The acquisition has been described as ‘high risk’ by Keith Howlett of Desjardins Securities.
At the end of July, Toronto-based organic and natural food company SunOpta Inc. announced the biggest acquisition in its history. It was set to buy Sunrise Growers, a California-based frozen fruit processor, for about $444-million (U.S.).
The deal, which closed in mid-October, was hailed by the company as a "transformative" transaction. It dramatically expanded SunOpta's frozen fruit business, a complement to its other arms that process and package soy milk, fruit juice and protein bars, among other organic and healthy food, snacks and drinks. Almost all its products are sold by retailers under private labels.
When the deal was announced, SunOpta president Rik Jacobs, who has since become chief executive officer, told analysts and investors that it would make the company "a global leader in private-label conventional and organic frozen fruit, two rapidly growing on-trend categories."
Sunrise would add $300-million to the company's annual revenue, which was $1.24-billion in 2014, the company said.
But shareholders were far less enthusiastic than company management. Almost immediately after the deal was announced, SunOpta shares began a downward spiral that took them from about $11 on the Nasdaq exchange to less than $5 early in October. They have since recovered slightly to about $6.
The big worry for investors appears to be the cost of the acquisition. To pay for it, the company issued $100-million of new equity, which diluted existing holdings, and borrowed $330-million at interest rates that range from 7 per cent to 9.5 per cent.
While the company projected about $10-million of cost "synergies" by the end of 2017, some analysts were skeptical of the deal.
Keith Howlett of Desjardins Securities described the acquisition as "high risk" and said in a report that the company "dramatically increased financial leverage" in order to acquire Sunrise. His target price for the shares, at $12 before the deal was announced, is now at $6. He has a "hold" recommendation on SunOpta stock, suggesting it will be volatile until the integration benefits from buying Sunrise become apparent next year.
In an e-mailed statement, SunOpta's Mr. Jacobs said the company is taking a long-term view on shareholder value. "We believe the strategic and transformative acquisition of Sunrise Growers leverages our unique business model in organic and non-genetically modified foods, and will enhance our product mix, accelerate our revenue growth and grow our margin profile," he said.
This Wednesday, the company will have another opportunity to talk about the benefits of the deal when it releases third-quarter earnings – its first report since the Sunrise transaction closed.
Among those with reservations, Rob Gibson of Octagon Capital Corp. says the Sunrise deal will result in "significantly lower" earnings per share for SunOpta "due to higher depreciation, interest expense and more shares outstanding."
Those numbers, combined with a "general weakness in the organic space," prompted Mr. Gibson to sharply cut his 12-month target price on SunOpta to $9.25 from $15.70 in early October, although he still has a "buy" recommendation on the stock.
Others are more positive.
Scott Van Winkle of Canaccord Genuity said the weak stock price is not a direct result of the Sunrise purchase itself, "but rather the volume of equity dilution." The acquisition will help with long-term growth, he said, and immediately adds scale to one of the company's core product lines.
The stock is undervalued as a result of the "financing noise," said Mr. Van Winkle, who has a $10 one-year price target on the stock. Early in 2016, there should be a "good clean quarter" on which to judge the company's true growth, he said.
Mr. Van Winkle noted that shares in many natural and organic retailers have been beaten down recently, but valuations of supplier companies in the sector are essentially at parity with conventional packaged food manufacturers. Over time, organic and natural food manufacturers should grow faster than conventional ones, he said.
Eric Gottlieb of D.A. Davidson & Co. said he thinks investors have "overcompensated" for the risks in the company and the current price is a "solid entry point." His 12-month target is $7.