Legendary small cap investor Chuck Royce bought a small Wall Street firm called Quest Advisory Corporation in 1972 and the rest as they say is history. One of the many funds he manages is the Royce Micro-Cap Trust (NYSE:RMT), a closed-end fund that invests primarily in companies with market capitalizations less than $500 million. One of its top 10 holdings is Seneca Foods (Nasdaq:SENEA), America's largest processor of fruits and vegetables. Chuck Royce believes in its business and so do I. Here's why.

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Cyclical Business

Seneca's business is a simple one. It buys fruits and vegetables through supply contracts with independent growers, and then packs them in cans or freezer bags for sale under their own brands or private label. Production is dependent on growing conditions, crop yields, etc. When weather is good, there is a tendency to overproduce, leading to lower prices in the marketplace. The reverse is true when weather is bad. But there's a fine line, 10% of its processed food is sold under its own brands that include Seneca, Libby's, Aunt Nellie's, Stokely's and Read; another 53% is sold under a private label, 21% is sold to institutional food distributors and the remaining 16% under the Green Giant brand for General Mills (NYSE:GIS).

Over the years it's developed into a vertically integrated, well-oiled machine, delivering fairly consistent earnings despite the vagaries of Mother Nature. In the past decade its gross margins have varied between 6.4 and 11.7% while operating margins have run anywhere from 2.7 to 6.6%. For example, in 2011, its operating margin was at 10-year low of 2.7% due to favorable growing conditions, which produced an oversupply of product and lower selling prices. Once the contracts are struck, the die is cast. Sometimes it works in its favor and sometimes as is the case in 2011, it doesn't.

SEE: 22 Ways To Fight Rising Food Prices


Seneca's goal is to continue to strengthen its position as a leading provider of processed fruits and vegetables in the United States and elsewhere. Its plan focuses on four basic ideas: 1) to expand its private label business as well as its licensed Libby's brand; 2) to provide its customers with the lowest cost, highest quality processed fruits and vegetables; 3) to continually develop new products that allow it to capitalize on the move by consumers to live a healthier lifestyle and 4) to pursue strategic acquisitions that result in no goodwill or other intangible assets on its balance sheet. In the next few paragraphs I'll provide examples of each.

In an effort to expand its private label business, it acquired Chiquita Brands' (NYSE:CQB) processed foods division in 2003 for $125 million and the assumption of $81 million in debt. At the time of the acquisition, Chiquita's division had sales of $404 million making an immediate contribution to its private label business. Prior to the acquisition, private label represented 36% of its overall revenue. In fiscal 2011, that was up to 53%.

Seneca operates 23 processing plants and 29 warehouses in eight states across the U.S. Its vertical integration and size provides it with economies of scale that others can't match. It won't hesitate making an acquisition if it feels it can add value for the customer through its logistics and supply chain. The margins aren't great for processing fruits and vegetables so you have to be very organized if you want to make money consistently, which it does.

People are starved for time these days. In an effort to broaden its offerings in frozen fruit, which is a prime ingredient for smoothies, it acquired Lebanon Valley Cold Storage LP and the assets of Unilink LLC in August 2010 for $20.3 million from Pennsylvania Food Group LLC. Of all its business segments, frozen food is the only one to grow revenues in each of the last two years. Expect further acquisitions in this area in the future.

In business since 1949, it has made over 50 strategic acquisitions including the ones previously mentioned as well as the purchase of Green Giant's processing assets in 1995. Just as it broadened its product offering with the frozen food acquisition above, it did the same in 2006 when it acquired a leading producer of canned fruits. Up until then it sold only canned vegetables. Acquisitions are a key ingredient in its continued success.

SEE: Mergers And Acquisitions: Understanding Takeovers

The Bottom Line

This is the type of business I just love. It's a family controlled enterprise with a long history of success. Its current stock price as of April 25 is $23.35. It hasn't traded below $15 since December 2002 providing investors with a certain amount of downside protection. Yet, if you look at its long-term performance, it's a chronic underperformer. My suggestion is to buy its stock whenever it drops under $20. The longer it stays under $20, the more you should buy. Be patient and you'll do just fine.

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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.