Value Library

The following is an excerpt from the ABC Perspective - January 2009 - Pg. 3

George Weston Limited

George Weston Limited, founded in 1882, is one of North America’s largest food processing and distribution companies. Although the Company reports consolidated results, it really has two distinct segments, Weston Foods and Loblaw. Weston Foods offers fresh-baked sweet goods, frozen baked goods and biscuits (including wafers, ice-cream cones, cookies and crackers). Loblaw is Canada’s largest food retailer selling drugstore and general merchandise and financial products and services. Loblaw employs over 140,000 full-time and part-time workers in more than 1,000 corporate and franchised stores.

During the last period of market turmoil, when high technology stocks were imploding, investors who sought safety in stable, easy-to-understand businesses were eventually rewarded. Back then, in the second quarter of 2000, we established a position in Canada Bread. It was a solid consumer staple stock that provided excellent returns for our unit holders. We believe that we have found a similar story in George Weston Limited, a food processor and bakery that also owns approximately 63% or 170 million shares of Loblaw. This stock, with a clean balance sheet and a 2.5% dividend yield should perform well even in a recession. People have to eat no matter how far commodity prices or auto sales decline.

Weston Foods, the bakery division, has fought admirably through several years of rising commodity prices, primarily wheat and fuel. Management astutely hedged their exposure on a rolling six month basis and managed to protect the financial results. They were also able to push through three price increases since the start of the year. When we adjust the Company’s EBITDA (earnings before interest, taxes, depreciation and amortization) for unusual charges, including the derivatives used to hedge commodity exposure, margins have shown excellent improvement, rising from 9.5% in the first quarter of 2006 to 12.5% in the third quarter of 2008. With dramatically lower wheat and oil prices, selling price increases and a weaker Canadian dollar, Weston Foods should report solid earnings as the hedges roll off.

Loblaw is currently in the midst of a three to five year turnaround plan necessitated by intense competition and price wars in the food retailing segment. However, recent results demonstrate some positive trends. Same store sales have increased 2.2% over the course of the first nine months of 2008 and 3.0% in the third quarter. EBITDA has increased 12.8% to $1.18 billion year to date and 16.6% to $499 million in the third quarter of 2008. Lower restructuring charges and cost reduction initiatives led to the improvements. On the Company’s recent conference call management’s outlook was conservative but we are cautiously optimistic that the same store sales growth is sustainable and that margins have stabilized.

From an investment standpoint, we think that George Weston Limited offers the best way to play the story. Essentially, when we back out the implied value of Loblaw from each share of Weston we were able to purchase the Weston Foods operating division at approximately 4 times EBITDA, while comparables trade at 8 times EBITDA. In support of our thesis, management recently announced two transactions that monetized a significant portion of this valuation gap.

On Wednesday October 22nd, Weston announced the sale of its dairy operations that generated $50 million in EBITDA for $465 million, or 9 times EBITDA. On Wednesday December 10th, the Company announced that its subsidiary, Dunedin Holdings, had agreed to sell its fresh bread and baked goods business in the United States to Grupo Bimbo, one of the world’s leading and largest baking companies. Grupo Bimbo, based in Mexico, paid approximately US$2.5 billion for operations that generated US$275 million of twelve month trailing EBITDA, essentially a 9 times EBITDA multiple. Note that Weston Foods retains its baking and distribution operations in Canada and its other US baking divisions, Interbake Foods and Maplehurst Bakeries. After monetizing the dairy and US bakery operations, the implied public market value of the “bread-stub” is less than 2 times EBITDA.

Speculation regarding the use of the cash proceeds quickly turned to talk of privatizing Loblaw. However, we believe that this scenario is unlikely from a value creation perspective since Loblaw already trades at 9 times EBITDA. Privatizing George Weston Limited would actually make more sense given the discounted valuation of the remaining US and Canadian operations. Management was quite clear that they were in no hurry to deploy the cash proceeds. They seem content to sit on almost $5 billion in cash (including $1 billion of cash held at Loblaw) and wait for an exceptional opportunity or opportunities to present themselves.

Given the current market turmoil we have to look to the past to find what worked. We believe that, similar to our investment in Canada Bread in 2000, owning George Weston Limited should provide a solid investment return for patient value investors.

Irwin A. Michael, CFA