Canada Breads premium brands a plus for Bimbo

Canada Bread's premium brands a plus for Bimbo

Grupo Bimbo's acquisition of Canada Bread builds on a number of recent deals aimed at strengthening the Mexican baker's hand in North America, consolidates the group's position as the world's largest baked goods provider and increases its exposure to higher margin premium branded sales. Katy Askew reports.

Grupo Bimbo struck a deal to acquire Canada Bread, the Canadian bakery business 90%-owned by Maple Leaf Foods, last week.

Bimbo will pay C$1.83bn (US$1.66bn), or C$72 a share, for the company. Including the C$8 per share dividend paid by Canada Bread last month, Maple Leaf said the price represents a 31% premium on its stock price as of 18 October, the day before the group announced it was considering strategic options for the baker. The price is a 7% premium on Canada Bread's closing price on 11 February, the day before the definitive agreement was announced.

According to JP Morgan Research analyst Alan Alanis, the price tag is a little higher than comparable acquisitions that Bimbo has used to expand in North America, although he points to Canada Bread's likely profitability.

"Price paid is slightly higher than similar recent deals by Bimbo in the US," Alanis noted. "The Canada Bread transaction takes place at 9.9x trailing EV/EBITDA; this is below Bimbo's 12x trailing EV/EBITDA. The higher-than-recent transaction multiple is likely because of Canada Bread's higher margins, we believe."

Canada Bread is Canada's largest baker by market share with a stable of strong brands. It also has a presence in the US and UK. The group generates annual sales of around C$1.43bn and EBITDA of C$185m. The group's profit margin stands at almost 13%, compared to Bimbo's EBITDA margin of 10%.

Given Canada Bread's high margins, it is perhaps understandable Bimbo management did not detail any expected synergies.

For Bimbo, the acquisition is about strengthening its global strategy and expanding its presence in Canada and the UK. The deal beefs up Bimbo's position as a global player in the bakery industry, expanding its geographical reach and diversifying its product line-up. As the Mexican company noted when the deal was announced, the move "advances Grupo Bimbo's global growth strategy" which has "led it to 19 countries in three continents with more than 100 brands and 10,000 products".

The transaction also improves Bimbo's hand in the US, expanding distribution in the market. In recent years, Bimbo has invested heavily in growing its presence in the consolidating US bakery market through M&A. The group took on the Beefsteak brand after the collapse of Hostess Brands last year, acquired the bread interests of Sara Lee in 2011 and took over the US business of Canada's George Weston back in 2008.

This steady expansion north of the border has widened the group's revenue stream. But operating in the North America is not without its challenges.

The US market for baked goods generates annual sales of around US$38bn but contracted 0.3% over the last five years, according to research firm IBISWorld. Likewise, IBISWorld details a "slight contraction" of the Canadian bread market over the last five years with industry revenue dropping at an annualised 0.9% a year. Canadian bread sales are expected to total C$6.3bn in 2014.

As a result, the bakery markets in North America are highly competitive, with sharp pressure on pricing. Operators have typically struggled to pass along higher input costs and profitability has come under pressure in the sector.

In this context, Canada Bread's premium positioning through brands including Dempster's, POM, Villaggio and McCavin's mean it is less exposed to the low-margin side of the bakery market and more able to command a premium for its products.

To fund the transaction, Grupo Bimbo will utilise cash holdings and financing available under existing long-term committed credit facilities.

According to ratings agency Fitch Ratings, this will put some pressure on the firm's credit quality and its BBB ratings. "Fitch expects Bimbo's pro forma total debt to EBITDA to increase to slightly above 3.0 times, which is high for the rating category, before trending to its long term target of 2.0x. Negative rating actions of Bimbo can be triggered if leverage remains above 3.0x for a sustained period of time," the ratings agency observed.

However, this risk is somewhat offset by the strategic benefits the acquisition brings. "Positively mitigating increase leverage, the acquisition of Canada Bread improves the company business risk profile," Fitch concluded.

For its part, Canada Bread's former owner Maple Leaf Foods said it will use the proceeds from the deal to pay down debt and strengthen its balance sheet in the near term.

In the longer term, proceeds will likely be used to reinvigorate the firm's struggling protein business.

Maple Leaf's core meat business has been hit by weak global pork markets, poor hog returns and commodities volatility. The company has also witnessed a decline in profitability and the bottom line has been hit by the investments it is making in its meat processing factories and distribution network. 

According to Canaccord Genuity analyst Derek Dley, the near-term outlook for the group's protein unit does not look much improved. "We continue to believe the near/medium term outlook for the protein group remains challenging, as the company will record duplicate costs in 2014 as it transfers production to its new large-scale manufacturing facilities, and closes down another five facilities throughout the year," he wrote in a note to investors.

Management would argue pressure on profitability in the short term is the cost of change. However, investors seem to be losing patience with the pace of Maple Leaf's transformation and the share price has fallen almost 7% since the disposal was announced last week.

TD Securities analyst Michael Van Aelst attributed much of that decline to the group's failure to pair the disposal announcement with news it plans to return capital generated to shareholders. "It did say that any return of capital to shareholders will be made within three years via one or more Dutch auctions. We argue that it should return excess cash to shareholders after closing and then re-lever the balance sheet in 2015 to pursue growth opportunities and/or return more capital to shareholders," Van Aelst suggested.

However, Van Aelst does argue that if Maple Leaf is able to hit its margin targets in 2015, there is considerable upside for its share price. "Should MFI achieve its 10% EBITDA target for 2015 (as opposed to our 8.7% margin estimate), we could see the share price reaching the mid-$20s." Maple Leaf shares closed yesterday at $15.39 a share.

Much will depend then on Maple Leaf's drive to improve the performance of its meat business. The disposal of Canada Bread could give it the necessary cash to push ahead with its production overhaul and invest behind its protein brands.