Looking beyond the drought
Shares of Nufarm (ASX:NUF) have reverted to the downside since our last review, with the company downgrading full year earnings once more. The market had previously been looking past weather-related earnings impacts. Investors have however become more disturbed now that the drought conditions have been prolonged, and now having a bearing on the FY19 outlook. Operational headwinds have also been experienced offshore. Sentiment has clearly been damaged, but we believe that the medium to longer term growth thematic facing Nufarm remains a strong one, having been bolstered by acquisitions.
Yesterday the agribusiness issued a trading update advising that the dry weather conditions in Australia have significantly impacted the domestic crop protection market, and in turn the company’s ANZ business. As a result, the earnings (EBIT) contribution from the unit will be between $5 to $10 million in FY18. This compares to the $51.6 million generated by the business last year. The result is also affected by the previously flagged manufacturing plant upgrade works at Laverton North.
With July one of the driest on record in many crop regions, this will impact sales at the Australian business, and also with an overhang of crop protection inventory.
Management have also expressed caution on the outlook, with the Australian Bureau of Meteorology forecasting a dry spring, and an El Nino watch alert. This could impact margins further into FY19, and Nufarm (ASX:NUF) is now looking at the ‘impairment implications.’ More positively, management are confident that market share in Australia has been retained.
Offshore, there has also been a delay in the French government’s decision on the company’s application to use its Nuprid 600 seed treatment in cereal crops. As a result, Nufarm is likely to miss the grower application window for the season, resulting in an earnings shortfall for FY18 of around A$12 million.
These factors combined have seen management downgrade FY18 underlying earnings (EBIT) to a range of $255 to $270 million. This is down from the company’s May forecast of around $317.4 million. The market responded by sending the shares down 11% on the day of the announcement. Several other stocks in the sector have also weakened in tandem.
The weather is a key risk for agricultural stocks, and clearly the extended drought in Australia has weakened the outlook nearer term. Mother Nature can be fickle however and can also turn sharply. Despite the bureaucratic delays in France, Nufarm’s geographical diversity is also a strength, and reduces the broader risks faced from both climate and regulatory perspectives. This diversity has been strengthened by recent acquisitions.
The below graphic shows the exposures added by the Century and FMC deals. These in our view will ‘turbo charge’ the company’s presence and longer term growth prospects in Europe.
Source: Nufarm (ASX:NUF) Company Presentation
With a growing offshore footprint, a weaker A$ should also provide an earnings buffer for Nufarm going forward.
Moving onto the charts, and the technical picture has weakened significantly since our last review and following the earnings downgrade yesterday. Prices have fallen back below a zone of support between $8.68 and $8.97. This consists of the 61.8% and 50% Fibonacci retracement levels respectively. Support at the 2018 low of $7.74 has also given way. A period of base building will now be required.
Regarding the monthly chart, prices have also breached the long-term uptrend line (upward sloping green line). Â The series of higher highs and higher lows in formation since 2014 had been indicative of a solid uptrend in play. A holding of support at $7.15, followed by a break back above the upward sloping trendline, would improve the technical picture.
Summary
Mother Nature has clearly taken its toll on earnings (and market sentiment), but Nufarm (ASX:NUF) is still in our view 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. We are therefore focussed on this thematic despite the nearer term earnings picture weakening somewhat.
The shares trade around 22 times FY18/FY19 earnings, but this drops away to 13 times for FY20. We retain a High Conviction buy rating on Nufarm for Members without exposure. It is important however to adopt a 12-18 month timeframe to allow for a normalisation of climactic conditions to ‘feed’ through to earnings and for the technical picture to recover.
Disclosure: Nufarm (ASX:NUF) is held in the Fat Prophets Concentrated Australian and Small & Mid-Cap Model Portfolios.
