Seneca Foods: Buybacks Slow Down And Results Not As Compelling

Introduction

Seneca Foods (NASDAQ:SENEA) (NASDAQ:SENEB) is a U.S. fruit and vegetable processor that popped on my radar screen following strong Q1 FY24 results as net sales rose by 12.6% while net income more than quadrupled to $23.1 million. However, this performance doesn’t seem sustainable as the financial results benefited from higher selling prices as well as a last in, first out (LIFO) credit. Adjusted for the First-In, First-Out (FIFO) valuation method, earnings growth was just over 11%. In addition, high interest rates are beginning to become a serious issue for the business, as interest expenses during the quarter soared by over 370% year-on-year to $6.6 million. In my view, the next two quarters could be challenging due to rising inventories and debt levels, and Seneca Foods could struggle to undergo share buybacks in the near future. My rating on the stock is neutral at the moment. Let’s review.

Overview of the business and financials

Seneca Foods was established in 1949 and is involved in the production of packaged fruits and vegetables as well as snack chips, sauces, gravies, and natural colorants. The company has 26 facilities across eight states, and it employs over 7,000 people, with fruits and vegetables being sourced from a network of over 1,400 growers. Over 80% of revenues come from canned vegetables, which means steel is a major expense, and private labels account for the lion’s share of sales. The most recognizable brand of Seneca Foods is Libby’s and its portfolio also includes Aunt Nellie’s, Green Valley, and CherryMan among others. The company has export customers in around 60 countries worldwide, but over 90% of its revenues come from the USA.

The business of the company is seasonal in nature, as the majority of vegetable inventories are produced between June and November, which means that peak inventory levels are reached in mid-autumn. Sales, in turn, typically peak in the third quarter of the fiscal year due to increased retail demand during the holiday seasons. The fourth quarter of the fiscal year is usually when the company carries out repair and maintenance activities. Inventory and accounts payable typically reach their lowest points for the fiscal year at the end of the fourth quarter or the beginning of the first quarter. Overall, Seneca Foods is vulnerable to cost inflation, particularly raw produce, steel, ingredients, and packaging materials and the company tries to reduce the risk here through short-term supply contracts, and grower purchase agreements (see page 13 here).

Looking at the financial performance of Seneca Foods for the past decade, we can see that this is a business with inconsistent revenue growth, as well as EBITDA and FCF margins that are often in the mid single digits.

While the company does not pay a dividend, it usually repurchases a significant amount of shares during periods of strong financial results and the tangible book value per share has doubled since 2015 to $75.78 as of July 1, 2023.

In Q1 FY24, Seneca Foods repurchased 43,600 class A shares for $2.2 million (see page 11 here). The difference between the class A and class B shares is that class A stock has voting rights of 1/20th of one vote per share, while class B has a full vote per share.

Turning our attention to the latest available financial results, at first glance Q1 FY24 was a strong period for the company as net sales increased by 12.6% year-on-year to $298.7 million while net earnings surpassed $20 million.

Yet, sales volumes were lower, and the main reason revenues improved was higher average selling prices due to inflation. If you’re thinking that the company managed to pass on cost increases to customers completely, the picture is not so simple, as Seneca Foods uses the LIFO inventory cost method. Looking at the LIFO reserve account to bridge the gap between the internationally dominant FIFO and LIFO methods, we can see that the company benefitted from a $1.7 million LIFO charge this quarter compared to a $19.2 million credit a year earlier. The adjusted net income thus grew by just 11.7% to $21.8 million in Q1 FY24. In addition, I’m concerned by the rapid growth of interest expenses as rising interest rates are starting to bite.

Looking through the company’s financial results, we can see that the weighted average interest rate on its senior revolving credit facility was 6.72% compared to just 2.8% a year earlier (see page 9 here). In addition, outstanding borrowings under this facility were much higher as a result of the higher value of inventories due to inflation.

As of July 1, 2023, inventories were over $200 million higher than a year earlier and considering they usually peak mid-autumn, I think it’s likely that debt levels and interest expenses are likely to increase significantly in Q2 and Q3 FY24.

Overall, I think that Seneca Foods booked decent Q1 FY24 results, as adjusted EBITDA and net income using the FIFO method remained above levels from a year earlier. Yet, the working capital needs of the business have increased significantly due to the pricier inventory, which has put FCF in the red. With interest expenses rising rapidly, I think that financial results for the next two quarters could be underwhelming and that share buybacks could decrease significantly.

Investor takeaway

In FY23, Seneca Foods repurchased 9.2% of its shares outstanding, but the amount spent on buybacks in Q1 FY24 was just $2.2 million. Using the FIFO method, the company’s results for the quarter don’t look as compelling as the ones using LIFO. I think the net income could take a serious hit over the next two quarters as inventories increase. While the stock is trading at just 0.71x tangible book value, I think Seneca Foods could be in the early stages of becoming a value trap. In my view, risk-averse investors should avoid this stock.