Season, Supply, Safety Issues Plague Nufarm

Australia | Mar 21 2019

Adverse seasonal conditions, supply issues and glyphosate safety concerns plagued Nufarm in the first half and continue to affect the company's outlook.

-Working capital worsens and net debt rises, no interim dividend
-Potential for an equity raising increases
-Chinese supply chain risk materialises, reflecting poorly on transition planning


By Eva Brocklehurst

Several issues of concern were raised after Nufarm ((NUF)) reported a disappointing first half. Cash flow was significantly worse than expected and European acquisitions are not expected to achieve original earnings guidance until FY20. Adverse seasonal conditions continue to plague the company's performance in FY19 amid supply issues, glyphosate safety concerns and poor execution.

The company now expects FY19 operating earnings (EBITDA) of $440-470m versus $500-530m previously, a -12% downgrade at the mid point. The reduction to estimates is attributed to Australia and Europe while expectations for North and Latin America are unchanged.

Working capital was significantly worse than brokers expected, increasing around $450m. Net debt has risen to uncomfortable levels, at $1.58bn, and caused the board to temporarily suspend the dividend.

Credit Suisse sums up the reaction to the results as a mismatch between market expectations in relation to the risks for the balance sheet and the ability/willingness of the company to effectively manage working capital fluctuations.

The drivers of a second half improvement in working capital stem from Australia, where the company will sell existing inventory and wind back production, amid expectations the drought will continue.

In Latin America Nufarm expects to convert receivables to cash in line with normal practice and strong sales are expected in North America, albeit with some risk for receivables if the US season is late. European seasonal conditions are noted to be reasonable.

Morgan Stanley asserts the share price has capitalised the short-term/seasonal headwinds and generating cash in the second half is key to a re-rating. The broker continues to believe the stock is oversold, as it is trading at a -29% discount to the industrials ex financials. A partial recovery in Europe is assumed amid a more gradual normalisation of conditions in Australia.

Deutsche Bank, while retaining a Buy rating, is cautious and highlights the reasonable amount of risk for the next 4.5 months. The company has estimated average net leverage at the end of the year will be "well below 3x", while the broker estimates it will be 3.0x, which does not leave much headroom.

Ord Minnett downgrades to Hold from Buy after reducing earnings forecast by -30% for FY19 and -26% for FY20. The broker assesses the balance sheet leverage target of 2x net debt for the medium term is challenged, and the business remains heavily dependent on the weather outlook. There is also potential for an equity raising.

Morgans, on the other hand, upgrades to Add from Hold, assessing the stock has been oversold. The broker expects a tough second half and acknowledges short-term catalysts are limited, but with the return to average seasons and a range of growth initiatives there should be an eventual recovery in earnings growth. The main downside risk, Morgans agrees, is if Nufarm cannot restore the balance sheet and requires another equity raising.

Supply Chain

The main issue contributing to the reduction in guidance, outside of the drought in Australia, is the problems with the transition of acquired product portfolios in EuropeMacquarie was not expecting anything extraordinary from the first half results but the extent of the reduction to guidance was worse than envisaged. Europe was disappointing as the Chinese supply chain risk has materialised.

The company has previously flagged uncertainty regarding Prochloraz sourced from China, which is sold by its Century business in Europe. The supplier of Prochloraz, Adama, has declared force majeure based on increased Chinese environmental compliance. This meant the partial or complete closure of a number of Chinese chemical facilities.

 While the affected Chinese plant has now resumed production, this is at lower levels. Nufarm is pursuing other potential supply options and expects a -$30m shortfall should be recovered in FY20.

Credit Suisse questions how transitional supply arrangements with the vendors of Century and FMC were allowed to disintegrate to the extent they did, and believes it reflects poorly on transition planning and execution. Even so, and despite the -$30m impact, Credit Suisse considers Europe is a large opportunity once the acquisitions are bedded down.

Meanwhile, brokers agree the Omega-3 seed development is a winner, which Credit Suisse values of $750m. US FDA approval is expected in the next six months and Canadian approvals over 2019. First commercial contracts are likely by the end of FY19 and an earnings contribution is expected in FY21. Nufarm has reaffirmed guidance for Omega-3 operating earnings of $8.5m for each 1% share of the market by 2028.

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