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California Drought Silver Lining For Select Harvests

Australia | Jun 01 2021

Beyond the current price and earnings trough that led to Select Harvests' horrible, albeit unsurprising first half result, brokers remain confident a multi-year cyclical recovery in almond prices is just around the corner

-Management’s pessimism over almond prices relates to increased Californian output
-Citi forecasts an average almond price of $7.05/kg in FY22
-Wilsons is forecasting Almond segment earnings declines of -7-45%

By Mark Story

Staring at the embers of what was arguably a dismal half year for Select Harvests, management for the fruit and nut grower attempted to put a brave face on the result by reassuring shareholders that tree health remains good with strong 2021 vegetative growth and high bud load.

Select Harvests operates a diversified portfolio of almond orchards, plus a state of the art processing facility in Carina, Victoria and value added processing in Thomastown, Victoria.

At face value Select’s first half result was the tale of two diametrically different stories. First the good news story: In line with sustained underlying yield improvements over several years, the company’s  almond crop was up 21% for the six months to 31 March 2021, and this drove a total revenue increase of 37.4% to $84.8m.

Aided by sales delayed from the second half of 2020, operating cash flow of $4.7m also improved significantly on the previous period.

However, due to lower global almond prices – down -20% to $6.00/kg – and higher production costs, the company’s net profit fell -93% from $17.4m to $1.3m. Almond earnings of $3.1m declined -89%, and were -74% below Wilsons’ forecasts.

Within commentary that accompanied the first half result, management anticipates low levels of pricing for its main product, almonds, for the remainder of 2021.

Pricing & earnings trough

Much of management’s pessimism over future almond prices relates to an expected increas in output from California which is largely responsible for setting the price. Following a record-breaking 2020 Californian crop, the USDA Subjective Almond Estimate indicates another large crop this year. As a result, US$ almond prices are forecast to drop -5% in FY21, and -4% in FY22.

Select anticipates the second half 2021 will be broadly consistent with first half 2021 based on an almond pool price of $6.00/Kg.

However, Wilsons notes a material deterioration in seasonal conditions, coupled with any negative news flow on the Californian crop could significantly alter almond price forecasts.

Beyond FY21, Citi continues to remain constructive on the outlook for almond prices. Much of the broker’s multi-year cyclical recovery in global almond prices outlook is based on lower Californian supply.

Despite the USDA’s expected increase in production this year, the broker remains aligned with the prevailing industry sentiment that California’s worsening drought and water supply situation will impact crop yields. With 75% of the state now in extreme drought, and 26% in exceptional drought, the broker believes conditions are likely to impact yields for the 2021 crop.

Citi expects US almond prices to move higher on the lower supply, with continued strength in export demand observed during calendar year 2021 reaching US$2.32/lb or slightly below pre-covid levels.

However, Bell Potter reminds investors that in the last decade, the USDA’s US crop estimates have had an average accuracy of 98%. The broker also notes, new plantings of 66,000 acres exceeded removals of 48,000 acres implying that there is still a tail of crop growth in outward years.

Meantime, the softer first half 2021 result and FY21 average almond price drives a $19m (-40%) reduction in Citi’s FY21 earnings forecasts. But the broker is forecasting an average almond price of $7.05/kg for Select in FY22, which the broker in hindsight believes will mark FY21 as a trough in both pricing and earnings.

Citi notes, a $6.00/kg average almond price for FY21 – on the back of the record 3.1 billion lbs. US 2020 almond crop, plus covid market disruptions – will represent the lowest price since full year 2012.

Due to the lower than expected average almond price, and the resulting higher operating deleverage, Citi has downgrade FY21 earnings by -40%. Based on slightly lower almond pricing in FY22, plus a smaller water cost saving benefit, and a higher horticultural cost assumption, the broker is also expecting FY22 and FY23 earnings to fall by -17% and -5% respectively.

Robust results

Due largely to lower almond price assumptions in FY21 and FY22, along with slightly higher cost of production, Wilsons is also forecasting Almond segment earnings declines of -7-45%. But with improved Food earnings and lower depreciation and amortisation partly offsetting the lower Almond earnings, the broker is forecasting group earnings (EBIT) declines of 0-44%.

However, looking beyond the half year result, Wilsons is encouraged by an uplift in food segment earnings, which in the broker’s view is evidence of the initial benefits from Select’s strategic review. As a result, the broker continues to see the risk/reward equation as biased to the upside.

Aided by the reclassification of parts of the Food segment as a discontinued business, food earnings of $5.7m increased materially on the previous period, while corporate costs declined -26% due to reduced employee payments and discretionary spend.

The broker reminds investors, on key factors Select exerts some control over, including crop yield and cost of production, the company continues to deliver robust results, with the latter continuing to compare well to the past seven years.

Looking to the factors outside of Select’s control, Wilsons is also encouraged by management’s guidance for materially lower water costs in FY22.

Citi notes, a higher than anticipated carry-over of water allocations from full year 2020 has seen water cost savings largely deferred to FY22. While current southern connected Murray Darling Basin allocation prices at $100/ML are likely to persist through FY22 according to ABARES, the broker has tempered water cost savings with a new cost per kg assumption of $0.72/kg – previously $0.51/kg in FY22.

As a result, Citi expects lower water costs to drive a $5 million earnings benefit from FY20 to FY23.

Citi is the only broker in the FNArena database that covers Select Harvests. The broker notes the company’s share price has historically been highly-correlated with spot almond prices, which Citi argues has priced the company’s orchard assets at a discount to their potential market value.

Citi has a Buy rating on Select and a target price of $6.80, but also notes revaluing the company’s orchards at the private benchmark implies a share price of $7.23/share, or 23% above the current share price.

By comparison, Wilsons retains an Overweight rating on the company and has a target price of $6.75, plus an earnings capitalisation FY23 PER 14.5x valuation.

But with US almond prices being the key near-term driver of Select, there is no change to Bell Potter’s Hold rating, and target price of $6.00.

CSLA retains a positive thesis on Select Harvests while cutting its target price to $6.50 from $6.75.

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