SAPUTO INC. $29 (Toronto symbol SAP; Aggressive Growth Portfolio, Consumer sector; Shares outstanding: 205.8 million; Market cap: $6.0 billion; SI Rating: Average) is Canada’s largest producer of dairy products. It accounts for around 35% of Canada’s cheese production, and 25% of milk output. Major brands include Saputo, Armstrong, Stella and Dairyland. Canada supplies 60% of its total sales.

The company is also one of the top five cheese producers in the United States, with roughly 5% of that market. Saputo’s U.S. businesses account for 30% of its sales. The remaining 10% of its sales come from dairy operations in the UK, Germany and Argentina.

Heavy regulation limits expansion opportunities in Canada, so Saputo has focused on expanding its U.S. and international operations through acquisitions. That’s riskier than internal growth, but Saputo has a strong history of identifying operations that can benefit from its economies of scale and marketing expertise. The high Canadian dollar also makes foreign purchases more affordable.

Saputo’s sales rose from $3.4 billion in 2003 (fiscal years end March 31) to $4.02 billion in 2006, but slipped to $4.0 billion in 2007. Earnings grew from $0.83 a share (total $173.7 million) in 2003 to $1.10 a share ($232.1 million) in 2005. Earnings in 2006 fell to $0.95 a share ($200.1 million) due to lower U.S. cheese prices and the higher Canadian dollar. Earnings in fiscal 2007 improved to $1.14 a share ($238.5 million).

New U.S. operations look promising

In April 2007, Saputo paid $249.2 million for the West Coast industrial cheese operations of U.S. dairy company Land O’Lakes Inc. This business specializes in mozzarella and provolone cheeses.

Saputo has signed a long-term deal to secure a supply of milk for the facility, which cuts the risk of this purchase. As well, a recent change to California’s milk-pricing formula for cheese makers could add up to $0.25 a share to Saputo’s annual profits.

In April 2008, Saputo paid $160 million U.S. for the operations of Wisconsin-based Alto Dairy Cooperative, which makes cheeses under a variety of brands and private labels. Alto should add $0.03 a share to earnings in the first year.

Saputo is also expanding in Europe. It recently acquired small cheese processors in the UK and Germany. These operations will give Saputo an opportunity to become comfortable with the European dairy market. That will help pave the way for more acquisitions.

Saputo also owns the third-largest dairy company in Argentina. New government regulations in Argentina should improve the supply of milk, and expand this subsidiary’s profits. Free trade agreements will also let this business expand exports to other countries in South America.

Besides dairy products, Saputo is also Canada’s largest producer of snack cakes, mostly under the Jos Louis and Vachon brands. It also makes tarts, cookies and cereal bars. This business accounts for about 4% of Saputo’s sales.

Growing interest in healthier foods has hurt demand for snack foods in the past few years. As well, higher costs for ingredients, packaging, labour and energy have squeezed this division’s profit margins. However, price increases should help offset the higher input costs.

Saputo’s steady cash flow lets it make acquisitions without issuing new shares or taking on too much debt. Long-term debt of $218.1 million is just 70% of its annual cash flow. Despite Saputo’s aggressive acquisition strategy, goodwill and other intangibles represent just 10% of its market cap.

Earnings should rise 25% this year

Thanks to new its new operations and rising dairy prices, Saputo probably earned $1.36 a share in the fiscal year ended March 31, 2008. The stock trades at 21.3 times that estimate. Earnings should reach $1.70 a share in fiscal 2009, which implies a more reasonable p/e of 17.1. Saputo also has a long history of increasing dividends. The current rate of $0.48 a share yields 1.7%.

Saputo is a buy.