Australia | Oct 01 2019
Nufarm has addressed a vulnerable capital position with the sale of its South American crop protection business and investors can now focus on fundamentals.
-Transaction reduces likelihood of Sumitomo takeover of Nufarm
-Caution prevails on outlook, given ongoing drought in Australia
-Brokers await reinstatement of dividend policy as debt is reduced
By Eva Brocklehurst
Nufarm ((NUF)) has caught a wind, selling its South American crop protection business at an attractive multiple. With gearing reduced, the company can confront the challenges posed by difficult seasonal conditions.
Nufarm reported FY19 underlying operating earnings (EBITDA) of $420.3m and net profit of $89.1m, largely in line with guidance. However, this was overshadowed by the announcement the South American operations have been sold to Sumitomo for $1.19bn. Sale proceeds will be used to pay down debt. After the divestment, the company will operate in five areas: Europe, North America, Australasia, Asia and seed technologies.
The master agreement for product development and commercialisation with Sumitomo has been renewed to 2025. Nufarm will still provide procurement services and certain products to the South American business and has been confirmed as the preferred commercialisation partner with Sumitomo for proprietary fungicides Pavecto and Indiflin in Germany, Poland and the UK.
Credit Suisse believes these agreements are noteworthy as they reinforce the company's strategic importance. Glyphosate sales will drop to 7% of gross profit post the divestment, which the broker believes is also important, given the nature of the issues surrounding that product.
In one flourish, Nufarm has addressed a vulnerable capital position and brokers observe that by selling the South American asset, the company's earnings profile will be less volatile. Macquarie points out, while Latin America is a high-growth region, it was also intensive in terms of working capital. The company had negative free cash flow from the business over the last five years and also exposure to FX volatility.
The deal remains subject to regulatory approvals and a shareholder vote, with completion expected in the first half of FY20. Morgans understands Sumitomo was seeking distribution capacity as it prepares to launch new products into South America, and notes the Nufarm Nuseed assets are not included in the sale.
The broker also suspects the transaction reduces the likelihood that Sumitomo will take over Nufarm in full. Nufarm will undertake a review of corporate costs to target future savings following the completion of the transaction.
Management has reiterated expectations that Australasia can return to $50-60m in earnings (EBIT) over the medium term. Morgans remains dubious, noting the Australasian business has also been affected by increased competition following industry consolidation and more imports from China.
While lowering estimates for earnings per share by -23% in FY20 and -22% in FY21, Ord Minnett suggests, if weather conditions improve, Nufarm is likely to experience earnings upgrades into FY21. However, this is a limited call given the current grim outlook for Australasia.
Australasian earnings backtracked in FY19 and the temporary closure of manufacturing plants was unprecedented, resulting in unrecoverable overhead costs. The company asserts it has addressed a significant overhang in inventory from drought conditions and made progress in re-setting the cost base.
The company's performance improvement program is ahead of schedule in Australasia, Macquarie agrees, with $10-15m and incremental operating earnings expected in FY20 as opposed to prior expectations for March 2021.
Adverse weather conditions in Europe as well as supply problems in the acquired portfolio also affected the FY19 result. The acquired European portfolio contributed $75m in operating earnings versus the business case of $110-115m. While the company has addressed some of the transition issues an impact on supply is still expected in FY20.
Morgan Stanley believes, having cleared some of the issues, investor enthusiasm for the Omega-3 business will gain momentum as various revenue and profit milestones are passed.
The sale of the South American division means the company is under less pressure to monetise Omega-3 in the short term and can extract better value from the approvals process and commercial sales as a result, in Macquarie's view. The broker estimates $40m in Omega-3 earnings in FY22, which represents $1-1.20 per share of potential value. First commercial sales are expected in FY20.
Ord Minnett would be interested in a timeline for reinstating the dividend policy as the balance sheet is repaired and working capital unwinds, while Morgan Stanley expects Nufarm to return to paying a dividend in FY20. Macquarie assumes no final dividend following suspension of the interim dividend, although acknowledges capital management can be explored following the sale of the South American business.
The board will want the company to achieve working capital targets before taking any action on funding capital management or growth opportunities, Morgans asserts. A reduction in corporate costs is considered highly likely following a simplification of the business model.
Wilsons, not one of the seven stockbrokers monitored daily on the FNArena database, calculates, on a post-divestment basis, the stock is trading on an FY20 enterprise value/EBITDA of 8.3x, which appears fair. The broker has revised its rating structure and has a Market Weight rating and $5.79 target for Nufarm.
Macquarie upgrades to Outperform from Neutral to reflect lower net debt, capital expenditure and a better ability to generate cash. FNArena's database has four Buy ratings and two Hold. The consensus target is $6.48, suggesting 12.3% upside to the last share price. Targets range from $5.35 (Ord Minnett to $8.30 (Credit Suisse).
See also, Better Conditions Ahead For Nufarm on August 2 2019.
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