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More Capital, But Risks Still Pervade For Nufarm

Australia | Sep 28 2018

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

A multitude of risks beset Nufarm and, in downgrading forecasts, several brokers suggest it may take time for the stock to re-rate.

-A return to growth expected as recent initiatives are progressed
-Europe projected to reach 45% of group operating earnings in FY19
-Glyphosate regulatory issues may linger

 

By Eva Brocklehurst

Besides Australia's severe east-coast drought, agricultural chemical producer/distributor Nufarm ((NUF)) was plagued with problems over FY18 and the usual benefits from geographic diversity were lacking. Consequently, the earnings outlook is downgraded and, as the balance sheet appears stretched, a capital raising has ensued.

Guidance for FY19 operating earnings (EBITDA) of $500-530m suggests no contribution from Australasia in the first half and around a $30m contribution in the second half. Normal rainfall conditions are assumed to return in the autumn. Deutsche Bank suggests a host of risks will weigh on the stock in the year ahead, including ongoing drought in Australia, volatility in Brazil, US tariffs, consolidation in Europe, Brexit and higher raw material costs.

Bell Potter envisages the primary drivers of earnings over FY18-21 include achieving a reduction in working capital towards a target of 35-37% of revenue, delivering on the Omega 3 initiative, integrating recent European acquisitions and the potential impact of any regulatory change around core products.

The company reported a statutory after-tax loss of -$16m in FY18 including -$70.6m in impairments in the Australian business. On a positive note, North and Latin American earnings were ahead of expectations and Credit Suisse notes any fears regarding drought in Argentina or transport/currency issues in Brazil came to nought. Citi also points out market share gains in both regions.

While Europe was weaker than expected, some of the factors are controllable, such as plant outages, while weather continues to be the wildcard. Following the acquisition of the Century and FMC portfolios, Europe is projected to reach around 45% of group operating earnings in FY19.

Climatic conditions, particularly in Germany, France, Poland and the UK are potentially the largest drivers of near-term earnings and drought, as northern Europe enters the planting window in March-April, is a risk.

The company made no changes to guidance for Omega 3 canola. Regulatory approvals for Omega 3 appear to be proceeding as planned, with guidance for first revenue from commercial contracts expected by the end of FY19.

Credit Suisse points out a failure to date to reach a commercial agreement with BASF and competing patent claims means there is some litigation risk in the near term. Investment in the Omega 3 project should begin to tail off from FY19 and Bell Potter calculates the return on invested capital hurdle of 16% requires only a fairly modest capturing of market share.

Capital Raising

The company announced a $303m fully underwritten 3-for-19 accelerated renounceable entitlement offer at $5.85 a share, an -11.9% discount to the dividend-adjusted prior close.

Sumitomo, the company's largest shareholder, has elected not to participate in the rights issue. Bell Potter suspects this may cause the market to shift its view, to Sumitomo being a seller rather than a suitor for the business, and result in a potential stock overhang. Deutsche Bank agrees the fact Sumitomo did not take up its entitlement could create a dampener for the stock.

Credit Suisse calculates the equity raising is around -6% dilutive and reduces net debt to a more comfortable 1.8x FY19 operating earnings. Morgans recommends shareholders take up the entitlement offer, given the 17% upside and suggests any re-rating of the stock is likely to take time. The broker downgrades to Hold from Add.

The valuation remains compelling, in Citi's view, and the capital raising could be a catalyst for re-rating as it removes a shadow hanging over the balance sheet. Morgan Stanley agrees a risk has been removed, although did not ascertain any need to raise capital in the first place.

Glyphosate

Glyphosate regulatory issues may linger but Credit Suisse suggests the safety aspect is supported by scientific evidence while the disclosure of a 12% contribution to gross profit provides a basis for quantifying the downside risks.

The biggest unknown is the recent ruling against Bayer (Monsanto) by a grounds keeper who contracted cancer after using glyphosate and, Bell Potter asserts, whether this paves the way for similar lawsuits in other jurisdictions, as well as the potential for a tail of liability to develop in a similar fashion to the asbestos liabilities recognised by building material companies.

While the industry has downplayed the risks, the broker believes that the hurdle rate required for investment will now rise to reflect the heightened risk profile. Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, has a Hold rating and $7.15 target.

The database shows four Buy ratings, one Hold (Morgans) and one Sell (Deutsche Bank). The consensus target is $7.69, suggesting 14.7% upside to the last share price. This compares with $8.04 ahead of the results.

See also Drought Casts A Pall Over Nufarm Earnings on July 24, 2018.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

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