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Consolidation Prospects Make Nufarm Appealing

Australia | Sep 22 2016

This story features NUFARM LIMITED. For more info SHARE ANALYSIS: NUF

Herbicide and pesticide producer Nufarm has a strong outlook for FY17, supported by cost savings and a better upcoming cropping season in Australia.

-Sustainable returns dependent on the market but further savings expected
-Acquisitions on the cards as plans to diversify continue
-Corporate appeal also noted, given key stake holders in the stock


By Eva Brocklehurst

Strong growth is expected for herbicide and pesticide producer Nufarm ((NUF)) in FY17, underpinned by cost savings, a better outlook in Australia, improvement in South America and lower FX losses. The company performed on cost reduction targets in FY16 with a very strong second half in South America. Nufarm reported an underlying net profit of $108.9m in the 12 months to July, down 7%.

Favourable seasonal conditions in Australia and a little self help should set up another year of profitable growth, in Citi's view. The broker remains a holder of the stock given the benefits of improving cash flows and earnings quality, as well as support from sector consolidation underway.

Citi considers the FY16 outperformance was mostly about timing and the measures to date are largely in the area of costs so sustainable returns are, to some extent, dependent on the market. Still, the broker is confident further savings can be generated beyond FY18.

Deutsche Bank was disappointed with the net operating cash flow in FY16 and, while the company's outlook lines up with its views, retains a Sell rating on the stock, which is trading at a 39% premium to the broker's valuation. The broker reduces FY17 earnings forecasts by 4-10% to reflect the net impact of lower earnings in Australia, Europe, seeds and higher net interest expense. This reduction is partly offset by higher earnings in the Americas and Asia as well as lower corporate costs.

The results trigger an upgrade to Add from Hold for Morgans. The broker considers the stock attractively priced for its growth profile. The first decent summer cropping season in four years is in progress in Australia while South America is also set for a bigger season. Hence, forecasts are upgraded.

The company remains on the look-out for consolidation opportunities to strengthen its product portfolio and also warrants corporate appeal, in the broker's view. Morgans highlights the fact that the chairman of Fuhua, one of China's glyphosate producers, has a 6.2% shareholding in Nufarm while Sumitomo Chemical owns 22.6%.

Consolidation prospects provide a supportive background, Macquarie agrees, and the potential for acquisitions or mergers is more relevant than ever. The broker suspects Sumitomo's blocking stake may be void at any bid above $11.65, well ahead of current share price levels. A third party approach that includes a reasonable premium could be relevant at current price levels.

On the other side of the coin, the company intends to participate in M&A in a targeted manner should appropriate acquisitions present. Macquarie finds it difficult to gain visibility on specific opportunities but notes the company has stated its intent to diversify in specific regions and crops.

The opportunities in industry consolidation are one of the reasons Credit Suisse upgrades to Outperform from Neutral. The broker adds $1 per share in value, assuming Nufarm can acquire an asset at good value. The broker observes there is $1.8bn in available credit but peak debt may reach $1.3bn. On that measure the company could have around $500m in debt-funded acquisition capacity. Nufarm has also indicated it is willing to partner to get the right deal.

Macquarie suspects the market was not keen on factoring in all the targeted savings but, with this result, believes expectations should now approach all management's targets. The broker forecasts $20m in incremental savings in FY17 and FY18. The result also suggests to Macquarie that the focus on higher returning products affected volumes, to the extent that a lack of fixed cost recovery meant margins declined.

Several brokers contend that management needs to seek a better balance of high-value, low-volume sales versus high-volume commodity sales in Australia. Macquarie believes a favourable seasonal backdrop should help in this regard.

Ord Minnett is one broker which notes the company has intentionally focused on higher margin products, and believes fine tuning of margins versus volumes needs to be done to lift utilisation rates and ensure profitability is maximised. The broker incorporates the full FY18 targeted savings of $116m into its model and includes a further $10m uplift in FY19, because of timing. On the broker's estimates management's key performance target of 16% return on funds employed should be reached by FY18.

The initiatives around improved performance, reduced costs and cash flow conversion are mostly sustainable and this underpins the stock's re-rating over the past 12 months, UBS believes. Execution on the strategy with seeds and expected cost reductions provide potential upside to the broker's forecasts in the near term.

UBS has a three-stage residual income model which indicates that the market is ascribing around 35% of the stock's value to medium-long term growth, in line with the industrials sector, ex financials. This is despite Nufarm having a better earnings outlook. The broker believes the Omega-3 strategy in seeds and greater depth in crop treatments are not captured in current valuation multiples.

FNArena's database shows four Buy ratings, two Hold and one Sell (Deutsche Bank). The consensus target is $9.02, signalling 0.8% in downside to the last share price. This compares with $8.06 ahead of the results. Targets range from $6.25 (Deutsche Bank) to $10.00 (UBS).

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