Tag Archives: Agriculture

article 3 months old

Select Harvests’ Outlook Curbed By Improved US Conditions

-Potential for more pricing uncertainty
-Forward demand still positive
-First half cash flow likely strong

 

By Eva Brocklehurst

There is good and bad in everything. Australian almond producer Select Harvests ((SHV)) was in an enviable position when prices surged over the last several years as drought engulfed California, the world's major producing region for the nuts.

Now with an El Nino event heralding a dry period in Australia's producing regions, California is receiving some much needed rain and snow fall. Current precipitation has eased the impact of the drought although larger rainfall is required, brokers note, before the impact of the long drought is fully mitigated.

Still, the prospect of a larger US crop, softer global demand, and some instances of customer defaults - albeit not for Select Harvests – have dented the almond price. Select Harvests has flagged prices are now down 10-15% from its FY15 pool price of $11.45/kg. While management was keen to suggest market conditions remain favourable, as forward commitments in the US are up 11%, the weaker pricing will have a negative impact on earnings in FY16-18.

Goldman Sachs lowers FY16, FY17 and FY18 earnings forecasts by 25%, 18% and 14% respectively to reflect weaker prices. The broker forecasts an almond price of $10.37, $10.13 and $8.86 per kg over those three years respectively, driven by the assumption that the Californian drought is receding and US crop yields are returning to normal. Goldman retains a Neutral rating and its target, lowered to $7.87 from $9.65, is based on a 25% price/earnings discount to the Small Industrials, reflecting the inherent agricultural risk.

Canaccord Genuity considers the downgrade to pricing has been largely factored into investor mindsets. The broker's analysis of the US harvest over the past five years reveals the percentage of US crop typically shipped from August to December averaged 45.6%. This year's stands at 32.3%, ascertaining a subsequent build up in inventory has resulted in almond traders clearing stock at lower prices.

The peak in the almond price was flagged in earlier commentary but Canaccord Genuity acknowledges its previous price forecasts were too optimistic. Short-term assumptions are further downgraded by 14.0% and long-term assumptions by 6.0%. The broker's long-term forecast almond price is around 25% below FY15 levels.

Despite the negative impact on investor confidence the broker notes the company has a strategically relevant asset, with an improving yield and production profile, and an opportunity to vertically integrate its business model over coming years. This should be the focus for investors in 2016. The broker's Buy rating is unchanged and the target reduced to $8.35 from $10.34.

After revising its estimates for prices lower Moelis notes the reversion to long-term averages will have a negative impact on earnings. The speed of the reversion has also been revised up. With relatively flat harvest volumes expected over the next five years this will put downward pressure on Select Harvest earnings. That said, while trimming assumptions, there is little change to the broker's underlying methodology.

Selling pressure is likely to exist in the short term but, on a 12-month basis, the broker considers the stock is oversold and retains a Buy rating, reducing the target to $9.25. Based on timing, first half sales reflect the unwinding of cash receipts from the sale of the prior year's harvest. Given the strength of Select Harvest's FY15 crop and high prices, strong cash flows are expected in the first half.

Morgans plays safe and downgrades the stock to Hold from Add. The company's sensitivity to the almond price is high, with the broker noting every US10c movement in the US dollar price per pound equates to the company's earnings declining by 6.6% based on forecasts. Morgans forecasts underlying profit in FY16 to fall by 17.5%, based on an expected almond price of $9.73/kg.

Almond prices have peaked and the broker believes the earnings upgrade story which drove the share price to record highs is over. While acknowledging the argument the stock is oversold relative to the fall in the almond price, Morgans is concerned prices may fall further. The company is controlling what it can, investing in risk mitigation, sustainable growth and increased scale and the broker would return to a more positive view if almond prices rise. Target is reduced to $7.50 from $12.00.

UBS lowers earnings forecasts by 42% for FY16 and by 8.0% for FY17. The broker accepts there is now additional risk to forecasts but also suspects a strong rebound in almond prices could occur in coming months.

California’s snow pack, a critical water source for almond orchards, is rebuilding in line with a normal year but, even if there is widespread snow in California over the remaining two months of winter, this is not likely to result in a significant rebound in production before the end of 2017, given the biennial nature of almond trees.

UBS believes there remain opportunities for the company over the longer term through further operational improvements and the company could even consider expanding offshore or into other nut varieties. UBS retains a Buy rating and lowers its target to $10.20 from $13.65.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Nufarm Ploughs Ahead Amid Heightened Risks

-Heightened risks in South America
-Strong second half skew
-Cost reductions on track

 

By Eva Brocklehurst

Herbicide and pesticide producer Nufarm ((NUF)) is grappling with a range of challenges as befits an agricultural exposure, none the least being an El Nino event. The company has signalled its earnings in the first half are likely to be flat or slightly higher, with unfavourable foreign exchange movements contributing to weaker guidance at the profit line.

JP Morgan trims forecasts to account for the expected FX loss of $10m, which is derived from exposure to volatile South American currencies, particularly the Brazilian real. For the full year the company expects underlying earnings growth and the broker's revised earnings forecast sits at $264.8m, around 11.8% above FY15.

Forecasts are achievable, in Credit Suisse's view, despite the challenges in South America. In that region the broker ascertains that despite rapid currency devaluation, the company is making gains in market share and clear channel inventories are providing a buffer. In comparison, the broker expects some competitors may experience a 50% fall in 2015 earnings in South America.

Credit Suisse highlights speculation on M&A among the larger players could mean Nufarm can acquire high-margin products, as portfolio divestiture may be required to alleviate competition concerns. The broker calculates Nufarm's balance sheet could possibly afford a $300m acquisition and still maintain its leverage.

