Although a major player in its industry, Maple Leaf Foods (TSE: MFI) doesn’t really create value for shareholders. In addition, despite optimism from analysts, MFI appears to be overvalued.
MFI is a consumer packaged meats company originally from Canada. The company produces prepared meats and meals, fresh pork, and poultry and turkey products.
Maple Leaf Foods Does Not Create Value
Great companies often have solid management teams who can effectively allocate capital to profitable projects. To get a good picture of management’s effectiveness, all one needs to do is look at the numbers. A metric that I like to look at is the economic spread, which is defined as follows:
Economic Spread = Return on Invested Capital – Weighted Average Cost of Capital
The idea is very simple; if the return on invested capital is greater than the cost of that same capital, then the company is creating value for its shareholders through well-thought-out projects. Otherwise, the company is destroying value and would be better off simply investing money into risk-free bonds.
For Maple Leaf Foods, the economic spread is as follows:
Economic Spread = 3% – 7%
Economic Spread = -4%
As a result, the company is not creating value for its shareholders, implying that management is inefficiently allocating capital.
Valuation – Possibly Overvalued
To value Maple Leaf Foods, I will use the H-Model, which is similar to a three-stage dividend discount model. The H-Model assumes that growth will decelerate linearly over a specified period of time. I believe this is a reasonable assumption because companies gradually slow down as they mature.
I will be using dividends to value the company because its free cash flow is volatile and difficult to predict. However, the dividend has been increasing gradually, therefore, making it an easier way to value the company.
The formula is as follows:
Stock Value = (CF(1+tg))/(r-tg) + (CFH(hg-tg))/(r-tg)
Where:
- CF = dividend per share
- tg = terminal growth rate
- hg = high growth rate
- r = discount rate
- H = half-life of the forecast period
For Maple Leaf Foods, I used the following assumptions:
- CF = C$0.8 per share
- tg = 3.1% (used 30-year Government of Canada yield)
- hg = 14.9% (based on five-year CAGR)
- r = 8.6%
- H = five years (assuming it will take 10 years to reach terminal growth)
As a result, I estimate that the fair value of Maple Leaf Foods is approximately C$23.58 under current market conditions. With its share price above C$25, the stock is likely slightly overvalued.
What Do Analysts Think of Maple Leaf Foods?
Maple Leaf Foods has a Strong Buy consensus rating based on four Buys assigned in the past three months. The average MFI stock price target of C$39.75 implies 56.4% upside potential.
Final Thoughts – MFI Stock Isn’t Impressive
MFI is a major player in the food industry that has the backing of analysts. However, the H-Model suggests that the company is already overvalued, meaning that analysts are potentially overly optimistic about MFI.
In addition, it doesn’t appear that the company’s operations create value for shareholders. As a result, investors may be better off looking for opportunities elsewhere.
