The good oil
Shares of Nufarm (ASX:NUF) have edged higher since our last review, despite the company last week downgrading full year earnings to the lower end of guidance. The market is it seems looking past short-term weather related earnings impacts, to the company’s leverage to a powerful thematic, strengthened by recent acquisitions, and the wider value on offer. We remain positive on the company and retain a High Conviction buy rating for Members without exposure.
What’s new?
Nufarm (ASX:NUF) has been performing well operationally, but near-term earnings growth has suffered a setback. Last week management revealed that underlying earnings before interest and tax (EBIT) for the 12 months to July 31 would be up around 5% on last year, or around $317 million. Previous guidance was for growth of 5-10%, so this is the bottom end of the range.
The company has cited “challenging climatic” conditions in Australia, New Zealand, Europe and North America. “Blame it on the weather” they say, but in this case, Mother Nature is a natural risk for agricultural related companies.
Some regions in Australia have recorded their driest April on record. This has implications for crops and crop protection products. The dry conditions have also reduced canola plantings. On the other side of the globe the winter in Europe and North America has pushed into spring.
A further earnings headwind noted by management was the decision, a few weeks ago, of the European Commission to restrict the use of neonicotinoids to indoor uses. The pesticides are used to protect crops from insects, but have been said to be harmful to bees and other pollinators. The restrictions though do not come into effect until after the end of the financial year (July 31), but will likely impact sales in the lead up.
Despite the revelations management were relatively upbeat, with CEO Greg Hunt stating that the underlying business was strong, and ‘better positioned’ to withstand adverse seasonal conditions due to a transformation program over the past three years. It is also worth noting that the majority of Nufarm’s sales fall into the second half.
Looking through the weather related impacts to near-term earnings, the underlying investment case for Nufarm (ASX:NUF) remains strong in our view. The thematic of rising food demand and the need to boost agricultural yields due to the shrinking supply of arable land is highly supportive.
There has been an increasing amount of M&A activity in the sector. This has been a sector-wide trend and we have regularly said during our coverage that Nufarm will play a significant part (either as acquirer or target) one way or another.
As we have noted previously, acquisitions over the past year have been astute, with deals “turbo-boosting” the crop protection company’s position in Europe in particular.
Crop assets secured from FMC included eight formulations used in broadleaf weed control applications. The $110 million will generate A$30 million in net sales in the first year of full ownership in fiscal 2019 and A$15 million in earnings before interest, tax, depreciation and amortisation (EBITDA), implying a slightly less than 7.5 times 2019 EBITDA valuation. The portfolio has an attractive near-term growth profile which is driven by new product launches and cross-selling opportunities for existing products. The margins of the products being acquired are also above Nufarm’s existing margins.
Source: Company Presentation
The acquisition came on the heels of the much larger $627 million acquisition of the ‘Century’ portfolio of European crop protection assets from Adama Agricultural Solutions and Syngenta Crop Protection. The ‘Century’ portfolio’ consists of over 50 crop protection formulations, including herbicides, fungicides, insecticides, seed treatments and plant growth regulators which are sold in 29 European markets including Germany, Spain, France, Italy, Poland, Romania and Hungary. The top 10 core products account for approximately 70% of net sales from the portfolio.
The Century acquisition will be transformative for Nufarm’s European business, with pre-transaction pro forma FY2017 sales of A$540 million expected to increase by just over a half (+53%) to A$826 million. Market share in Europe will increase, but still be only mid-single digit in herbicides, insecticides and fungicides, giving further scope for growth. The price of the transaction is also reasonable in our view at 7 times FY2019 EBITDA. The deal is expected to be mid to high single digit earnings per share accretive pre-amortisation in the same year.
Europe is now the largest regional contributor for earnings following these deals, although the company’s position in other key markets is also strong. Sales growth as noted in the below graphic has been robust across the globe.
Source: Company Presentation
As identified in our last review, Nufarm (ASX:NUF) is also pushing through with other growth initiatives. Included is the company’s GM omega-3 canola for use in feed and human consumption.
The new proprietary product could also have a significant environmental benefit, with one hectare of canola set to provide the omega-3 yield equivalent to that from 10,000 kilograms of wild caught fish. The product has received approval from the Australian regulators and this could pave the way for other countries to follow suit.
At an investor presentation last week management highlighted the market opportunity with a projected global fish oil deficit of 850kt in 10 years. This is based on stagnant supply of traditional fish oil and with demand increasing at around 7% per annum. Management believes that the company can deliver EBITDA of A$1000 per tonne of fish oil equivalent. This though will take some time to come through to earnings, with the first contribution coming in FY21. The market though is likely to price this potentially large value driver in ahead of time.
Source: Company Presentation
There also remains another plank to the Nufarm thesis. The company’s performance improvement program delivered an incremental net EBIT benefit of $26 million last year, and is set to deliver at least $116 million by FY18.
Moving onto the technical picture and regarding the daily chart, prices have pushed up from a zone of support between $8.68 and $8.97. This consists of the 61.8% and 50% Fibonacci retracement levels respectively. A sustained break above resistance $9.26 would further strengthen the outlook.
Regarding the monthly chart, prices are currently holding above the long-term uptrend line (upward sloping green line). The series of higher highs and higher lows in formation since 2014 is indicative of a solid uptrend in play. An upward rotation towards resistance sighted at $10.13, being the 50% Fibonacci retracement, is now feasible.
Summary
Shares of Nufarm (ASX:NUF) have edged higher since our last review, despite the company last week downgrading full year earnings to the lower end of guidance. The market is it seems looking past short-term weather related earnings impacts, to the company’s leverage to a powerful thematic, strengthened by recent acquisitions, and the wider value on offer.
Nufarm is well placed to benefit from the world’s rising demand for food, shortage of arable land (with the weather a part of this) and the need to increase yields. Astute acquisitions have also strengthened the company’s leverage to this thematic. The shares trade on around 21 times FY18/FY19 earnings, but this drops away to 15 times for FY20.
We remain positive on Nufarm (ASX:NUF) and retain a High Conviction buy rating for Members without exposure.
Disclosure: Nufarm (ASX:NUF) is held in the Fat Prophets Concentrated Australian and Small & Mid-Cap Model Portfolios, as well as the Fat Prophets Global Contrarian Fund (ASX: FPC).
