Take up rights
Agribusiness Nufarm (ASX:NUF) recently revealed full year results, with the company reporting a statutory net loss after tax of $15.6 million, versus a $114 million profit a year earlier.
Total revenues actually rose 6.3% to $3.3 billion, although the extended drought in Australia took its toll. Nufarm has also announced that it is proceeding with a $303 million capital raising to bolster the balance sheet.
It has been a tough year for Nufarm, and this is clearly evident in the latest set of results. However, we believe that the numbers may well mark the nadir for the crop protection company, and also with some signs that the drought in Australia is beginning to break. Kinder climactic conditions would provide a big boost for the company and given the underlying thematic remains a positive one.
There is little doubt that the demand for crop protection products is going to remain robust, with a rising global population, changing dietary habits, and an increasing shortage of arable land. The company’s growth prospects in Europe have also been turbo-charged by last year’s deals, making Nufarm a much more rounded company. The fund raising may also provide capital for further bolt-on acquisitions, and with opportunities aplenty given strong M&A activity in the sector globally.
We recommend Members continue to hold their shares in Nufarm and take up their share entitlements. Please note the closing date is 5pm (AEDT) Wednesday, 17th October. We are also comfortable recommending Nufarm as a buy for those Members without exposure and prepared to adopt a 12-month timeframe at a minimum.
Full year Results
Before moving onto the details of the rights issue, we will take a look at the company’s results to 31 July 2018, which were characterised by growth at the top line, but weakness at the bottom. Nufarm saw revenue growth in all regions bar Australia, and as total turnover reached $3.3 billion, an increase of 6.3% on last year. Underlying earnings were down just 1%, but impairment charges of some $114 million made for a net loss after tax of $15.6 million, a $130 million reversal on last year. This saw the final dividend trimmed to 6 cents per share, versus 8 cents a year ago.
Source: Nufarm
Total crop protection sales increased by 6% to $3.1 billion, but underlying EBITDA (earnings before interest taxes depreciation amortisation) fell by 1% to $395.7 million mainly due to the Australia/New Zealand segment. Underlying gross profit margins were however steady at 28.3%.
Seed technology sales in the period were up by 10% to $185.5 million and delivered an underlying EBITDA of $43.6 million, which was down 4% on last year, and as gross profit margins were 43.8%, below the previous year of 46.7%.
Sales in Australia/New Zealand were down 10% at $590.1 million on the prior year, with the severe drought in Australia taking its toll on the autumn and winter cropping periods. Underlying EBITDA was $23.7 million compared to $64.9 million in the prior year, with autumn one of the driest on record, while winter was very dry in the eastern and southern states, and has now extended into spring. Scheduled plant shutdowns also impacted the Australian result to the tune of $8 million.
There is no question that the extended drought in Australia has had a significant impact on Nufarm’s bottom line. Some respite may be on the horizon however, with several drought-stricken areas seeing heavy rainfall recently. Parts of eastern Australia saw more than a month’s rain in one day, which will be welcome after the drought was extended by the driest September on record.
Elsewhere, the company’s performance in North America was much more encouraging, with sales up by 10% to $833.7 million, and underlying EBITDA up 12% to $99.5 million. The North American business increased market share in all three of its key segments. The group also plans to extend its manufacturing capacity in mid-2019 to facilitate sales growth into the south-eastern region of the USA.
Latin American crop protection sales were up 8% on the previous year to $885.2 million. Underlying EBITDA rose 2% to $97.4 million. Nufarm also continues to increase market share, given the crop protection market in Brazil was actually down 7%. A focus on higher margin sales also saw earnings lift in Argentina, despite a prolonged drought there. The overall performance would have been even better but for currency weakness. In constant currency terms Latin America sales would have increased 17% and underlying EBITDA 12%. Nufarm does actively manage its current exposures.
Source: Nufarm
In Asia, sales were up 3.0% but earnings were off 11%. Sales into Japan were down 18%, due to increased generic competition. The outlook for growth in China has improved following the establishment of a sales and marketing joint venture with locally based Fuhua Group.
Given the acquisitions last year, there was much interest in the performance in Europe, and these were up to scratch in our view.
Sales rose by 19% to $642.6 million, and underlying EBITDA jumped 24% to $149.9 million, thanks to the portfolio additions, and a stronger euro. Climactic conditions didn’t play their part either though, with a late start to the season and a severe drought and heat waves in many parts of the Continent.
Management reports that the newly acquired product portfolios performed strongly in FY18, ‘reflecting well executed integration plans and a positive response from the customer base.’We continue to believe that the deal making in Europe undertaken will be a definitive ‘game changer’ for the company and turbo charge its growth plans.
The company outlaid some US$575 million on the European acquisitions, with related costs of $22.2 million. This, together with impairment charges and tax asset write-offs of $91.5 million at the Australian business, meant there were $114 million in material items for the full year.
Source: Nufarm
The extended drought conditions in Australia have had a significant impact on the group financials, with inventory levels rising, cashflows dipping, and gearing levels on the rise. Net debt more than doubled to $1,374 million at 31 July 2018, although $335 million of the increase related to funding for the European acquisitions. Interest coverage however remained strong at 5 times.
