Small Caps | Mar 18 2019
Difficult conditions in rural Australia have dampened the outlook and Elders expects first half earnings will be materially lower.
-Guidance incorporates a material improvement in the second half
-Costs likely to start rising
-Have agricultural stocks dropped to "buy" levels
By Eva Brocklehurst
Severe drought on the east coast, lower wool volumes and a steep fall in cattle prices have combined to drag on the outlook for rural services business Elders ((ELD)).
FY19 guidance is been revised to earnings (EBIT) of $72-75m, down -3.5% on FY18, and earnings in the first half will be materially lower than the prior corresponding half, at $45.7m. Flat retail earnings are expected, with growth initiatives such as the Titan acquisition expected to offset the reduced summer crop. First half results will be reported on May 20.
Brokers understand that guidance includes a material improvement in the second half, with better winter crop conditions and a recovery in the cattle price from current lows. However, while this can be reasonably assumed, the bias is considered to be to the downside.
Morgans expects underlying net profit of $28.3m in the first half, down -29%, and remains cautious about operating conditions, reducing FY19 and FY20 forecasts for net profit by -12.2% and -11.9%, respectively. Given the steep fall in the share price recently, the broker believes tough conditions are factored into the stock and upgrades to Hold from Reduce.
Wilsons suspects the five-year run of strong cost containment has ended. In the five years to FY18 the broker estimates cost reductions generated around $40m in improvements to operating earnings. A period of investment on IT infrastructure subsequently ensued, and the broker suspects operating expenditure has increased. Costs have also increased in personnel and marketing. Wilsons sticks with a Hold rating and has a $5.79 target.
Bell Potter had assumed there would be around $50m in new acquisitions in FY19 that would make a meaningful contribution to the results for the year. Now, the broker scales back expectations and downgrades net profit forecasts by -14% for FY19 and -9% for FY20.
Bell Potter acknowledges that achieving guidance for FY19 is dependent on a better winter season and, if this fails to materialise, this could mean a further -$10-15m risk to operating earnings (EBITDA). The broker believes the point in the cycle has been reached where seasonal downgrades for agricultural stocks can be bought, and upgrades to Buy from Hold. The broker's target is $6.70.
In terms of the recently-announced bid by Nutrien for Ruralco ((RHL)), Morgans believes, should the takeover proceed, Elders will be competing with a much larger peer group and this, potentially, removes the corporate appeal that was previously attached to the stock. At the same time, the broker suspects Elders should benefit from any downside from the merged group, although this is difficult to quantify.
Given management's comment and strict financial discipline, Morgans does not expect Elders to bid for Ruralco.
Nutrien is a US$32bn company that owns Landmark, which is the largest operator in Australia's rural services industry, and well ahead of both Elders and Ruralco. Given the ACCC did not oppose the proposed merger of Elders and Ruralco in 2013, Morgans does not believe competition concerns will impede the transaction.
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