Nufarm Needs More Evidence To Justify Rally

This story features NUFARM LIMITED. For more info SHARE ANALYSIS: NUF

-New products to the fore
-Recovery in North America
-Oz winter key to second half
-Cost benefits largely factored in
 

By Eva Brocklehurst

Nufarm's ((NUF)) stock has been boosted recently as a result of several factors but brokers remain cautious, viewing the equity as fair value given its exposure to the vagaries of weather and soft commodity prices. 

One aspect which keeps Credit Suisse upbeat is that the company is entering the commercialisation phase of numerous, high margin new products, such as fungicides in Europe. Nufarm is targeting sales and gross margin expansion over the next three to five years and the broker suspects 30% gross margins could be achievable by FY20 with an improved mix of product, up from 26.5% in FY14.

To achieve this, significant optimisation of R&D, sales and marketing is required. Credit Suisse observes Nufarm spends less than its competitors Adama and Cheminova in this area. While acknowledging the importance of marketing and R&D in driving sales and margins, the company believes it has surplus activity that can be rationalised to provide better expenditure outcomes.

The broker is not yet confident enough to project cost savings to the bottom line. Nufarm has indicated any re-investment strategy will be gradual, that is, executing on cost savings and then evaluating re-investment options. The broker also observes the relationship with major shareholder Sumitomo, which has a 23% stake, continues to deepen. Recent distribution agreements bring the total sales of Sumitomo products to just under $100m.

Earnings are heavily skewed to the second half but JP Morgan takes heart in management's confidence it can generate improved profitability over FY15. Seeds are the weakest performing segment, delivering a loss in the first half. Management still expects growth in seeds in FY15 but is more modest about its targets. The broker recalls an "ambition" to double 2012 earnings within 3-4 years (disclosed in 2013). This now seems to be a more distant goal.

In North America the company is hopeful of an earnings recovery, driven by a more normal spring in the US. In Brazil the second corn planting is down 10%, which will affect demand for crop protection. In Europe as in Australia, given normal seasonal conditions, the second half is expected to be slightly stronger.

The market has moved quickly to factor in the positives from cost cutting but proof of delivery will be required to justify any upside from here, in Macquarie's view. The broker believes the company is on the right track, with improved balance sheet metrics and focus. Still, seasonal conditions will be important to monitor in coming months. On the subject of weather conditions, rain has been more favourable since the first half but the key winter rainfall period in Australia is from April to June so that feature is still to play out. At this stage, conditions are more favourable in eastern Australia than in Western Australia.

South America remains a strong performer, Macquarie notes, with margins up strongly in Brazil, driven by better product mix and strong demand for the company's differentiated offerings. Seeds were the main disappointment, because of weak seasonal conditions, competition in China and some product timing issues. Macquarie believes the broader margin and earnings upside opportunity remains attractive.

UBS also considers the stock fair value and found some quality issues in the first half result. While some PE multiple re-rating is warranted, given the focus on growing cash flow, UBS believes the stock price now incorporates some of the targeted cost reduction benefits outlined by Nufarm. The broker wants more detail around strategic initiatives and evidence of successful execution in order to factor in further outperformance.

Deutsche Bank was not so impressed and believes the first half results to be a negative for the share price. The broker does not consider the outlook commentary sufficiently upbeat to sustain the recent rally in the share price. The result was boosted by FX gains and lower R&D expense while net operating cash flow was weaker than forecast. Deutsche Bank downgrades to Sell from Hold. The broker considers the market is pricing in the full extent of the $116m cost reduction program and potential corporate activity but remains wary about the recent decline in soft commodity prices.

After strong share price appreciation Morgans also downgrades, to Hold from Add, but remains a buyer on any material weakness. The broker was pleasantly surprised by the first half result, minus seeds, given the hot, dry Australasian summer, noting that North America had returned to profitability and the South American result was solid. Europe also performed better than Morgans expected. The first half result is not enough to justify the recent rally but, taking a medium term view, the broker believes there is further upside if Nufarm delivers on its targets. Morgans would be a buyer below $6.50.

FNArena's database shows no Buy ratings. There are four Hold and two Sell. The consensus target is $6.78, which compares with $5.86 ahead of the first half result and signals 4.4% upside to the last share price. Targets range from $6.05 (Deutsche Bank) to $7.20 (Morgans).
 

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