Meanwhile, Nufarm's cost reductions are on track and are expected to deliver incremental savings of $20m in FY16. Credit Suisse believes the stock is close to fair value as longer-dated savings from FY18 are yet to be fleshed out properly. UBS also considers the stock fairly valued as end markets remain mixed and there is limited scope for upside. The company's focus on working capital efficiencies is expected to be the main driver of improved cash flow conversion.

Deutsche Bank takes a negative view of the AGM update, given the tough seasonal conditions and risks apparent in South America and with the seeds business. The company has made progress in improving margins and returns but this appears to be already incorporated in the share price. Moreover, the broker suspects the market is pricing in potential corporate activity - with Sumitomo holding a 23% stake - as well as the full extent of the $116m cost reduction program.

North America has made a positive start despite soft commodity prices, with earnings improvement expected depending on normal seasonal conditions. Brokers note European and Asian sales were up modestly in the first quarter.

Australian revenue was down in the first quarter, given the dry seasonal conditions, although demand improved following some good rain in early November. Seed sales were slightly lower and the extent of earnings recovery in this business is dependent on the Australian canola crop. In Brazil, stricter credit polices have resulted in some sales being forfeited.

Neither Morgans nor Macquarie is overly concerned about the soft start to FY16. Morgans points out that 50% of Nufarm's profit can fall into the fourth quarter alone. The second half is the northern hemisphere’s key crop period and Australia’s winter crop.

While downgrading estimates to reflect the FX losses, Morgans expects improved seasons, rising market share and new products will underpin strong double digit growth over the next few years. The broker retains a Hold rating, nonetheless, as on near-term multiples the stock appears fairly valued.

Macquarie has an Outperform rating, given the medium-term earnings profile remains intact and, despite seasonal risks, the outlook is underpinned by underlying growth and productivity improvements. Furthermore, the $20m in incremental cost savings for FY16 is likely to be weighted to the second half.

Macquarie believes the company is doing well in Brazil, given the circumstances, and the prospects for Europe and North America are favourable, with both skewed to the second half. Macquarie, too, suspects industry consolidation will provide a supportive background, given the prospect that industry manoeuvering prompts Sumitomo to act on its stake.

Goldman Sachs, while disappointed with first half guidance, also notes this is seasonally the weaker half. On average it accounted for only 27% of the full year earnings over the past three years. What is more disappointing is the heightened macro headwinds, such as increased competition, the depreciating Brazilian real and rising credit risks in South America.

These factors, plus adverse weather conditions, appear to offset the benefits of market share gains and increased plantings, in the broker’s view. Goldman Sachs, not one of the eight brokers monitored daily on the FNArena database, has a Sell rating.

The database contains five Hold ratings, with one Buy (Macquarie) and one Sell (Deutsche Bank). The consensus target is $7.95, signalling 2.0% downside to the last share price. Targets range from $6.10 (Deutsche Bank) to $9.00 (UBS).

See also, Can Nufarm Hold Onto Efficiency Benefits? on September 25 2015.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Moelis Spies Promise In Huon Aquaculture

-Positive consumer trends
-Well positioned for China exports
-Increasing scale provides upside risk

 

By Eva Brocklehurst

Australian consumption of a once luxury item, salmon, is increasing, owing to the farming of stocks, the health appeal of such fish and use in takeaways such as sushi, as well as marketing in lifestyle and cooking shows on TV.

Small cap stock Huon Aquaculture ((HUO)) is Australia's second largest, vertically integrated producer of salmon and growth in its operations is being driven by these factors as well as a favourable trend in local agricultural exports to Asia. Fish as a portion of total animal protein consumption is most highly represented in Asia, at 26%.

Moelis believes Huon Aquaculture is well positioned to take advantage of the growing wealth in China, which boosts demand for global protein sources, of which fish is a strong preference.

There is no suitable climate in China for salmon aquaculture, which means all produce is imported. Australian salmon is produced in Tasmania – salmon mortality increases in warm water - and has historically commanded a significant global price premium given its remote location and high quality.

Huon Aquaculture deployed the funds raised when it listed on ASX last year to expand the business, with the intention of delivering high production volumes with increased efficiency. Moelis initiates coverage of the stock with a Buy rating and $4.91 target.

The broker's valuation reflects a conservative approach to key operational metrics, but upside risk is identified as the company's controlled growth strategy is proven successful.

The broker expects domestic consumption per capita will increase as the convenience aspects of salmon products are expanded, such as pre-packed portions and ready-to-cook packs, with modern cookware contributing to faster and easier preparation. Prices are also now more consistent, given the increasing scale of aquaculture.

Moelis has factored in increases in harvest volumes that reflect management's outlook for the industry and the company's ability to scale up operations to meet demand.

Credit Suisse also has faith in the long-term outlook and has a Neutral rating and $3.30 target. Weaker pricing in the wholesale market troubled the broker recently.

The largest cost for Huon relates to feed, with disruptions caused by drought or other factors affecting feed products and having the potential to increase costs. Fuel costs are also significant, given the need for boats, barges and tankers in the operations.

Risks which cannot be completely controlled largely emanate from environmental factors, such as algal blooms, pollution from natural disasters and spills, as well as diseases. Food safety is also a higher risk in seafood farming, with incidents having potential to damage customer confidence in a brand.

Huon Aquaculture competes with the main listed farmer of salmon, Tassal Group ((TGR)). Seafarms ((SFG)), largely a prawn farmer, and Clean Seas Tuna ((CSS)) are also smaller listed aquaculture entities.

