.S., possibly in 2024.
In addition, the management has made a large repurchase in the past few years, and it is not ruled out that the company may use the surplus cash to repurchase after continuing to repay debts; Combined with dividend yields, these actions are also a catalyst in themselves.
Finally, about half of the company's debt is denominated in US dollars, so changes in the US dollar interest rate cycle, while not the most important factor, are the icing on the cake.
The betting cycle is simple
How to make money from Mr. Market?
It is an undeniable fact that cyclical stocks have not grown for a long time, do not have any "sexy" stories, and are bland or even boring. The author agrees with this view, but any investment opportunity occurs when the value is far greater than the price and there is a path to realize the release of value. It's just that we can't know exactly which quarter or month will actually start the upward cycle, but it is relatively certain that we will get closer and closer to this change in 2024.
At the same time, this is why the current 10%+ FCF yield and mid-single-digit dividend yield are so important, if you need to wait, take the dividend yield at the bottom valuation, and do not rule out a potential buyback after the debt repayment is over, these are all waiting rewards.
Finally, if this is an opportunity for a pure betting cycle reversal, isn't it a bit too simplistic? The market is smart and emotional at the same time, why do we make money? The author believes that the cycle reversal is only part of this opportunity and may provide a potential catalyst, more about buying the company's underlying business and cash flow in a good position.
Companies listed in Hong Kong, but with overseas operations, have actually been in a good price position for the past two years. A large part of the outflow of funds from Hong Kong stocks is due to concerns about the macro environment. But because of this, some companies with poor overseas fundamentals have been wrongly killed in valuation, providing unique investment opportunities. Leaving Hong Kong is bearish on China's fundamentals, so overseas fundamentals that have been killed for this point (especially when the overseas fundamentals are not that bad) offer this unique opportunity.
(The author is a fund manager of Buzhu Low Column Fund of Shanghai Buzhu Private Equity Fund Management Co., Ltd.) The author holds WH Group in his position, and only uses this as an example to illustrate the situation, valuation and catalyst of the pig cycle, and readers should pay attention to investment risks. This article was published in Securities Market Weekly on December 30, 2023. The views in this article only represent the author's personal and do not represent the position of this journal. The individual stocks mentioned in the article are only for analysis and do not make investment advice. ）