Events and Valuations

One of the recurring themes that many value investors use is to buy companies which have been battered by bad 'events'. The market thinks the sky is falling, and the value investor determines that the event is temporary and places a bet on 'reversion to the mean'.

The most famous examples of this has been Warren Buffett (WB) buying American Express after the salad oil scandal (he actually put around 40% of the partnerships assets in AXP!). Another example could be again WB buying Washington Post in the early 1970's after the Watergate scandal. He determined that these were solid businesses with deep moats and the events were temporary. A recent example could be Sanderson Farms (SAFM), they are a poultry processing company and were hammered after the constant bird flu scares in 2005-06. What did the market think? People will stop eating chicken? Usually what happens after an 'event' is that the company focuses on PR and people either forget (we all know we have short memories) or find safety in the fact that this happened, now the company is more careful (because the PR told them they instituted these state of the art QA process). Anyways during the ensuing few months people resumed eating chicken and the stock went up around 50%.

Now, after the pet food recalls hit (anyone remember?) the firms that produced pet food got severely beaten down. The pet food industry has GDP plus type growth (4-5%) and is fairly recession resilient. The future also seems to be bright for this industry as baby boomers buy pets to accompany them during their waning years. I read the 10K for Menu Foods, and determined the following, (1) Customers which accounted for 40% of the sales no longer would order from Menu (2) A lawsuit was filed (which is almost resolved with minimal damage to menu) (3) The restructuring cost Menu around $55 million (4) The existing customers have increased demand, so their sales are down around 20-30% on average.

This did effect Menu's intrinsic value, the question is by how much? Is the market too negative on Menu's prospects? I believe it is, menu produces an essential product and has its sales down and hence the profits are down (although it did turn positive last qtr). The company is taking the right steps in terms of reining in the expenses and assuring customers that it has put processes in place to make sure this does not happen again. Mr. market has hammered the stock around 80%, while I believe the value should be down around 30%. Running numbers on the company my model predicts that the firm should be valued at around $2.50/share while it is trading at $1/share today. Having said that, there are better buys avaliable in this market and Menu's debt level is higher than what I am comfortable with. This is a case study in value investing and not a buying opportunity.