Australia | Aug 02 2019
A preference share deal with a major shareholder has reduced the likelihood of a substantial equity raising for Nufarm and brokers now focus on the longer-term outlook.
-FY20 outlook improved by potential for lower debt levels and higher earnings
-Despite flooding in some parts, US business in a strong position
-Main growth opportunities lie with seeds and Omega-3
By Eva Brocklehurst
Inclement weather in North America has combined with a drought-stricken Australia to cause Nufarm ((NUF)) to pull back on FY19 guidance, although support from the company's major shareholder has placed a plank under the balance sheet. With the reduced likelihood of a substantial equity raising, brokers can now focus on the longer-term outlook, anticipating a return to more normal seasonal conditions in FY20.
The company has placed $97.5m in preference securities with its largest shareholder, Sumitomo Chemicals. While a capital raising was widely expected, support from Sumitomo was probably under-estimated, Credit Suisse suggests. Removing the balance sheet risk is a clear positive.
The company has guided to operating earnings (EBITDA) of $420m versus $440-470m previously. Morgan Stanley was disappointed with this downgrade, although acknowledges it was largely anticipated. Offsetting this, the preference share transaction has removed the risk of a large equity raising. Hence, with these most significant concerns removed, the broker believes investors can focus on the inherent value in the stock.
Citi agrees the placement is a strategic move that relieves balance-sheet concerns and confirms the commitment of the company's largest shareholder, providing valuation support, reiterating a Buy rating. Bell Potter, not one of the seven stockbrokers monitored daily on the FNArena database, also has a Buy call, basing this on the prospective multiplier effect of higher earnings, under more normal weather conditions, and lower net debt levels.
The broker finds it worth noting that the 17% short interest on the stock has scope to unwind should this more positive outlook prevail, and maintains a target of $6.15. Ord Minnett is more circumspect, mainly concerned about the earnings profile as Australian drought conditions and European supply chain issues prevail.
Europe, which contributes around 20% of group revenue, remains constrained. Macquarie notes supply problems with China have worsened, resulting in higher costs and lower sales for the European business although Nufarm expects to control the supply chain in time for the autumn selling period. Credit Suisse allows for an additional sourcing impact in its numbers in the second half that are partially carried forward into FY20.
While flooding is currently an issue in the US, Ord Minnett acknowledges the US business is in a strong position to capitalise on increased receivables and recent flooding may create favourable conditions in the crop, turf and ornamental segments. Corn and soybean plantings received good to excellent conditions as of late July, while continued rain caused poor soil conditions in the midwest.
Yet, the dividend has been reduced and there are lingering issues on the balance sheet. In the broker's view, the main growth opportunities are in the form of Omega-3 canola. Macquarie is positive about FY20, believing the Sumitomo support and improved earnings outlook should help reduce gearing, noting the Omega-3 opportunity is also likely to firm up via US FDA approval. The broker is attracted to the potential in the seeds business, closely linked with Omega-3.
Citi assumes no final dividend will be paid in FY19 and that payments return in FY20 with a 30% pay-out policy. Credit Suisse, too, assumes no final dividend is paid in FY19 and removes an FY20 interim dividend from forecasts as "insurance".
Assuming some detriment to the North American margin and only a partial recovery in Australia in FY20, the broker forecasts closing debt of $1.6bn in the first half and $1.1bn at the end of FY20 and considers the valuation undemanding on the back of the FY20 outlook.
Morgan Stanley assesses the Sumitomo transaction effectively works as bridging finance, providing Nufarm with the flexibility to navigate the high point in working capital. Having Sumitomo as a counterparty should also address concerns about the outlook for that company's existing 16% stake in Nufarm. Citi also makes this point, as Sumitomo did not participate in the last two equity raisings.
The securities placed with Sumitomo may be exchanged at any time after 24 months at a price of $5.85. If it chooses to do so, Sumitomo's stake would rise to 19.9%, Citi calculates, still below the 20% threshold where Foreign Investment Review Board approvals are required.
A quarterly distribution of 6% is payable for the first 12 months and 10% thereafter. No ordinary dividend is may be declared until distributions are declared on the Sumitomo securities.
Nufarm has underperformed global peers over the past year, Macquarie points out, since a Brazilian judge placed a suspension on the use of glyphosate in Brazil and the Californian jury found Monsanto liable for damages from a claim that glyphosate caused an individual's cancer.
The broker accepts that Nufarm is dealing with a more highly leveraged balance sheet (which may be partly to blame for the -28% fall in its share price since August 2018) and has greater exposure to poor Australian seasons versus global peers, but finds the glyphosate litigation against both Bayer and Monsanto a useful context in which to judge the stock's performance.
FNArena's database has four Buy ratings and two Hold. The consensus target is $6.20, suggesting 28.7% upside to the last share price. Targets range from $4.90 (Ord Minnett) to $8.24 (Credit Suisse).
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