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Treasure Chest: Nufarm Beats Down Costs

Treasure Chest | Jul 28 2020

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

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. In closing several areas of underperformance, Nufarm can turn around its European business and also take advantage of improving agricultural conditions in Australia.

-Underperforming European division likely in a trough
-Cost base expected to materially improve
-Drought pressures in Australia also easing


By Eva Brocklehurst

Subdued expectations for agricultural chemical producer Nufarm ((NUF)) have been driven by a European division that has significantly underperformed, along with uncertainty over the lockdowns in North America.

However, improving agricultural conditions in Australia and a concerted effort to rationalise the company's cost base means several brokers consider the outlook for the business has improved substantially.

UBS upgrades Nufarm to Buy from Neutral as the balance of risks is now more favourable. The market appears to have significantly re-based expectations for Europe, which the broker considers has been overdone.

Significant pressure on European earnings over the last couple of years has created poor investor sentiment, underscored by a -600 basis points decline in operating earnings (EBITDA) margins to 16% in FY20.

While growth targets have not been achieved the broker envisages an opportunity to "right-size" the European cost base is now evident. This includes potential reductions in personnel and manufacturing rationalisation.

Some normalisation of cyclical factors is expected and UBS believes a combination of cost reductions could support a margin of 23% in Europe by FY22. An improvement of margins to 23% would drive upside in European earnings to around $200m and this is around 20% above the broker's FY21 forecast.

Cyclical factors such as drought and input cost pressures are starting to reverse as well, and along with the potential for re-setting the European cost base UBS assesses substantial upside. The broker has taken a deep dive into why European profit margins deteriorated while evaluating the cost base, which helps to determine the level of opportunity that lies in cost reductions.

Agricultural Outlook

Seasonal conditions have improved in Australia, Morgan Stanley agrees, with the area planted under winter crops forecast to increase 23%. North America and Europe, meanwhile, are acknowledged to be challenging.

Lockdowns in North America have impacted demand for turf and ornamental inputs and this is a high-margin segment for the company. A rainfall deficit has also accumulated in key regions of France, Germany and Poland.

Combined with the pandemic, this is affecting margins. Still, Morgan Stanley continues to envisage meaningful upside under normalising conditions, and US Food & Drug Administration approval of Omega-3 should provide a positive catalyst in coming months.

Ord Minnett notes the acreage report for June from the US Department of Agriculture was also slightly positive for fertilisers, seeds and agricultural chemicals.

Manufacturing Closures

Earlier this month Nufarm announced the cessation of manufacturing at Laverton, Australia, for insecticides and fungicides. The company expects annualised benefits to operating earnings of around $5m from early in FY22.

The closure of herbicide (2,4-D) manufacturing at Linz in Austria is also expected to generate a $10m benefit in the first half of FY21. Insecticides and fungicides are considered to be high-margin, albeit low volume, products.

Credit Suisse agrees Nufarm is chipping away at its cost base and believes the reaction to the closure of manufacturing at Laverton and Linz should be positive, assessing the decision recognises the reality of sub-scale manufacturing.

Closure costs in Australia are expected to be partially mitigated by the sale of the site at Laverton. Credit Suisse estimates a saving of $5m would represent around 20% of product costs and a reasonable improvement in the competitive position of the company post the closure.

The plant operates at below nameplate even under normal seasonal conditions and some product is already produced elsewhere under tolling arrangements. Nufarm expects to close the site within 18 months. While 2,4-D manufacturing at Linz will terminate, other products will continue to be produced such as copper fungicide and the laboratory will remain in use.

In June, uncertainty over the earnings outlook amidst the pandemic caused both Morgans and Macquarie to downgrade, to Reduce and Underperform respectively. Macquarie pointed out the June quarter is Nufarm's largest seasonal quarter and the substantial uncertainty created by the lockdowns made it difficult to assess the outlook.

FNArena's database has four Buy ratings, one Hold (Ord Minnett) and two Sell. The consensus target is $5.31, signalling 28.2% upside to the last share price. Targets range from $4.70 (Ord Minnett) to $6.74 (Credit Suisse).

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