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Written by the Mackenzie Growth Team
Although we see enthusiasm in the U.S. markets following the presidential elections, it’s important that we reiterate our philosophy of focussing on businesses that have secular growth tailwinds that can grow irrespective of specific events like the elections or Fed decisions.
Sector allocations are generally a residual of our security selection process. As a growth team we are typically more invested (and thus overweight) in the sectors where sustainable growth is more easily found – information technology, healthcare, and industrials.
Staying true to our process, we look to invest during market dislocations when companies have problems that we deem are solvable. Our funds are a concentrated collection of 30-50 businesses that add high value to their customers.
Keeping this in mind, we will be doing a company spotlight on Neogen.
In the past month, we hosted Neogen’s CEO at our office in Toronto. Many investors may not know Neogen by name but have likely benefited from their products. It’s a 3.3-billion-dollar company based in Lansing, Michigan. The company is a global leader in Food Safety (71% of revenue) and operates an Animal Health division (29% of revenue). We have long-admired Neogen given its enviable position in global food supply chains with long established relationships with the world’s largest food producers, grocery stores, QSRs (quick-serve restaurants) and CPG (consumer packaged goods) companies.
Neogen has a portfolio of products that helps reduce the likelihood of food-borne illnesses in the world by testing for well-known pathogens like E. Coli, Listeria, Salmonella, etc. but also verifying that packaged goods are free from known allergens like Peanuts, Wheat (Celiac), Soya, Dairy among others. The company makes both readers and consumable chemistry for companies to release batches of manufactured food for consumption. These food test protocols are required by law to ensure low levels of food borne illnesses.
The recent E. coli outbreak linked to McDonald’s highlights the critical need for robust food safety measures and traceability. Food safety regulations could become more stringent following such high-profile outbreaks. We saw significant interest in the food safety market following the Chipotle Mexican Grill outbreak in 2015.
In late 2021, Neogen announced its intention to merge their business with 3M’s Food Safety Division. This merger closed in September of 2022 where Neogen issued cash and stock to 3M shareholders for this transformative deal. We had the opportunity to update our model and study 3M’s Food Safety business during 2022. We spoke with former employees of both companies as well as industry experts and customers of both entities to diligence the merger. It became clear that Petrifilm was the crown jewel of the deal with substantial market share globally for indicator testing (an area that Neogen didn’t have significant presence). Given the cash needs of 3M in 2022 for legal purposes (earplug lawsuit, PFAS litigation) we believe that Neogen had an opportunity to pick-up a great asset opportunistically from a seller that needed liquidity. As a result, we began to purchase shares in 2022 once the deal closed and some legacy 3M shareholders sold their shares from the transaction in the open market.
Despite some early success from the merger, Neogen has struggled to integrate certain backend operations while implementing a new ERP system and inventory management system for the combined entity. The company attempted to de-risk the deal by entering into various multi-year transition service contracts for the production of key 3M food safety products and certain backend services. Unfortunately, due to some communication issues, 3M didn’t fulfill some of the required volumes which led to short supply dynamics on some of those products over the past 18 months. As a result, many customers were negatively impacted as the limited supply “allocation” dynamics created challenges releasing product. Neogen has worked aggressively to fix the bulk of their short supply issues which lasted a few quarters and we are encouraged with their recent progress.
In our recent discussion, the CEO expressed confidence in the current integration of 3Ms food safety business, getting their systems and teams in place. These things do take time but certain metrics around open orders, 2-day ship rates have significantly improved. The Company continues to maintain its full-year outlook for FY2025. Their focus now is on gaining market share and demonstrating reliability to their customers on the supply and availability of product.
While Neogen was navigating through this execution misstep, the food industry started to see the impact of higher prices on food volumes. The rapid food inflation over the past couple years has resulted in consumers buying fewer groceries and switching to lower priced brands. That dynamic negatively impacted Neogen’s core business as lower food volumes require less food testing. As we look into 2025, we are happy to see the moderation of food inflation which should allow food volumes to grow again in the near future.
The recent 3M Food Safety merger, execution missteps in production and lower food volumes created a compelling entry point for our fund. We have been opportunistic in our purchases of Neogen and have become a top 10 shareholder in the company. We are excited about the stability of their end markets while viewing the proliferation of new allergens (wheat, sesame) and emerging middle class globally demanding better food safety protocols in their food supply.
The contents of this document (including facts, views, opinions, recommendations, descriptions of or references to, products or securities) are not to be used or construed as investment advice, as an offer to sell or the solicitation of an offer to buy, or an endorsement, recommendation or sponsorship of any entity or security cited. Although we endeavour to ensure its accuracy and completeness, we assume no responsibility for any reliance upon it.
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