Huon Aquaculture has seven hatcheries and 14 farm sites at four locations, with sales representation in all states of Australia. The company's “Fortress Pens” reduce losses caused by predators and it employs full-time veterinarian services.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Incitec Pivot Running On Ammonia

-Project economics attractive
-But fertiliser market is weak
-As is explosives demand 

 

By Eva Brocklehurst

Brokers have sniffed ammonia in the wind as Incitec Pivot's ((IPL)) outlook hinges on the plant currently being constructed in Louisiana, US. The company dodged mounting challenges in FY15, delivering earnings growth of 11%, with fertiliser a key contributor as production volumes at Phosphate Hill stabilised, while the weaker Australian dollar lent a hand.

The company has confirmed its Louisiana facility is on budget and on track for first production in September 2016. The project economics remain attractive, brokers believe, as weakness in global ammonia prices is offset by a sharp fall in US gas prices. To Citi, despite the challenges in the company's end markets, this project and the potential cash flow is what the game is all about.

The underperformance of the share price following the results announcement is driven by the cautious outlook management offers, JP Morgan maintains. In particular,  with regard end markets for explosives in both the Americas and Asia Pacific. The domestic fertiliser distribution market also faces heightened competitive dynamics.

Still, JP Morgan remains positive on the stock, given the Louisiana commissioning will mark an end to a long period of elevated capital expenditure and generate a significant increase in cash flow.

Credit Suisse considers the company executed well in FY15 in the face of difficult markets for explosives and fertiliser. A tailwind from the Australian dollar helped, admittedly. The broker notes the company's improved disclosure allows the inclusion of a derivative offset to foreign currency denominated debt in its valuation for the first time and upgrades its rating to Neutral from Underperform.

The broker acknowledges that nitrogen and phosphate market fundamentals will become more difficult in the near term, and only correct on the back of additional supply cost inflation. Meanwhile, explosives earnings are not expected to improve in the near term as coal fundamentals remain weak.

The outlook is fraught, in Morgan Stanley's view, with an Underweight rating upheld. The broker maintains that core earnings drivers are deteriorating, overshadowing the falling currency and the upcoming start of the Louisiana plant. The broker expects downgrades to consensus earnings expectations will be forthcoming across FY16-18 and place pressure on the stock.

The pressure on the explosives industry is structural, Morgan Stanley also contends. Ammonium nitrate (AN) demand may now be in a permanent state of decline, as global growth shifts and pressure builds on bulk commodities and metals. Longer term, the broker surmises, new technologies have the potential to displace explosives and reduce bulk commodity demand. Meanwhile, supply of AN continues to grow.

On the fertiliser front, conditions are also weak and the broker expects the El Nino weather pattern in the Pacific will result in poor agricultural conditions in Australia in FY16. The risks for both urea and diammonium phosphate (DAP) prices and volumes appear biased to the downside. Morgan Stanley expects the economics of the Louisiana plant, while screening well, will offer little offset to the weakness until at least FY17.

With management commenting that it will pursue capital management, Morgan Stanley incorporates a $500m buy-back across FY17-18 ,with the impact largely offset by increased net interest costs. Macquarie estimates a 10% buy-back would be 6.0% accretive at the current share price and considers November 2016 the most likely timing for such an announcement.

Macquarie also considers the positives outweigh the negatives and believes Louisiana should drive a step-change in earnings and related cash returns to shareholders. The main earnings growth driver in FY16 is likely to be the weaker Australian dollar, and one quarter's contribution from Louisiana. Earnings growth is then expected to accelerate to 37% in FY17 as Louisiana contribute for a full year.

The broker acknowledges that fertilisers were weak in FY15 but cites the company's expectations of a partial improvement in margins, given urea stock levels are back to normal. That said, Macquarie concurs that the El Nino development makes guidance for volumes optimistic but also believes the impact is likely to be small.

The outlook may be challenging but for Deutsche Bank the key earnings drivers are intact while UBS also finds value in the medium term as the stock offers an annual free cash-flow yield of 12% and a 5.0% dividend yield on forecasts two years out.

The result was weaker than Morgans expected, the market conditions challenging and earnings forecasts have been revised lower. Still, the cash cow promised at Louisiana and the prospect of capital management keeps the broker on a Hold rating.

FNArena's database contains five Buy ratings, two Hold and one Sell (Morgan Stanley). The consensus target is $4.20, suggesting 14% upside to the last share price. Targets range from $3.45 to $4.50. Thedividend yield on FY16 estimates is 3.6% and on FY17 5.1%.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Weekly Broker Wrap: Small Caps, El Nino, Telcos, Slots And Warehousing

-Domestic economic tailwinds elusive
-Insurers benefit from El Nino
-Value adding to mobile plans continues
-Aristocrat dominates slot machines
-Warehousing growth to benefit GMG

 

By Eva Brocklehurst

Queensland Conference

Morgans notes domestic tailwinds are more elusive than usual at its Queensland conference, which featured 36 companies across several sectors. Housing and service sectors are working hard to take up the reins after the mining boom while Australia is navigating a period of soft growth.

Several businesses, such as IPH Ltd ((IPH)), Silver Chef ((SIV)) and Lovisa ((LOV)) are looking to grow offshore, while AP Eagers ((APE)) is seeking innovative digital strategies to grow its market share in the automotive industry. Meanwhile, enablers of digital technology such as Rhipe ((RHP)) and NextDC ((NXT)) are obtaining benefit from the way corporates handle and store data.

The broker notes Australian food products are being sought from exporters such as Capilano ((CZZ)) and, indirectly, Elders ((ELD)). Inbound tourism also appears to be thriving and driving expansion for Echo Entertainment ((EGP)) and Mantra Group ((MTR)).

Morgans believes, over the next 40 years, as the population ages, demand will increase substantially for health care, travel and wealth management. Servicing this model are Flight Centre ((FLT)), Gateway Lifestyle ((GTY)) and Japara Health Care ((JHC)).

