Australia | Mar 30 2010
By Chris Shaw
Even though Nufarm recently guided to an interim loss, the actual result released yesterday was still disappointing, as the quality of earnings fell short of revised expectations in the market. Moreover, management's guidance implies a monster second half result and stockbrokers retain their doubts whether this is achievable.
As Deutsche Bank notes, the operating loss for the period of $4.0 million was boosted by a lower than expected net interest expense. This suggests things could have been even worse in an earnings sense as Nufarm dealt with both lower prices and volumes during the six months.
Geographically the result also held some surprises as while Europe was better than expected, the North and South American and Australasian businesses all fell short of forecasts.
Along with the interim result, management reiterated full year earnings guidance, which is for earnings of between $110-$130 million. This implies a significant skew to earnings in the second half and so Deutsche Bank sees it as something of a stretch, especially as recent movements in foreign exchange markets and structural changes in the glyphosate market have not been favourable.
JP Morgan also sees meeting full year guidance as a challenge for Nufarm, as it will require near record second half earnings, this at a time when conditions remain difficult. Bank of America Merrill Lynch is similarly cautious, pointing out Nufarm will continue to face margin pressures in many markets thanks to excess supply and increased competition from China.
Given such conditions BA Merrill Lynch suggests while gross margins and earnings should eventually improve, it is likely to be a gradual process. This reflects the fact Nufarm has less power in the American and European markets than it does in Australia thanks to its 75% domestic market share.
Recent improved Australian weather conditions lead Credit Suisse to suggest there should be something of an earnings recovery for Nufarm in this division at least, though it too remains cautious on the margin outlook shorter-term.
This lack of fundamental valuation support from a more certain earnings outlook has BA Merrill Lynch suggesting Nufarm shares should trade at a discount to its historical average multiple, at least until there is greater earnings clarity.
Post the interim result, stockbrokers have adjusted their forecasts lower not only in FY10 but through to FY12 in some cases, the FNArena database showing consensus earnings per share (EPS) estimates now of 45.7c in FY10 and 70.2c in FY11. The issue, as JP Morgan points out, is there remains little if any confidence with respect to earnings for this year at least.
To reflect this, BA Merrill Lynch has applied a FY11 earnings multiple of 11.2 times to its earnings per share forecasts, which the stockbroker notes is below Nufarm's historical average multiple of 13.2 times. This gives a price target of $8.00, down from $8.50 previously.
Others in the market have similarly cut price targets on Nufarm post the interim result, JP Morgan among the more aggressive in lowering its target to $7.69 from $9.47. Deutsche Bank has cut its target to $7.50 from $8.00, while the average price target according to the FNArena database now stands at $8.40, down from $9.30.
The falls in price targets have been accompanied by some downgrades in ratings as both JP Morgan and Deutsche Bank have downgraded to Sell recommendations from Hold previously. Overall, the FNArena database shows Nufarm is now rated as Sell five times, Hold twice and Buy just once.
Aside from the uncertain earnings outlook, Nufarm is also out of favour with brokers as it is cum a rights issue of around $250 million at present. BA Merrill Lynch notes this will reduce Nufarm's debt from its current levels of more than $1 billion, but the refinancing operation will also act to overhang the shares as the issue price is expected to be set at a material discount to the current share price.
At the same time, Nufarm CEO Doug Rathbone is reducing his holding, selling three million shares off market and signalling his intention to reduce his current 16 million share stake to around 10 million eventually. While further sales are not expected short-term, this could also overhang the market for some time.
The Sumitomo tender offer for 20% of Nufarm shares at a price of $14 is also unlikely to help the share price in coming months. JP Morgan suggests there may have been a number of investors who bought the stock in an attempt to participate in the tender at a rate above 20%. The remainder of these holdings are likely to be sold into the market once the tender offer is completed, potentially weakening the share price.
Those investors hoping for a full offer from Sumitomo are advised not to hold their breath, BA Merrill Lynch suggesting the Japanese company is more likely to sit on its 20% stake for the time being, so it can fully assess both management and the economics of moving to full ownership.
Post its interim result shares in Nufarm are weaker and as at 1.30pm the stock was down 40c or 4.6% at $8.28. This compares to a range of $8.26 to $14.46 over the past year and means the stock is now trading almost in line with the average price target as shown in the database.