Looking ahead the company expects earnings growth to resume, and is forecasting 2019 underlying EBITDA to be in the $500 million to $530 million range. This is based on a combination of revenue growth, a partial recovery in the Australian business and the full year impact of the European acquisitions. The outlook assumes average seasonal conditions for the major selling periods in key markets, which can never be guaranteed, but recent weather patterns are more encouraging. Rising earnings will also lower working capital and debt levels medium-term.
Nearer term, the company is focussed on reducing balance sheet risk, whilst also allowing the financial flexibility to engage further acquisitions. Hence, management’s decision to pursue a capital raising.
Earnings are also set to get a further lift from management’s ongoing cost savings and performance improvement program. The company aimed to deliver a net benefit of $116 million in underlying EBIT by the 2018 financial year, with investment in technology, some of which has been pushed into the FY19 year.
As covered in our last review, sentiment towards Nufarm had also been impacted by a legal judgment in the US, against industry peer Bayer-Monsanto which had been ordered to pay damages in the order of US$289 million. A California state court found that Monsanto’s Roundup weed-killer product contributed to the terminal cancer of a former school groundskeeper. The jury determined that the product and related glyphosate-based brands presented a substantial danger to people using them.
Nufarm also notes that the verdict is being contested, with Bayer-Monsanto claiming the jury’s decision is wholly at odds with “over 40 years of real-world use, an extensive body of scientific data and analysis which support the conclusion that glyphosate-based herbicides are safe for use and do not cause cancer in humans.” We will follow proceedings closely, for glyphosate remains (the company has diversified its product base significantly in recent years) an important product for Nufarm, contributing 12% of group gross profit.
At the seeds business, the company has also continued to make progress with the commercialisation of proprietary omega-3 canola. After receiving regulatory approvals in Australia earlier in the year, the USDA recently approved omega-3 canola for cultivation in the US. Nufarm remains confident it will be first to market with a land-based, sustainable, long-chain omega-3 solution. This would certainly be a big win for the environment – Nufarm estimates that one hectare of omega 3 canola has the potential to produce a similar yield of oil from 10 tonnes of wild caught fish.
The Entitlement Issue
Moving onto the rights issue, the entitlement offer is on the basis of 3 new shares for every 19 held (record date 1 October), at a price of $5.85, an 11.9% discount to the previous close before the announcement. Entitlements can be traded on the ASX. The shares have pulled back towards the offer price since Nufarm returned from a trading halt.
The retail entitlement offer opened last Thursday, 4th October, and closes at 5pm (AEDT), next Wednesday, 17th October. The institutional component of the offer has been completed, raising approximately $238 million. Below is a list of the key dates in relation to the offer.
Source: Nufarm
We believe that the rights issue has sound logic and given the unprecedented headwinds Nufarm has faced.
This includes in particular the extended drought conditions in Australia which have been a once-in-a-century event for some regions. Through the raising, Nufarm is looking to moderate debt levels (taking net debt/underlying EBITDA from 3 times to 2.4 times), and also not be financially hamstrung as it looks to invest and take advantage of M&A opportunities.
The company took advantage of anti-trust decisions as larger peers have combined, with the acquisitions in Europe last year, and more are to follow. Nufarm is ‘well advanced’ with some negotiations, and is looking to outlay $100 million here over the next two years. Management also want to invest in manufacturing capacity in the Americas, to take advantage of growth opportunities there.
All this makes sense in our view, given that the global crop protection market is forecast to grow strongly, as the population rises and the amount of arable land continues to shrink. The OECD forecasts that the global population will reach 9 billion by 2050, with 90% of the required growth in crop output expected to be driven by higher yields.
Source: Nufarm/OECD crop protection market forecasts
Moving onto the charts, and the technical picture has weakened significantly since our last review, and in recent months. After breaking a zone of support between $8.68 and $8.97, support at the 2018 low of $7.74 has also given way, in addition to that at $7.07 and $6.22 being the 127.2% and 161.8% Fibonacci retracements. The breach of the last layer of support comes following the discounted rights issue, and an extensive 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). The series of higher highs and higher lows in formation since 2014 had been indicative of a solid uptrend in play. Support at $7.15 has also been breached, and has further damaged the technical picture. Some consolidation will now be needed to improve the outlook, and a move back towards the 38.2% Fibonacci retracement at $8.44 and ultimately the upward sloping trend-line.
Summary
It has been a tough year for Nufarm, and this is clearly evident in the latest set of results. However, we believe that the numbers may well mark the nadir for the crop protection company, and also with some signs that the drought in Australia is beginning to break. Kinder climactic conditions would provide a big boost for the company and given the underlying thematic remains a positive one.
There is little doubt that the demand for crop protection products is going to remain robust, with a rising global population, changing dietary habits and an increasing shortage of arable land. The company’s growth prospects in Europe have also been turbo-charged by last year’s deals, making Nufarm a much more rounded company. The fund raising may also provide capital for further bolt-on acquisitions, and with opportunities aplenty given strong M&A activity in the sector globally.
Nufarm shares trade around 14 times FY19 earnings, but this drops away to just 11 times for FY20. We believe this is a modest valuation, and given the positive longer term thematic drivers.
We recommend Members continue to hold their shares in Nufarm and take up their share entitlements. Please note the closing date is 5pm (AEDT) Wednesday, 17th October.
We are also comfortable recommending Nufarm as a buy for those Members without exposure and are prepared to adopt a 12-month timeframe at a minimum.
Disclosures: Nufarm is held in the Concentrated Australian and Small/Mid-cap managed account portfolio.