Morgans highlights AP Eagers, Aveo Group ((AOG)), IPH and Vitaco ((VIT)) as its key selections from the conference.

El Nino

This summer promises one of the strongest El Nino events since 1950, with a large negative impact being widely canvassed for eastern seaboard harvests. The impact of El Nino on rain and temperatures varies by region but Macquarie highlights, with a few notable exceptions, the insurance sector is more favourably placed.

In general, capital goods companies are negatively impacted, regardless of region, while materials sector companies have mixed fortunes. This does mask differences, the broker concedes, between those companies with exposure to hard commodities and those with exposure to agriculture.

Specifically, companies facing downside risk include Incitec Pivot ((IPL)) and Nufarm ((NUF)) as materials suppliers. GrainCorp ((GNC)) and Murray Goulburn Unit Trust ((MGC)) would be adversely impacted by reduced yields.

Bell Potter suggests the good news from an El Nino event is for lower insurance losses and the strong event that is forecast for this summer may signal loss ratios could be down to almost 60%. The event means lower rainfall and delayed tropical monsoons .This signals increased bushfire risk but fewer cyclones.

The broker also observes there is very little correlation between El Nino and bad debts in agribusiness. While isolating flood and drought impacts is difficult, Bell Potter believes floods tend to have a larger adverse impact on banks.

Assuming the El Nino arrives and increased hail activity, which is also a feature, is not concentrated in metro/CBD regions, the broker's analysis indicates very little impact on the insurers and banks in general.

Telco Pricing

Telstra ((TLS)) has raised handset subsidies on 24-month plans this week, by reducing iPhone 6S handset pricing. Goldman Sachs believes Telstra is responding to increased competition since the iPhone 6S was launched. This heightened competition, if sustained, could be negative for industry margins, the broker suspects.

Telstra also continues to add value to its plans in fixed broadband, with bonus data and the inclusion of Telstra TV on $119/$149 plans. The broker observes telco advertising spending grew 12.5% in September, versus a slump of 2.8% for the broader advertising market.

Slot Machines

Aristocrat Leisure ((ALL)) continues to dominate gaming machine performance in the September quarter, with UBS noting it was performing well ahead of its peers. The company appears to be retaining its installed base market share across the eastern seaboard.

New products from Ainsworth Game Technology ((AGI)), IGT and Sci-Games have entered the market and it seems to the broker, while early days, that Ainsworth's games are gaining traction ahead of the other new entrants. Ainsworth is growing its installed base share at the fastest pace relative to peers, although UBS observes momentum has slowed.

UBS estimates Australia will represent around 16% of Aristocrat's segment earnings in FY16, versus 27% in FY14, but it remains an important market, being the second largest regulated class III video slot market behind North America.

Warehousing

Demand for modern warehousing is a global growth trend which Macquarie notes is led by three key operators, Prologis, Global Logistic Properties and Goodman Group ((GMG)).

Goodman is Macquarie's preferred stock to play the theme as it has a well managed capital structure, geographic diversity and superior returns. 2016 supply additions in Japan will be at the highest level in 10 years.

Despite a spike in vacancy rates and decline in spot rents, Macquarie is not concerned about the impact because of Goodman's approach to staging additional supply. Similarly in China, while supply is set to accelerate, net absorption is also likely to remain high.

In the current environment, Macquarie observes Goodman offers higher free cash flow and dividend yield versus Global Logistic, which is listed in Singapore, although the latter is considered more attractive on a relative net asset valuation.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Material Matters: Commodity Outlook, Bulks, Base Metals, Oil, Platinum And Grains

-Low US rates prolong volatility
-Bulks hardest hit from China slowdown
-Emerging markets not taking up slack
-Issue for oil is looming Iran supply
-Profitable arbitrage in sorghum, barley

 

By Eva Brocklehurst

Outlook

Energy, industrial metals and agricultural products remain oversupplied, Citi observes, because of a sluggish world economy as well as the over-investment in developing new supply in the last decade. The broker expects Chinese economic stimulus will lift growth by the end of the year and this should have a positive impact on energy, industrial commodities and bulks, with the exception of iron ore, where new supplies are likely to continue to dampen prices even if steel demand rises.

Nevertheless, a continuation of very low interest rates in the US, which has caused a significant amount of the commodity price volatility in the past two years, as capital flees in the search for yield, should also prolong that volatility. Chinese growth prospects, and the extent of any downturn, remain the key to the outlook.

If the world's second largest economy weakens then demand could fall further and pull prices down. The bullish potential for prices, other than a Chinese rebound, lies in supply disruptions in oil from Iraq, Nigeria or Venezuela and the unfolding El Nino impact on crop production.

Few commodities, if any, have escaped the recent rout. Citi observes, even if China contagion fears are overdone and a global recession does not evolve, growth in China will not continue at its former robust pace and no other emerging market is likely to take up the slack. Moreover, the US Federal Reserve surprised the market with its dovish tone in September, heightening expectations that rates would not begin to rise until 2016.

Citi expects bulk commodities will be hit the hardest by the weaker demand from China followed by base metals. International steel, aluminium and petroleum product markets should remain under pressure as China continues to export its surplus. Macquarie concurs. In many markets there has simply not been enough pain inflicted to accommodate the drop in demand and break the cycle where prices continue to grind lower.

Macquarie, for the first time since 2013, is slightly more comfortable that Chinese demand may have hit a cyclical low. Nevertheless, ex China, the emerging markets are becoming a larger concern, following currency moves and the flight of capital.

