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Brokers Not Chicken About Ingham’s Outlook

Australia | Feb 16 2017

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

Poultry producer Ingham's posted a robust maiden first half and brokers suspect prospectus forecasts may be beaten.

-Investors should be mindful of the potential drop in volume growth in the second half
-Cost reductions to drive earnings growth as revenue slows in the second half
-Leading position in a rational Australian industry with high barriers to entry


By Eva Brocklehurst

Strong volumes characterised the maiden first half for chicken producer, Ingham's ((ING)). Brokers suspect, given the split in the first half:second half in the prospectus that the company is on track to exceed FY17 forecasts.

First half operating earnings (EBITDA) of $95.2m were up 9%, and 48% of FY17 prospectus forecasts. Poultry volumes were very strong, increasing 12.9%. Volume growth is expected to moderate in the second half with the cycling of EDLP (every day low prices) initiatives in the major supermarket channels.

Cost Reductions To Drive Earnings Growth

While there is upside to FY17 prospectus estimates of around 2%, Citi advises investors to be mindful of a second half drop-off in volume growth, and the competitive environment in New Zealand. The main drivers of a good second half result, in the broker's view, will be more cost savings and operating leverage from higher volumes.

Citi notes the poultry supply chain is sensitive to changes in demand and the initial spike in pricing in early 2016 produced some pressures that will ease over time. This results in the benefit being delayed to the second half of FY17, While poultry volumes were up 10% excluding ingredients, Citi estimates prices fell -5-7% in Australia.

In New Zealand. on the other hand. while there was a decline in poultry volumes a better sales mix led to pricing growth. Citi believes evidence of a successful lowering of costs is the key driver of the share price.

Earnings are envisaged tracking 4-11% ahead of prospectus forecasts and 2-9% of Morgan Stanley's estimates. The broker also expects cost reductions will drive earnings growth, as revenue growth slows in the second half. Management expects Australian volumes will be in line with prospectus forecasts, which implies growth will slow in the second half to zero from 15% in the first half.

Macquarie believes the company is well on the way to achieving, if not modestly exceeding, prospectus forecasts. Valuation is undemanding and the broker expects confirmation of the sustainability of margin improvements will provide a catalyst for the stock to re-rate. Australian earnings margins increased 50 basis points to 7.4% in the half.

Macquarie notes the company also appears to have managed the fall-out from strong demand in key lines. The company is reported to be still in negotiations with one key QSR (quick service restaurant) customer. Industry feedback suggests this is McDonald's. The outcome of negotiations are not expected to impact the second half but Macquarie expects it might impact FY18.

NZ Conditions Remain Tough

Macquarie also believes the challenging conditions in New Zealand will remain a drag on the second half. Nevertheless delivery on prospectus forecasts is not predicated on a material turnaround in NZ operations.

UBS notes market concerns around the risk of rising imports for New Zealand were somewhat alleviated, as exports to Australia were down year-on-year. The broker likes the stock as the company has a leading market position in a rational industry that has high barriers to entry and attractive returns. There is margin upside as well. The broker believes the current share price is undervaluing the medium-term earnings opportunity.

Credit Suisse notes the competitive dynamics are very different between Australia and New Zealand. Oversupply is the main problem in New Zealand, while Australia is a more meaningful business because of its larger size and being the major beneficiary of the company's efficiency programs. The company's major competitor is also following a similar strategic path, such as increasing automation and focusing production on certain states while rationalising it in others.

The strong result has increased the broker's conviction that surprises could be on the upside. Results also affirmed the broker's view of the longevity of earnings growth beyond FY17. Although mindful of the supply chain challenges and some increasing seasonality, Credit Suisse suspects there is enough benefit from the higher volume base and efficiencies to enable FY17 prospectus forecasts to be beaten.

While the broker suspects some may view comments such as "Australian volume growth is expected to moderate" somewhat negatively, this comment needs to be taken in context of the strong first half. There are some reasons for caution but Credit Suisse believes there are enough drivers of growth to mitigate concerns.

FNArena's database shows five Buy ratings and one Hold (Morgan Stanley). The consensus target is $3.72, suggesting 12.3% upside to the last share price. Targets range from $3.40 (Morgan Stanley) to $4.00 (Morgans, yet to update on the results). The dividend yield on FY17 and FY18 forecasts is 4.0 % and 6.0% respectively.

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