Australia | Sep 24 2020
This story features NUFARM LIMITED. For more info SHARE ANALYSIS: NUF
A performance improvement program and recovery in agricultural conditions are expected to provide Nufarm with a better earnings trajectory over coming years.
-Has the structural erosion of returns in Europe ended?
-Is the stock trading at too great a discount?
-First sale for the omega-3 canola division
By Eva Brocklehurst
Nufarm ((NUF)) is increasingly confident demand for agricultural protection will recover across European, US and Australian summer crop markets and expects to realise $35-40m in operating earnings (EBITDA) benefits by FY22 from its performance improvement program.
While visibility is low, Wilsons is encouraged by the start to FY21, and the divestment of the Latin American segment reduces gearing to more manageable levels. The company continues to focus on reducing its cost base as European margins weighed on profitability in FY20.
Bell Potter also assesses the earnings downgrade cycle appears to be ending and, based on performance improvement targets and investments, anticipates operating earnings will be maintained at $360-385m inclusive of the benefit of omega-3.
The main concern is whether structural erosion of returns within the European business has come to an end, as the broker suspects -550 basis points of margin has been competed away since the company's Century/FMC acquisitions.
Macquarie maintains a neutral view on the stock and in order to become more positive needs evidence of improved earnings potential being delivered. Still, the easing of raw material costs and the performance improvement program should assist.
Despite the evidence of a recovery, Ord Minnett is looking for a greater valuation gap to compensate for the volatile earnings and regulatory overhang. The broker notes a "Farm to Fork" paper in Europe sets out a target for a -50% reduction in use in risk of chemical pesticides by 2030.
As Europe is a key exposure the broker is not comfortable with this risk, suspecting other regions may follow suit. Macquarie notes signs Chinese ingredient manufacturing is normalising, although expects this will not benefit Nufarm until the second half of FY21 because of inventory lags.
The business in Europe has been beset by a number of of negative factors over recent years but there are increasing signs Nufarm is overcoming the headwinds. Nufarm signalled around -$50m in negative impact on earnings from temporary factors in Europe because of the drought and higher raw material costs out of China but a path to recovery is envisaged through FY21-22.
A cost-cutting program worth -$20-25m will be delivered by FY22 which is expected to support an earnings recovery. UBS forecasts FY21 European operating earnings of $144m, up 45%.
Profits will also improve from reduced expenses in Europe, North America and in the corporate business as well as the previously announced closures of manufacturing plants. The closures are unlikely until the end of FY22 and costs have been provisioned.
Goldman Sachs expects the seasonal headwinds will be quickest to reverse, as opposed to structural factors, and the further benefits from raw material cost reductions and market pricing will likely be weighted to the second half of FY21 and FY22. The broker expects a continued focus by the market on Europe and execution remains crucial.
While acknowledging the market remains somewhat sceptical, Goldman Sachs reiterates a Buy rating as valuation remains attractive even post the outperformance in the stock on the back of the results.
UBS also reiterates a Buy rating, highlighting the strong second half from the Australasian, North American and Asian business. Agricultural conditions in these regions continue to be favourable and earnings momentum is expected to continue.
The broker believes the stock is trading at too great a discount to global agricultural peers which likely represents the deterioration sentiment regarding Europe. This now appears overdone as cyclical factors are reversing.
Trend growth was solid in North America although the first half was affected by high channel inventory. There were lower earnings from the turf and ornamental segments because of reduced activity in the second half but Credit Suisse expects performance going forward should improve because of favourable weather and a normalisation of inventory.
Goldman Sachs also expects the turf & ornamental trajectory is a key swing factor given the lingering impacts of the pandemic in the US, and there will be a headwind in North America from currency as well. On the positive side there were operating efficiency gains associated with the ramp-up of the Greenville herbicide facility.
Macquarie notes the product portfolio in North America was also enlarged through a new distribution agreement with product launches planned for 2021.
Nufarm has announced its first sale for its omega-3 canola business, to a global salmon producer, with shipment this month. The 2020 harvest has occurred and Nufarm expects this will become positive for earnings in FY21 amid a doubling of oil production.
Management has signalled the contract should generate $30m in revenue which Morgan Stanley expects will bring forward long-awaited upside for the business. The broker adjusts forecasts for the new September year-end with FY21 estimates reduced by -9% at the earnings (EBIT) level. FY22 forecasts decline by -4%.
Nufarm is moving to a September 30 year end to align better with the seasonality of agricultural earnings and will report the additional two months on November 19.
Among those brokers not included in the seven monitored daily on the FNArena database, Goldman Sachs has a Buy rating and $5.30 target, Wilsons believes the stock reflects fair value and has a Market Weight rating with a $4.29 target, and Bell Potter has a Hold rating with a $4.40 target. The database has five Buy ratings and two Hold. The consensus target is $4.96, suggesting 15.3% upside to the last share price.
See also, Nufarm Emerging From The Trough on September 3, 2020.
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