Another analyst. Another bear. ANZ analysts suggest that while prices did recover modestly in September, this may only be a short-term reprieve. Most emerging market economies are seen moderating from high rates of growth and financial risks are rising after a period of rapid leverage. Brazil and Russia are in recession and China's growth is expected to slow to 6.0% over the next two years.

The rate of Chines infrastructure spending is also behind schedule with only 30% of the target spent in the year to date. While some more expenditure is expected as the year draws to a close, the analysts observe after a visit to China, that the private sector, where a higher-than-normal level of investment is being channelled, appears to be finding little reason to proceed quickly.

Bulks

Macquarie has lowered forecasts across the board to reflect current market conditions, lower energy prices and new FX estimates. Long term prices for half the commodities the broker covers have been downgraded, particularly nickel, steel and iron ore.

Iron ore, manganese ore and the coals - thermal and coking (metallurgical) - appear set to sustain many years of sufficient supply and Macquarie lowers forecasts by 10-20%. The ANZ analysts suspect iron ore prices could test US$50/t with Chinese steel output slowing at a time of rising seaborne supply and are likely to remain flat for the next two years.They expect some price relief in thermal coal towards the end of the year as the northern winter sets in.

Base Metals

Macquarie observes that nickel is the prime example of a base metal suffering from the weakness in demand, with high inventories and weakness in stainless steel. Supply cuts in aluminium are occurring but the broker finds minimal potential for a recovery in the price over this decade. Copper and zinc are sustaining lower future mine supply but, given current market conditions, are also unlikely to recover much ground.

The ANZ analysts suspect that in the case of copper, prices may have formed a base after Glencore decided to close 400,000 tonnes of capacity in Africa. Aluminium exports from China have eased but volumes remain at elevated levels.

Oil

The oil outlook is bearish and the return of Iran to the market early next year will add to the supply. US production may be falling, particularly shale, but OPEC production is rising and non-OPEC remains strong as well. Citi expects prices to grind lower in the fourth quarter and the broker's economists have added a bearish risk to the mix by putting the odds of a global growth recession at over 50%.

A balanced market in oil is considered unlikely until the end of 2016. ANZ's analysts also expect oil to stay lower for longer. The surplus is expected to continue for the next 18 months although the severity of the oversupply is gradually declining. In terms of Iran, they note that opposition to the deal in the US is strong and this may mean any relief to sanctions could be pared back.

Platinum

The scandal involving Volkswagen and the fiddling with pollution controls on its cars could affect the platinum group metals, which are used heavily in emissions control systems. Brokers believe, while it is too early to tell the extent of the implications, the longer-term impact on diesel engines could be significant. Macquarie expects further pressure on the platinum price as a result of the scandal.

Grains

ANZ analysts observe that Chinese grain prices have been at elevated levels compared with global prices, providing an opportunity to import grain at the expense of domestic supply. Import quotas for corn, wheat and rice are controlled, which prevents any leakage of China's price support to the global market. This is not the case in the unregulated feed markets of sorghum and barley.

The analysts highlight the profitable arbitrage in this markets has meant imports have jumped sharply. Feed grain stocks are already high in China and government losses are increasing, with reports of storage and quality constraints. However, a repeat of the surge in imports - in the last 12 months Chinese imports of Australian barley rose sharply - is unlikely over the next year and China is not expected to have the same influence on prices as it did in 2014.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Can Nufarm Hold Onto Efficiency Benefits?

-Well placed through footprint, share
-Progress on improving margins, returns
-But is this already factored into price?


By Eva Brocklehurst

Nufarm ((NUF)) is doing the right thing, brokers contend, given the volatile operating conditions for agricultural chemicals and the weather outlook. The company is strengthening its sales of higher margin products and undertaking operational efficiencies. This has helped drive a strong FY15 result.

Management remains confident it can achieve net efficiency benefits of $116m by FY18. Nufarm is anticipating another year of solid earnings growth, assuming average seasonal conditions in major markets.

A large part of the efficiency benefits in FY16 will emanate from closure of the Botlek facility in The Netherlands. JP Morgan notes the company has not provided an estimate of the costs that will be required to achieve the net benefits, and there will be costs of a one-off nature. Still, the broker also highlights the opportunity to simplify the product portfolio. There are around 1,000 units in the company's 8,000 unit global portfolio that contribute less than 1.0% of gross profit. Rationalising these should allow manufacturing efficiencies and a reduction in working capital.

FY15 earnings were comfortably ahead of Citi's estimates as margins benefitted from tight management. If it were not for a $9m lift in bad debt provisions in Latin America, earnings would have been up 25% instead of 18%, the broker observes. Both Europe and North America were stronger than expected. Seeds were weak, largely because of the first half loss. Nonetheless, the balance sheet, once a source of concern, is now in better shape.

The company is well positioned, mainly as a function of its broad geographic footprint and market leadership in key herbicide sectors. Citi upgrades FY16 and FY17 forecasts by 6.0% and 10.0% respectively. While the multiples do not look particularly startling the broker remains a holder of the stock for the benefit of the ongoing lift in earnings quality.

Deutsche Bank prefers a Sell rating, given the stock is trading at a 24% premium to its valuation. Acknowledging the good progress on improving margins and returns, the broker believes this has already been incorporated in the current share price. Deutsche Bank also believes the market is pricing in the retention of the full extent of the net cost reduction program ($116m) and potential corporate activity, with Sumitomo holding a 23% interest.

The broker considers the FY15 result mixed, slightly better than expected but tempered by significant restructuring costs, a lower effective tax rate and higher average debt levels. Deutsche Bank reduces earnings forecasts by 1-3% to reflect the net impact of higher earnings in the Americas, Australia and Europe which are more than offset by higher net interest and lower earnings in Asia and in seeds.

