Michael McCain is confident about his plan to turn Maple Leaf Foods Inc. around. He figures that if he spends a billion bucks he can achieve double-digit earnings growth over the next five years.
Given that Maple Leaf stock is quoted at a mere 12 times profits it looks like a screaming buy – if his confidence is warranted.
But investors have their doubts and so they should.
Mr. McCain, whose family owns about a third of the company and also controls it, is convinced that the way to make money in bakeries and meat is to get big and lean. His plan is to spend $1.3-billion (some of that money has already been deployed) to build larger plants, close smaller ones, upgrade technology, simplify the manufacturing process and close the "cost gap" with the massive U.S. plants he wants to emulate.
If all goes as Mr. McCain foresees, the average plant size of the new Maple Leaf will be 2.2 times bigger than it is today. The plants will have state-of-the art technology to run continuous lines at high speeds and offer better food safety.
As part of the new plan, productivity will shoot up to 80 kilograms of output per worker from 50 today. There will be 60 per cent fewer products.
The upshot is bold predictions of higher profits. Companywide margins are supposed to expand by three quarters by 2015. On an annual revenue base of about $5-billion, that moves the needle, hence the forecast for double-digit earnings per share growth.
The logic behind these moves seems sound on paper. Economies of scale can lower costs and Maple Leaf's are high, particularly relative to U.S. competitors. The market share of those U.S. firms in Canada is only 8 per cent, but it's doubled in the past few years and it's probably still growing, which costs Maple Leaf as it uses lower prices to maintain market share.
Maple Leaf contends that its get-big strategy works best if it's adopted by a firm that already has lots of market share, as Maple Leaf does.
And yet investors have questions. An obvious one is why did this take so long? The concept of economies of scale and simplification aren't new. Why didn't this happen sooner?
"This is the curse of the 65-cent dollar," Mr. McCain told me. When the loonie was lower, the company was very profitable and bringing in new capital, priced in U.S. dollars, would have been prohibitively expensive.
A second and related question: why did Mr. McCain need more than 70 consultants to help him draw up this plan? It seems like a bureaucratic process that lacks the kind of entrepreneurial spirit you'd expect from a CEO who also owns a lot of stock. Is this lack of confidence?
No, says the CEO. The company needed exhaustive research to find the right solution to its problems and "we don't staff up for this kind of investigation every day."
And what about execution risk? Does it make sense to move to a high-volume, big-plant model that can handle large, non-stop production runs if you don't have the high-selling brands to justify that production?
Maple Leaf, you'll recall, is going to cut its number of products by 60 per cent, but it foresees overall volume staying the same or increasing. That means a smaller number of products will have to sell well enough – a lot better than they do today – to take advantage of high-throughput plants. Yet there's precious little talk about brand development in the company's presentations.
Mr. McCain says most of the product-line reduction involves things like different package sizes, which consumers won't notice. He insists the company has products with enough demand to run plants hard and efficiently.
More questions
So why doesn't he buy stock? Because he can't, under the shareholder rights plan adopted this summer and because "I'm already up to my eyeballs" in Maple Leaf shares.
Did he consider the risk of a rising loonie? The economics of the plan are based on the Canadian dollar being at parity, he says, and if the dollar goes to $1.20 (U.S.) it will hurt," but it might be fatal without the new investments.
Some investors appear to think that the arrival of West Face Capital will light a fire under Maple Leaf shares. West Face, a hedge fund, is described as an activist investor. It bought a roughly 10-per-cent stake in Maple Leaf from Ontario Teachers' Pension Plan, which used to own about a third of the company but has now decamped, apparently in frustration.
I'm not sure I'd count on West Face changing things. What can this hedge fund do that Teachers, with a much bigger position and two board seats, couldn't?
Mr. McCain rules out selling the company right now – but says he's for maximizing shareholder value in the long term – because a sale wouldn't do as much as a successful retooling. That leaves investors to either buy into his vision or avoid the stock.
The strategy makes a lot of sense and this is a cheap stock that might do very well for investors. But it might be cheap for a reason: There are risks that aren't always obvious.