A dry argument
Shares in agribusiness Elders (ASX:ELD) have been volatile so far in 2018 after a strong performance last year, and following a fairly brief announcement that saw the shares turn sharply lower last Friday. The company issued a profit downgrade following dry weather across Australia, and weaker cattle prices. Prices and volumes for sheep and wool remain robust, but the market focussed on the negatives, with the shares down some 15%. This has largely wiped out the gains in the shares since the March lows, with the stock pulling back in 2018 after more than doubling last year.
While the price action since our last review is disappointing, we believe that this is purely corrective in nature, and that the underlying fundamental argument for Elders remains very strong.
Limited rainfall in Australia in recent months will make for average winter cropping conditions (and subdued cattle/farmland prices). The weather is always a key risk factor for agi stocks, but conditions will normalise. Management’s ‘Eight-Point’ turnaround programme has been executed extremely well in recent years, and has further to run. The company offers in our view strong leverage to rising demand for meat products within the Asian region, while further weakness in the A$ is set to act as an ongoing tailwind in our view.
In the release titled ‘Seasonal Update’, management revealed that they expect underlying earnings before interest and taxation (EBIT) for the full year 2018 to be in the range of $70 million to $74 million, and $59 million to $63 million for net profit. Both these numbers compare favourably to the FY17 EBIT of $71.0 million and net profit of $58.4 million. The company remains on track to deliver ‘consistent’ earnings in the September full year. Investors though did not take the announcement with a pinch of salt.
Dry conditions have seen a decline in Retail earnings as chemical input demand has fallen away.
The previously flagged decline in cattle prices are impacting the company’s Agency earnings. On the bright side, sheep and wool prices and volumes have remained robust over the course of 2018 and are consistent with the prior year. The dry conditions have also seen an increased utilisation of feedlots. The additional earnings from these two segments will partially offset earnings lost in Retail and Agency.
Weather can often be harsh, and the reaction of investors to what was a very brief trading update also looks excessive.
This is also as the medium-term earnings picture looks strong. Management reiterated that Elders remains on track to hit its target of 5% to 10% EBIT growth by 2020. While many areas of Australia have been affected by drought as the map below shows, conditions will normalise.
Source: Bureau of Meteorology
Cattle prices have also come off the boil, but we believe prices will rebound, with demand set to accelerate, driven by changing dietary habits within the Asian region. The graphic below shows the step-change that is occurring in the global demand for beef.
Source: Elanco
Elders (ASX:ELD) is well leveraged to this thematic, and potentially may get more so, with reports that the company is considering a potential move for agricultural supply business PGG Wrightson across the Tasman. The price tag has been thought to be in the region of $600 million and as Elders CEO Mark Allison noted “We couldn’t fund it ourselves. We would have to go to the market.”
Increasing speculation in the media has also seen the company announce today that it ‘has not made any definitive proposal to acquire PGG Wrightson.’ This follows a newspaper article which suggested that Elders was set for a “$300 million raising’ as it circles the target.
Elders’ has certainly risen from the ashes since the financial crisis but in our view will not want to bite off more than it can chew with an overpriced acquisition. The financial progress in recent years has been impressive, and management will not want to potentially undo the good work.
Source: Elders (ASX:ELD) Company Presentation
Turning to the technical picture and looking at the daily chart, previous overhead resistance at the January intra-month high of $8.86 as shown by the dotted red line has given way. Support is now being tested around the $7.08 region. Momentum has clearly been checked, with the share price falling below the 50 day moving average and hovering around the 200 day moving average (red line).
On the monthly chart, Elders (ASX:ELD) has traded consistently higher since 2013, underpinned by a rising trend line (upward sloping solid-green line). Previous overhead resistance has been breached at the January intra-month high of $8.86 as marked by the dotted red line. We still expect further gains to evolve over the broader horizon. Adding to the bull case is the strength of the underlying long-term uptrend, which has been in place since mid-2014.
Summary
Shares in Elders (ASX:ELD) have been volatile so far in 2018 after a strong performance last year, and following a fairly brief announcement that saw the shares turn sharply lower last Friday. The company issued a profit downgrade following dry weather across Australia, and weaker cattle prices. Prices and volumes for sheep and wool remain robust, but the market focussed on the negatives, with the shares down some 15%. This has largely wiped out the gains in the shares since the March lows, with the stock pulling back in 2018 after more than doubling last year.
While the price action since our last review is disappointing, we believe that this is purely corrective in nature, and that the underlying fundamental argument for Elders (ASX:ELD) remains very strong. The weather is always a key risk factor for agri stocks, but conditions will normalise. Management’s ‘Eight-Point’ turnaround programme has been executed extremely well in recent years, and has further to run. The company offers in our view strong leverage to rising demand for meat products within the Asian region, while further weakness in the A$ is set to act as an ongoing tailwind in our view.
We believe the shares offer good value in this context, trading on a FY19 price earnings multiple of 13 times. We recommend Elders (ASX:ELD) as a high risk buy to Members without exposure and with a medium to long-term investment horizon.
Disclosure: Elders (ASX:ELD) is held in the Concentrated Australian Share and Small/Mid-Cap Models.