Market conditions remain challenging in the Americas, given lower crop prices and tight farm economics and the broker notes there is the prospect of an El Nino event in Australia, which, conversely, delivers a possible positive for southern Brazil.

Macquarie welcomes further detail on the business improvement program and retains its Outperform rating. Benefits seem to be coming in earlier than originally expected and this should improve market confidence. Macquarie expects 19% compound earnings growth over the next three years, factoring in 70-75% of targeted cost savings and notwithstanding the volatility inherent in an agricultural exposure.

Nufarm does not envisage the El Nino event will be a material risk to achieving earnings growth in Australia. This is because of a number of years of relatively weak demand in spring, and because lower average rainfall with an El Nino in eastern Australia usually comes with higher rainfall in the west.

Macquarie also observes the company becoming less dependent on top line growth than in the past and more intent on profit and margin. The focus for Australia is maintaining a 30-35% market share and a matching cost base. That said, the Brazilian business enjoyed 8.0% sales growth in FY15 in local currency terms, largely because of market share gains and a focus on newer, higher margin products. Nufarm still expects profit growth in FY16 in Brazil but with crop protection volumes to be higher and prices and margins relatively flat.

The quality and strength of the earnings are a reason Morgans is a happy holder of the stock. The broker is pleased with the margin improvement. Results reflect a strong recovery in Australia and North America, a better-than-expected performance in Europe, and a commendable outcome in South America, given the conditions.

Morgans believes Nufarm provides investors with a solid exposure to global agricultural markets. Based on near-term multiples the broker considers the stock fairly valued, although, taking a medium-term view there is strong upside if the company delivers on its targets. Morgans retains a Hold rating.

The broker defends Nufarm as not yet in a position to quantify additional one-off type costs. The targeted benefits, along with underlying growth, should mean the company can generate earnings in excess of $350m by FY18 but, at this stage, Morgans is more conservative and forecasts FY18 earnings of $334.5m.

Goldman Sachs remains cautious about the medium term because of lower agricultural chemical demand, lower crop prices and currency headwinds from a lower Brazilian real and euro in FY16. The broker believes Nufarm will find it hard to secure and sustain the cost savings over the longer term when benchmarked to peers.

The broker, not one of the eight stockbrokers monitored daily on FNArena's database, upgrades earnings forecast by 2.8% for FY16 and 1.8% for FY17. With the stock trading above its target of $6.63 a Sell rating is retained.

Five of the seven covering Nufarm on the database have updated on the results so far. In total, ratings include one Buy, five Hold and one Sell. The consensus target is $7.47, suggesting 3.7% downside to the last share price. Targets range from $6.25 (Deutsche Bank) to $8.30 (Macquarie).
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Murray Goulburn Dairy Well Set To Prosper

-Material recovery in prices expected
-Earnings upside from value-adding
-Large investment in state-of-the-art

 

By Eva Brocklehurst

Australia's value-added dairy products have grown at a rapid rate over the last few years. MG Unit Trust ((MGC)) is the so-named - unusually ordinary for current times - ASX-listed entity for Murray Goulburn, Australia's largest milk processor. Murray Goulburn accounts for 38% of the national intake of milk and 54% in Victoria.

There were more than 2,500 farmers supplying 3.6bn litres of milk in FY15 to the co-operative. It has nine processing facilities, in three Australian states and China. Several brokers have initiated coverage recently, with supportive views based on the expectation of a material recovery in dairy prices over the next couple of years.

The company has expanded substantially since 2012, when it revealed a strategy to increase its exposure to value-added dairy products, culminating in a listing in 2013. Murray Goulburn has invested $229m to upgrade existing UHT, butter, cheese and infant nutrition facilities and expanded into processing fresh milk in NSW and Victoria. Its flagship brand is Devondale.

Bell Potter initiates coverage with a Buy rating and $2.37 target. The broker believes the stock offers leverage to the benefits of its recent capital investment and this could lift farm-gate returns by a further 50-60c per kilo of milk solids, independent of moves in the price of the commodity.

Over the last five years the supply of milk from the major exporting countries has materially outpaced demand, which delivered a significant correction in prices. Now, at current levels this is typically associated with a contraction in supply, which Bell Potter observes is starting to happen. For example, New Zealand FY16 milk production is forecast to be down 2-3%.

The weakening Australian dollar is also beneficial. Morgans expects significant earnings upside to flow as a result, plus from the investment in higher margin, value-added product. The company expects to deliver additional cost savings to achieve a target of $280m by FY19, without assuming any improvement in dairy prices or a falling currency.

Additional benefits are expected to come from the $550-635m in capital invested in state-of-the-art cheese making, UHT and nutritional facilities. Assuming a 15% return on investment, Morgans calculates the capital projects should deliver additional earnings between $82.5m and $95.3m. The new facilities should be highly automated and provide a cost advantage over competitors.

Morgans cites figures from Rabobank, which signal demand for dairy from emerging countries is strong. By 2020, Asia's import demand for dairy product is expected to increase by more than Australia's current production, as its consumers demand more protein and a westernised diet. Australia, being the fourth largest exporter, is well positioned to supply China.

The Free Trade Agreement with China should increase Australia's competitive position in this market. Food safety issues in China also mean Australia's produce is viewed favourably.

The trust allows investors to participate in the earnings pool that is linked to the farm-gate milk price. Outcomes for suppliers through farm-gate prices and dividends are aligned to outcomes for investors through distributions. Essentially, the higher the milk price paid to suppliers the higher the distribution to unit holders. The main risk in this structure is that unit holders lack voting rights.

