Small Caps | May 13 2015
-Long-term growth profile
-Benefit from vertical integration
-Import threat containable
By Eva Brocklehurst
Tassal Group's ((TGR)) share price has suffered recently on the back of negative short-term earnings revisions amid fears increased volumes of salmon could affect future prices. The fear has been partly justified, as weaker prices in the March quarter caused the company to dampen expectations for the second half. Price weakness has flowed, not from additional domestic supply, but, as Credit Suisse observes, from Norwegian imports, coinciding with a Russian ban on Norwegian salmon.
The company is Australia's largest, vertically integrated producer of farmed Atlantic salmon. Credit Suisse believes the company offers an attractive long-term growth profile which is underpinned by strong demand. Global prices can be volatile but there are limitations in major producing regions such as Norway and Chile which support the long run trends.
Despite recent growth, imports remain around 22% of the domestic market and are restricted to certain categories because of quarantine rules. Credit Suisse expects domestic producers can respond to increased imports, given better product and vertical integration, but this takes time. Hence, imports are a short-term risk to domestic volumes and pricing, having grown strongly in recent years.
Major changes from the Senate inquiry into Tasmanian aquaculture currently underway are not considered likely. The report is due in August. Still, coupled with a review of Macquarie Harbour fish biomass limits, there is some regulatory downside risk. Tassal envisages any change will be phased in and production can be flexed to contain any adjustments. Environmental factors are an ongoing risk for the fish farming business, although Tasmania is relatively disease free in a global context.
Credit Suisse expects Tassal to benefit from further efficiencies derived from selective breeding and improved farming methods, with an established infrastructure that allows capital expenditure to target optimisation. The broker expects further benefits from volume growth in FY16, offset by lower margins, and initiates coverage of the stock with an Outperform rating and $3.85 target.
Other brokers covering the stock on the FNArena database have similar price targets. Morgans has a Hold rating and $3.75 target. This broker remains concerned about the domestic market's ability to take up a further increase in salmon supply, given a subdued retail environment. The company has re-entered the lower margin export market and this adds some risk in the broker's opinion. Still, Morgans concurs the stock is fair value and trading multiples are not stretched.
JP Morgan has a $3.86 target and a Neutral rating. The broker downgraded FY15 earnings estimates last month to reflect falls in the wholesale salmon market, but still expects Tassal will deliver 17% growth in FY15. JP Morgan observes pricing did not recover at Easter, as expected, despite volumes being up strongly. This was blamed on discounting. The broker flagged an 11% fall in the export salmon price, as the Norwegian krone price per kilo weakened and the Australian dollar improved slightly against the krone. Tassal needs a price of $7.50-8.00 per kilo to generate a decent margin, JP Morgan calculates.
Tassal has improved in many aspects of its environmental sustainability and the broker is encouraged by the transparency of the company's reporting. Still, JP Morgan is cautious about the potential for oversupply in the next few years and the magnitude of compensation risk needed for what is, after all, an agricultural stock.
The consensus target on FNArena's database is $3.82, suggesting 18.3% upside to the last share price. The dividend yield on FY15 and FY16 consensus forecasts is 4.2% and 4.8% respectively.
There are three major domestic salmon producers in Australia and Tassal has 47% market share. Huon Aquaculture ((HUO)), which listed last November, has 35%. JP Morgan highlights the fact that Tassal earned around 23% of its revenue from the wholesale market in FY14 whereas Huon Aquaculture earned 85%. Major supermarkets account for most of the domestic retail channel while wholesale, Credit Suisse observes, is relatively fragmented.
Australian producers are capable over the medium term of containing the threat from imports, as these are restricted to frozen and value-added products, while the weaker Australian currency should benefit domestic producers, in Credit Suisse's view. Demand for Atlantic salmon is growing, driven by consumer awareness of health benefits and shifting trends in consumption to seafood from meat, as well as improved relative affordability.
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