Australia | Mar 23 2017
Despite a stronger-than-expected first half result, agricultural chemical supplier Nufarm has retained a cautious outlook. Brokers focus on omega-3 and M&A potential.
-Marketplace remains competitive, soft commodity prices are low
-Improving margins and returns, but is this already in the share price?
-Next catalyst expected to be potential acquisitions, to broaden exposure
By Eva Brocklehurst
Agricultural chemical supplier Nufarm ((NUF)) has offered what appears to be a softer outlook for the second half, after posting a robust first half result. The company has removed the word "solid" from full year guidance for underlying operating earnings (EBIT) growth, instead using the label "improved".
Average seasonal conditions in major markets are assumed, with pressure in Latin America continuing, given issues in Argentina and the later timing of sales in Brazil. Market conditions are expected to remain competitive, as prices for soft commodities are low because of high inventories and strong harvests.
The first half, which is usually the weaker half, was stronger than many brokers expected. Sales growth was 15% and earnings were up 19%, while net profit grew 67%. Nevertheless, brokers highlight a competitive Australian marketplace and the company's more cautious commentary regarding the outlook in Latin America. Strong results were recorded in North America, Europe and Asia. Seed technologies also materially improved, although still recorded a loss of -$200,000 versus -$4.4m in the prior corresponding half.
Earnings are highly skewed to the second half, in line with Australia's winter crop and the northern hemisphere's main cropping period. Nufarm generates around 70% of its earnings in the second half so the largest near-term risk will be weather conditions as the US, European and Australian growing seasons approach. The company's strength lies in its diversity of product and geography.
Morgans was pleased tha, for the first time in a while, there were no material one-off items. The broker expects the company to achieve its targeted $116m in net cost savings by FY18. The main negative in the half was a weaker-than-expected Australian performance. After strong share price appreciation, Morgans downgrades to Hold from Add. The broker would revisit its view on any material weakness.
Ord Minnett expects FY16-19 compound annual growth in earnings of 9.3%. While the broker notes the cautious tone and a tough global crop protection market, expectations for "improved" earnings are highlighted.
Nufarm may have removed the word "solid" from its FY17 earnings growth guidance but, on the basis that the company maintains its cost-saving program and will deliver around $20m in incremental benefits, Credit Suisse believes earnings of $308m are achievable.
Deutsche Bank considers the first half result, while above expectations, is mixed, as full year guidance appears to have softened. The company has made good progress on improving margins and returns and the broker believes this has already been incorporated into the share price. The broker retains a Sell rating, with the stock trading at a 47% premium to its valuation.
Potential asset divestments from global agricultural chemical deals provide the next potential catalyst for Nufarm, in Macquarie's opinion. These sorts of acquisitions should enable the company to broaden its portfolio and deepen exposure to existing regions. These scenarios are underpinned by a 50:50 debt-to-equity assumption.
Macquarie expects the company to be disciplined in this regard. As the company is already overweight in herbicide, at 63% of FY16 revenue, the broker ascertains the insecticide and fungicide segments should appeal more from an M&A angle.
Ord Minnett notes the company continues to express interest in acquiring forced divestments that may come to market and, while no specific targets have been flagged, believes opportunities in Europe or the US could arise.
Credit Suisse continues to factor in $1 per share in upside from M&A on the basis of a highly accretive acquisition and believes there are several large assets in play which complement the company's strength in herbicides.
Conversely, Deutsche Bank takes the view that Nufarm is not likely to participate in the current round of global crop protection industry consolidation, as Sumitomo has a 23% shareholding, and any divestments are likely to be sizeable and vigorously contested. Deutsche Bank estimates the company's balance sheet capacity to be $100-150m. Nufarm also warrants corporate appeal in its own right, Morgans contends.
Over coming years, the company's omega-3 canola product could be a game-changer but is unlikely to be a material earner until FY20, Morgans believes. Ord Minnett's focus is on the performance improvement program and the opportunity in the omega-3 platform. Management has submitted filings for regulatory approval in Australia and expects to do the same in the US and Canada this month. Commercialisation is expected to commence in 2018-19.
The platform comes from a research collaboration with CSIRO and the Grains Research and Development Corporation to develop canola which can produce long-chain omega-3 oil, which contains nutrients essential for human health. The project uses genetic technologies to transfer plant genes to canola from micro algae to produce the oil, which is similar to that found in fish and thus reduces pressure on wild fish stocks.
UBS also notes the sharpened focus on the omega-3 initiative. The broker now incorporates around $0.75 in valuation for this option. This assumes the company achieves 5% market share over 10 years with a 20-25% earnings margin. UBS ascribes around a 50% probability to the development, given the uncertainties associated with the project and its economics.
Credit Suisse also envisages the omega-3 project as an opportunity and it commands $10m in earnings in its models over FY19-20. Nufarm might be able to earn a profit margin of around US$250/t or more, Credit Suisse calculates, assuming that it is the producer of the omega-3 canola oil.
The company could simply be a canola seed seller or choose to grow, process and sell a high omega-3 oil further down the value chain. The company is not without competition in this regard, the broker notes. Grain processor Cargill has teamed up with BASF to develop a commercial omega-3 canola variety by 2020. Dow is also working on a variety.
The consensus target on FNArena's database is $9.64, signalling -0.4% in downside to the last share price. This compares with $9.07 ahead of the results. Targets range from $6.60 (Deutsche Bank) to $10.75 (UBS). There are three Buy ratings, three Hold and one Sell (Deutsche Bank).
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