The potential for investors to benefit from a control premium does not apply. Still, given the new structure provides greater access to capital, Morgans believes Murray Goulburn will be involved in consolidating the dairy industry. Because of the lack of unit holder control, the stock deserves to trade at a discount to the average market multiple. Morgans initiates with an Add rating and $2.50 target.

Macquarie also initiated earlier this month with an Outperform rating and $2.70 target. This broker also maintains, with dairy becoming a preferred source of global protein and demand continuing to rise, that Murray Goulburn is well set to prosper.

In FY16 the company expects value-added goods will make up over 70% of total volumes compared with 52% in FY12. Murray Goulburn operates in the second lowest-cost dairy region globally, Victoria. Its well-known brands are also entrenched in their respective categories.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Weekly Broker Wrap: Dairy, Strategy, Pathology, Tourism, Oil And Banks

-Dairies benefit as milk prices surge
-What is attractive as risk aversion fades?
-PRY more sensitive to pathology growth
-Tourism benefit flows to retail
-Discretionary retail benefit from lower oil
-Pressure continues on major banks

 

By Eva Brocklehurst

Dairy

The global dairy price index has risen 48% since the beginning of August. Macquarie believes the main driver of the price response at recent auctions is a significant reduction in Fonterra's offer volumes. These have fallen because of changes to product mix and more product being sold outside the auction marketplace. There is also a 2-3% reduction in forecasts for New Zealand's milk collection.

Macquarie believes Fonterra's reduction in its 12-month offer quantities for a third time last week amplifies worries about a shortage in global supply. Buyers that are only able to access the auction platform are being squeezed, the broker suggests, and may be bidding up the price to cover forward requirements.

A further recovery in dairy prices is good news for NZ farmers and could ease unit holder concerns about Fonterra providing further support to farmers. The problem for Fonterra, the broker maintains, is that the pass-through benefits of lower costs are eroded as input prices rise and this translates to lower earnings. Macquarie's preferred play on the dairy recovery story is Murray Goulburn ((MGC)), with a target of $2.70.

Movements in global dairy ingredient prices have a high correlation to Australian farm gate milk prices. Bell Potter notes Murray Goulburn, Australian Dairy Farms ((AHF)) and Bega Cheese ((BGA)) are positively correlated to rising dairy prices. Average forward curve prices in Australian dollars are implying gains of 10-11% for whole milk powder and butter, while skimmed milk powder is likely to be flat in FY16.

Strategy

Goldman Sachs adds Blackmores ((BKL)), Costa Group ((CGC)) and M2 Telecommunications ((MTU)) to its small and mid cap focus list. In September to date the list has performed in line with the ASX small ordinaries accumulation index. Over the past 12 months the list is up 1.8% while that index is down 10.6%.

Key performers in September have been Ebos Group ((EBO)), amaysim Australia ((AYS)) and Tassal Group ((TGR)), outperforming by 7.5%, 4.2% and 4.0% respectively. Detractors were Genworth Mortgage Insurance ((GMA)), Austbrokers ((AUB)) and Dick Smith ((DSH)), underperforming by 6.2%, 5.4% and 4.6% respectively.

Australia's equity market is down around 15% from its April 27 peak and has performed more in line with emerging rather than developed markets, UBS observes. This is probably because of Australia's relatively high commodity exposure and associated economic links to China. However, some of the apparent correlation may be countered by the banking sector, which has corrected under its own specific issues.

Taking out resources and banks the market appears closer aligned to the developed market, with pressure coming just in the last six weeks. UBS expects market growth to be around the low single digits in FY16 but it could rebound in the next few months on fading risk aversion in relation to China and the US Federal Reserve.

Stocks that have emerged with value and appear attractive to UBS include AMP ((AMP)), ANZ Bank ((ANZ)), Harvey Norman ((HVN)), Incitec Pivot ((IPL)), Lend Lease ((LLC)), Macquarie Group ((MQG)), Mirvac ((MGR)), Perpetual ((PPT)), Qantas ((QAN)), ResMed ((RMD)), Stockland ((SGP)) and Westpac ((WBC)).

Pathology

Credit Suisse is shifting attention for cost inflation to the main drivers of pathology volume growth. Long term, the correlation with Sonic Healthcare ((SHL)) and Primary Health Care ((PRY)) in terms of pathology revenue growth and Medicare pathology outlays growth is high.

The broker notes utilisation was the major contributor over the past five years, accounting for about half of the growth in pathology. This includes increased disease prevalence/test offering and collections. This is followed by population growth. The growth in the aged population is not a material driver.

Calculation of valuation sensitivity to utilisation growth suggests the risk to Primary Health Care is greater because of its higher weighting to pathology earnings. Tempering the broker's enthusiasm is the outcome of the Medical Benefits Schedule review, which could mean removal of certain pathology items. Sonic Healthcare presents as a better investment option in the broker's view because of a more geographically diverse business model.

Tourism

One of the brighter spots in Australia's economy is tourism, as it benefits for the steady move lower of the Australian dollar. Year on year growth in overseas departures has halved to around 3.5% in the first half of 2015, UBS observes. Arrivals have picked up, to be up 6.0% year on year. The broker expects this income from tourism should contribute more than 25 basis points to GDP growth over the past year.

UBS also notes that upswings in tourism contribute to improvements in retail sales, reflecting not only more inbound tourists but also more locals choosing to holiday domestically. The broker expects an increasingly positive impact on the tourism sector from the Australian dollar's decline with support for retail spending, non-mining capex and GDP growth over time.

Oil

Oil price declines should detract from global headline inflation around 0.5-1.5 percentage points in 2015-16, Commonwealth Bank analysts maintain. Australia is a net energy exporter and lower oil prices may lead to lower coal and LNG prices. The analysts calculate the negative terms of trade effect is equal to around 0.5% of GDP. 

