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File photo of one of Saputo’s line of cheeses. (Christinne Muschi for The Globe and Mail)
File photo of one of Saputo’s line of cheeses. (Christinne Muschi for The Globe and Mail)

DAIRY

Saputo’s Australian purchase: Did it overpay, or will it pay off? Add to ...

Saputo Inc. is willing to pay top dollar for a small Australian dairy company, and for good reason.

If Canada’s largest cheese company is to maintain its record of rewarding investors with earnings growth, the company needs to tap into new sources of demand. A takeover of Warrnambool Cheese and Butter Factory Co. Holdings Ltd. would provide Saputo with the staging ground to export to emerging markets in Asia – a move that seems crucial to future stock gains, given the slowing pace of growth for dairy products in North America.

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While the acquisition still faces local opposition, several analysts are optimistic about the odds of the deal going through and see gains ahead for Saputo’s stock. Six out of 11 analysts covering the stock rate it a “buy” and the average price target is $52.78. The shares closed Monday at $49.05.

The “strategic rationale for the transaction remains clear,” Irene Nattel, an analyst at RBC Dominion Securities, said in a note. A presence in Australia, the world’s third-largest dairy exporter, would provide Saputo with “opportunities to capitalize on growing global demand for dairy solids.” She has a $52 price target on the shares.

Saputo’s biggest challenge may be living up to its own history. Ms. Nattel points out that the company has delivered 20 per cent average annual growth in net income since its 1997 IPO, largely because of its disciplined approach to acquiring other companies.

The question now is whether the company may be overpaying for its latest target. The bidding war for Warrnambool has pushed the Australian firm’s share price up to about 60 times trailing earnings, making it the most expensive dairy company in the world by that measure, according to Reuters.

Saputo needs to find growth if it is to justify its relatively rich valuation. Its shares trade for about 18.5 times earnings, an above-average multiple.

It has appealed in the past to dividend investors looking for a conservative play on growth.

But the cheese maker appears to have run out of easy ways to boost its gains at home. The company’s disappointing third-quarter earnings, announced last week, showed flat earnings in Canada and declining profits in the United States. International results provided the bright spot and suggest the company’s best prospects for future growth may lie in Asia.

China, in particular, offers large opportunities. Its consumption of milk, cheese and butter are still far below European and U.S. levels, but demand is expected to grow by 13 per cent a year over the next five years, according to Macquarie.

Saputo already sells to more than 40 countries, but for years has been looking for an entry point into China via Australia. After more than a decade of weighing its options, the Canadian company made its move for Warrnambool in October, coming over the top of an initial offer made by another Australian company, Bega Cheese Ltd.

“It appears that Saputo is prepared to compete in Australia against the dominant local market players,” Desjardins Securities analyst Keith Howlett said in a note last week that put a $57 target on the stock.

Saputo’s incursion into Australia sparked a three-way fight for control of Warrnambool, stirring up a protectionist backlash against the would-be Canadian interloper.

“It’s in Australia’s national interest that we maintain national control,” Gary Helou, managing director of Murray Goulburn Co-operative Co. Ltd., said recently in a television interview with an Australian news channel.

Murray Goulburn moved to protect itself from new competition by trumping Saputo’s initial $7 (Australian) per share offer with a $7.50 all-cash bid in October. Saputo sweetened its offer to $8. Murray Goulburn moved up to $9 last week. Then Bega re-emerged to add more of its own shares to the offer. Saputo reacted by matching the $9 and removing the conditions on the minimum amount of Warrnambool shares tendered, making the offer worth about $487-million (Canadian) not including assumed debt.

“Australian takeovers appear as interesting as Aussie rules football,” Mr. Howlett said. “We expect this drama will play out over another three to four months.”

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