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Nufarm Unfairly Discounted?

Australia | Oct 19 2017

Nufarm has progressed with its transformation and there is scope for continued earnings growth, although Morgan Stanley believes this is yet to be factored into the market's outlook.

-Further potential from organic growth, cost reductions and efficiencies
-Stock still trading at a substantial discount, considered unwarranted
-Challenges in crop protection weighing on the share price

 

By Eva Brocklehurst

While retaining significant earnings momentum, Nufarm ((NUF)) continues to transform its business and an improvement in profitability has coincided with a substantial de-leveraging of the company's balance sheet.

Morgan Stanley suggests Nufarm's is now a higher-quality business and initiates coverage with an Overweight rating. The company has delivered a 450 basis points lift in returns on funds employed, to 14% from FY14-17. The broker still envisages 14% growth in earnings per share in FY18-20 and identifies potential beyond the current initiatives.

This potential comprises organic growth, cost reductions and efficiencies in the balance sheet, which the broker believes are yet to be reflected in the current valuation. Legacy concerns prevail, notably the slump in glyphosate prices in 2008-11 and the impact this had on the company.

Credit Suisse considers the stock has experienced the benefit of lower costs – three manufacturing facilities have been closed and all sites now sold – and market share gains that are likely to be sustained in the near-term.

The risks, in the broker's opinion, nonetheless, centre on the seasonal conditions in Australasia, as well as some adverse effects from the ornamental and turf sectors in North America from recent hurricanes. Ord Minnett also points out that challenges remain in crop protection, in the absence of M&A, and this weighs on the share price.

Morgan Stanley agrees investors may want consistent delivery of higher earnings before considering a higher rating but stresses this is unwarranted, arguing that a premium to history is justified and a discount unnecessary.

On consensus forecasts the stock trades at a -17% discount, on par with the 5-year average and at a discount to the 1-3-year average. Yet, the company's reliance on commodity glyphosate products has declined to 20% of sales in FY17 from 28% of sales in FY10. The broker estimates the gross profit contribution has declined to less than 20% from around 30% over this period.

Moreover, sales reliance on the Australasian region has declined to 22% in FY17 from around 30% of sales in FY10. The improvement in business, geography mix and profitability has coincided with a de-leveraging of the balance sheet. Leverage has declined to 2.3x in FY17 from 3.2x in FY14.

In contrast to Morgan Stanley, Deutsche Bank believes, with less leverage it will be more difficult to undertake an acquisition of any size. The broker also contends the company retains challenges in Argentina, Australia and in its seeds business.

The seeds business may struggle, as Australian canola volumes are likely to be down around -30% this year, following a 50% increase in FY17. Argentina earnings also declined by -97% in FY17 because of the elimination of import restrictions that allow greater access to the market for imported products.

Omega-3

An area of potential upside is the company's Omega-3 project ,which seeks to address a projected global deficit in supply of fish oil. If successful, the company will be in a position to offer a land-based, sustainable source of Omega-3. Commercialisation is expected in FY19.

Initial earnings are expected from FY20-21 and Morgan Stanley expects the market to be educated on this initiative over the next 12 months. This should then move the market to ascribe a value to Omega-3. The broker currently values a project at $0.72 per share.

Industry Consolidation

Industry consolidation, a key theme in the agricultural chemical industry over the past few years, is another area of potential upside for the stock. A capital raising would be more than likely forthcoming if such were to occur, Morgan Stanley acknowledges, but suggests the market would welcome an acquisition in view of the company's cautious approach to the balance sheet and transaction funding.

The opportunity to add scale is a strategic positive although any transaction will carry execution risk. The company has stated it is aware of the potential for acquisitions that might result from the current round of industry consolidation but is disciplined in order to ensure any such opportunities represent compelling value.

FNArena's database shows two Buy, four Hold and one Sell rating (Deutsche Bank). The consensus target is $9.11, suggesting 2.2% upside to the last share price targets range from $6.75 (Deutsche Bank) to $10.40 (Morgan Stanley).

See also, Will Acquisitions Provide Impetus For Nufarm? On September 27 2017.

This stock is not covered in-house by Ord Minnett. Instead, the broker whitelabels research by JP Morgan.
 

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