The most positive impact is expected to come for those companies which are large consumers of energy, such as manufacturing, electrical and transport. The other positive impact is the boost to household spending. Oil prices are expected to remain at low levels over the next two years. At this stage, firms in the domestic market have not signalled a major intent to pass on lower oil prices to consumers and the analysts suspect lower prices will be absorbed in margins.

The analysts calculate the income gain for householders should equate to around 0.3% of household income from the drop over the past year in average petrol prices. There is also a second round benefit if lower transport costs are passed on. Discretionary retailers are also usually the first to benefit from a sizeable fall in petrol prices.

Banks

Recent commentary from the Australian Prudential Regulation Authority (APRA) chairman has suggested major banks still have some work to do to achieve the financial system enquiry's recommendations to be unquestionably strong.

JP Morgan does not believe this will translate into another round of capital raising, but does expect continued dividend reinvestment plan (DRP) support will be required. The more challenging task is to meet the broader benchmarks.

The leverage ratio, created as a simple metric by which regulators could assess appropriate balance sheets size, is recommended as a minimum range of 3-5%. Australia's major banks are currently at around 5.0%, lagging their top quartile global rivals which average a 6.0% ratio. JP Morgan expects returns on equity will remain under pressure, as the majors rely on further re-pricing initiatives to sustain returns.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Fresh Growth Expected For Costa

-Additional royalty stream
-Barriers to entry high
-Increased focus on berries

 

By Eva Brocklehurst

Costa Group Holdings ((CGC)) occupies an enviable position in a growing market - fresh, healthy food. As retailers respond to increased demand by investing more in providing fresh food the company's products are central to the table.

The company has four main categories in produce: berries, mushrooms, tomatoes and citrus. Combined, these have grown 11% per annum over the past three years. UBS expects future growth will be supported by rising consumption and new capacity.

International growth should also drive earnings as the company earns royalties on its intellectual property in blueberries in the Americas and Morocco, and the company has are joint ventures in Morocco and China. Costa also operates a marketing and logistics business.

Costa's proforma FY16 profit forecast is $48m, which will be up 24% year on year. UBS forecasts market growth of 3.0% pre annum over the next three years in which Costa's core categories should grow by 9.0%. Beyond FY16, UBS forecasts compound net profit growth of 13%.

The broker initiates coverage with a Buy rating and $2.80 target, envisaging the stock as a medium-term investment. The leading market position in high growth categories is attractive but, as an extra filip, so is the more predictable earnings compared with others in the agricultural sector. Around 75% of the crops are under protection.

Goldman Sachs also initiates on the stock, with a Buy rating and $2.79 target, adding the stock to its conviction list. This view is underpinned by expectations of compound earnings growth of 17% over FY15-18. The broker estimates dividend/free cash flow yields of 4.6%/2.5% and 5.8%/7.5% for FY16 and FY17 respectively. 

The company is considered a beneficiary of the growing Australian demand for berries. Moreover, the asset base is difficult to replicate, given the significant capital expenditure required, and the company has a strong position via its patent protection in five types of blueberries.

UBS does highlight two areas which need to be known. Some leases are not at arms length, in that they are with entities associated with the Costa family. The leases generally have long tenure and some unfavourable provisions for the company.

The other issue is the Driscoll's brand ownership. UBS observes the company sells both raspberries - where Driscoll's owns the IP - and blueberries - Costa's IP - via its joint venture. If the agreement were to cease, the IP created by Costa in Australia under the Driscoll's brand, would be lost to Costa. Still, the broker does not believe these materially disadvantage the company over the longer term.

The company has over 3,000 hectares of farming land, with seven mushroom facilities and 20 hectares of glasshouse across Australia. In Australian berries, Costa has 54% market share based on its own production and this increases to 84% when third party production through marketing via the Driscoll's JV is added. Costa has 42% of the Australian market share in mushrooms and 18% in tomatoes. Goldman forecasts berries to contribute more than 40% of earnings by FY18.

Costa is the largest citrus producer in Australia but its citrus, unlike the other three, is not grown under protection and remains significantly exposed to weather and related risks. Goldman Sachs believes the company has low bargaining power with customers in this area, because of the fragmented nature of the industry.

The company sources 80% of its produce from its farms in South Australia. While production has been declining over the past decade because of rising imports and droughts, the turnaround in Australia's currency should support earnings, Goldman maintains, as around 50% of citrus produce is exported. Main export markets are Asia, the US and New Zealand.

Around 67% of the company's sales come through the four main supermarkets in Australia. In Goldman's view, this is one of the main risks in terms of concentration. Supermarkets enjoy significant bargaining power with suppliers and the increasing competition in this segment could lead to margin pressure for suppliers. Still, Costa probably enjoys a better bargaining position than many because of its significant market share in berries and snacking tomatoes.

The company remains a significant beneficiary of the fact that in Australia, fresh imports account for only 2.0% of sales, as a result of strict quarantine regulations and the perishable nature of the product. Consumer demand for local fresh produce remains high. Costa will service this demand through yield improvements and capacity expansion.

Costa's royalties come from the US and Africa Blue joint ventures, as Costa's blueberry varieties are used in the Americas. This revenue stream is expected to grow as demand in the US grows and further plantings occur in Morocco.

The brokers expect Costa to move beyond current operations in berries, with Driscoll's blackberry varieties currently in the quarantine process. Tomato and mushroom farms are also likely to increase further, particularly in NSW.

The company is a significant marketer of bananas and produces bananas in northern Queensland. Costa considers this a commoditised product and doe not have any significant growth plans. The company also markets and grows avocados but is predominantly a price taker, with no plans to grow this business either.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.