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Can Ingham’s Deliver?

Australia | Dec 21 2016

This story features INGHAMS GROUP LIMITED. For more info SHARE ANALYSIS: ING

Brokers are crowing about newly listed poultry producer, Ingham's Group, but concede there are a risks investors should be wary of.

-Ingham's benefits from strong market share and high barriers to imports
-Risks in re-negotiating contracts with major supermarkets
-Demand expected to underpin double digit earnings growth


By Eva Brocklehurst

Poultry producer Ingham's Group ((ING)) has spread its wings to the ASX and several brokers have initiated coverage of the stock, noting its cheap price but highlighting the stock is not without risks.

In a market which is increasingly sceptical when it comes to IPOs (initial public offerings), Credit Suisse believes the stock will have to do more than just screen cheaply. It will need to deliver on prospectus forecasts and grow earnings thereafter.

The company will always face challenges in a competitive, mature industry, the broker acknowledges, but could surprise to the upside. The broker's conviction in this area is based on the strong market position, competent management and a plausible margin expansion program.

Ingham's is a vertically integrated poultry producer, in operation since 1918. Poultry comprised 87% of its FY16 revenue with the remainder being stockfeed sales. The company operates in the Australasian marketplace, which has a high restriction on competing imports and stiff quarantine procedures for disease mitigation.

This environment, as well as stable product demand, underpins broker confidence in the stock. The risks include changes to import rules, supply chain disruptions and changes to customer relationships. Ingham’s has long-term customer relationships and multi-year contracts with major retailers and quick service restaurants.

On the latter, Morgan Stanley is cautious. As contracts roll over there is a risk with re-negotiating with major customers. Woolworths (which the broker estimates provides 38% of Ingham's revenue) has invested $1bn in prices over the past two years, including over $50m in the chicken category.

Ingham's has been a beneficiary of this price investment via higher volume growth. While major contracts are in place until the end of FY18, the broker suspects, given Woolworths' strong bargaining position, that Ingham's may be forced to lower prices, effectively handing back recent gains.

While the valuation may be cheap, the broker emphasises that the earnings risk needs to be priced. Morgan Stanley prefers to assess valuation on an Enterprise Value/EBITDA (earnings before interest, tax, depreciation and amortisation) basis as the company has significantly more financial leverage versus its peers.

Ingham's is still in the early stages of cost reductions, including plant automation, labour productivity improvements, network rationalisation and procurement savings. Morgan Stanley estimates gross cost savings of $144m remain to be found. While cost cutting is the primary driver of margin expansion, operating leverage and premiumisation should also drive margins.

Morgans (not to be confused with Morgan Stanley) has few concerns, believing the leverage to attractive industry fundamentals is significant and the stock is undervalued. Consumer preferences for leaner meat means chicken is the cheapest and most versatile protein, accounting for two of the top five fresh products sold in Australian supermarkets.

As supermarkets continue to focus on the fresh category, and Ingham's has scale, it provides a degree of bargaining power when negotiating with supermarkets, in the broker's opinion. As an example, supermarkets funded the cut in the prices of BBQ birds and Ingham's was a beneficiary of the strong uptake since that time.

The broker expects demand should underpin double digit growth in earnings per share over the forecast period. Over time, the broker expects the stock to be placed in the ASX200. Still, Morgans acknowledges the key risks include the market power of the major retailers and the loss of a major contract.

Macquarie estimates 101% of average cash flow conversion in FY17, noting a dividend pay-out range of 65-70% of net profit is targeted. The FY17 dividend is expected to be franked. The broker does point out that the business is highly integrated and small changes or variations in upstream areas, such as breeder eggs, hatcheries or broiler farms can have a compound effect down the chain.

The company has highlighted that price competition in the wholesale market could persist for longer than expected, coupled with the fact its major Australian competitor (Baiada) is unlisted and, hence, has less pressure to deliver short-term results.

The low end of Macquarie's valuation range is broadly in line with the company's peer group and 10% above competitor Tegel. The broker believes a premium to NZ-listed Tegel is justified for a number of reasons, including relative scale and exposure to the larger Australian market, potential to narrow the margin differential and a lower reliance on export markets for future growth.

FNArena's database has three Buy ratings and one Hold (Morgan Stanley). The consensus target is $3.66, suggesting 15.9% upside to the last share price. Targets range from $3.40 (Morgan Stanley) to $4.00 (Morgans). The dividend yield on FY17 and FY18 estimates is 4.9% and 6.4% respectively.

Goldman Sachs, not part of FNArena's daily monitoring, has initiated coverage with a Buy rating and price target of $3.70. Underpinning Goldman's positive view is the anticipation of 12% EPS CAGR over the next three years, driven by the company’s "Project Accelerate" cost out program.

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