Planting seeds of growth
Nufarm (ASX:NUF) shares have fallen materially year-to-date, roiled by a challenging backdrop, including the gathering El Niño. We believe the shares have overshot to the downside, with the market underappreciating the strong growth opportunity in the seeds business and likely resilient international performance, differentiating the company from the companies with a more concentrated Australian exposure. This was displayed when Nufarm yesterday updated its guidance for the financial year ending 30 September. The forecast underlying earnings were below expectations, but the shares proved resilient (-0.2% on the day), contrasting from the harsh reaction many companies have faced when making any negative adjustments to the outlook.
The El Niño in the room
At the beginning of September, the Australian Department of Agriculture, Fisheries and Forestry projected global crop production in 2023-24 to remain above 2022-23 levels despite extreme weather events and El Niño. There was a slight downward adjustment from the June Agricultural Commodities Report, driven by lower forecast wheat and coarse grain production.
While the effects of major weather events like this are very complex to forecast, the overall weight of the scientific expectations we have seen is that the present El Niño will be a strong one. These events tend to be irregular in their impact across different geographies. Eastern Australia, historically, has seen decreased rainfall and higher temperatures during El Niño, leading to dry conditions – a negative. Australian farmers’ recent strong run is set to come to a halt in 2023-24, with a significant reduction in production anticipated.
Overall, even well-resourced scientific departments worldwide struggle to forecast agricultural production outcomes accurately, but the direction is usually on point. We believe this anticipated headwind/uncertainty has weighed on Australian-based Nufarm’s share price.
This type of uncertainty will intermittently hit Nufarm and its peers, but we like that Nufarm is well diversified by geography and exposed to attractive industry drivers over the long term despite some inevitable cyclicality anticipated along the way. We anticipate elevated soft agriculture prices, supporting demand for Nufarm products. Underpinning long-term drivers include the growing global population and higher disposable income, increasing demand for quality food. Arable land limitations require improved yields to meet demand. There is also a growing demand for precision agriculture and sustainable crops, and Nufarm is well-placed to take a share of this growing market. At current levels, investors can gain exposure to the highly prospective seeds business cheaply in our view. We rate Nufarm a hold while awaiting a better technical setup.
On the technical picture, the 2022 rally in Nufarm to above $6 failed this year, with the stock falling below the primary uptrend established back in 2019/2020. This raises the scope for further corrective downside price action towards the low $4s in the coming months. A breakout above the 2022 downtrend at the $5.40 level would confirm an inflection and a more bullish outlook over the medium term.
FY23 update
Nufarm (ASX:NUF) guided for underlying EBITDA in the range of $430 million to $440 million. This implies a substantial slowdown in 2H23 after posting underlying EBITDA of $316 million in 1H23. We note that management had already flagged a strong skew to earnings in 1H23, typical for the business. Due to timing issues, cash flows should improve in the second half relative to the first half.
Nufarm (ASX:NUF) CEO Greg Hunt said, “We expect to deliver another good result for FY23, following on from the record earnings result delivered in FY22. Despite a very challenging operating environment, we have seen the benefits of revenue diversification across the Group, with some softness in crop protection offset by a very strong performance in seed technologies.”
Positively, Mr Hunt noted Nufarm (ASX:NUF) remained on track for FY26 sales aspirations. Full-year results are due in mid-November.
The FY23 update marks a step down from earlier guidance for modest underlying EBITDA growth over FY22, which was a bumper year. Nevertheless, given the inherent difficulties in forecasting any single year for businesses in this industry, it is the medium-term growth prospects for the seeds business that most excite us. Back in 1H23, the seeds business delivered revenue growth of 25% to $231 million, and underlying EBITDA increased 34% to $62 million. We expect a long runway of superior growth in this business, including for the Omega-3 canola rollout. The higher relative margins should help lift group margins as this becomes a larger part of the overall sales mix.
Source: Nufarm (ASX:NUF)
Nufarm (ASX:NUF) has impressed with execution in the seeds business. As shown in the graphic above, a slew of products is in the pipeline, with a substantial market opportunity for a company of this size.
Medium-term aspirations are to grow seeds revenue to $600-$700 million by FY26, with 20-25% EBITDA margins. We anticipate an upward re-rating as this business grows, even if it falls somewhat short of that goal.
In conclusion, we view Nufarm (ASX:NUF) as undervalued around current levels and maintain a hold recommendation. The resilience the shares exhibited to this week’s FY23 update suggests the market is beginning to view the correction as overdone.
