Can Nufarm Hold Onto Efficiency Benefits?

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

-Well placed through footprint, share
-Progress on improving margins, returns
-But is this already factored into price?

By Eva Brocklehurst

Nufarm ((NUF)) is doing the right thing, brokers contend, given the volatile operating conditions for agricultural chemicals and the weather outlook. The company is strengthening its sales of higher margin products and undertaking operational efficiencies. This has helped drive a strong FY15 result.

Management remains confident it can achieve net efficiency benefits of $116m by FY18. Nufarm is anticipating another year of solid earnings growth, assuming average seasonal conditions in major markets.

A large part of the efficiency benefits in FY16 will emanate from closure of the Botlek facility in The Netherlands. JP Morgan notes the company has not provided an estimate of the costs that will be required to achieve the net benefits, and there will be costs of a one-off nature. Still, the broker also highlights the opportunity to simplify the product portfolio. There are around 1,000 units in the company’s 8,000 unit global portfolio that contribute less than 1.0% of gross profit. Rationalising these should allow manufacturing efficiencies and a reduction in working capital.

FY15 earnings were comfortably ahead of Citi’s estimates as margins benefitted from tight management. If it were not for a $9m lift in bad debt provisions in Latin America, earnings would have been up 25% instead of 18%, the broker observes. Both Europe and North America were stronger than expected. Seeds were weak, largely because of the first half loss. Nonetheless, the balance sheet, once a source of concern, is now in better shape.

The company is well positioned, mainly as a function of its broad geographic footprint and market leadership in key herbicide sectors. Citi upgrades FY16 and FY17 forecasts by 6.0% and 10.0% respectively. While the multiples do not look particularly startling the broker remains a holder of the stock for the benefit of the ongoing lift in earnings quality.

Deutsche Bank prefers a Sell rating, given the stock is trading at a 24% premium to its valuation. Acknowledging the good progress on improving margins and returns, the broker believes this has already been incorporated in the current share price. Deutsche Bank also believes the market is pricing in the retention of the full extent of the net cost reduction program ($116m) and potential corporate activity, with Sumitomo holding a 23% interest.

The broker considers the FY15 result mixed, slightly better than expected but tempered by significant restructuring costs, a lower effective tax rate and higher average debt levels. Deutsche Bank reduces earnings forecasts by 1-3% to reflect the net impact of higher earnings in the Americas, Australia and Europe which are more than offset by higher net interest and lower earnings in Asia and in seeds.

Market conditions remain challenging in the Americas, given lower crop prices and tight farm economics and the broker notes there is the prospect of an El Nino event in Australia, which, conversely, delivers a possible positive for southern Brazil.

Macquarie welcomes further detail on the business improvement program and retains its Outperform rating. Benefits seem to be coming in earlier than originally expected and this should improve market confidence. Macquarie expects 19% compound earnings growth over the next three years, factoring in 70-75% of targeted cost savings and notwithstanding the volatility inherent in an agricultural exposure.

Nufarm does not envisage the El Nino event will be a material risk to achieving earnings growth in Australia. This is because of a number of years of relatively weak demand in spring, and because lower average rainfall with an El Nino in eastern Australia usually comes with higher rainfall in the west.

Macquarie also observes the company becoming less dependent on top line growth than in the past and more intent on profit and margin. The focus for Australia is maintaining a 30-35% market share and a matching cost base. That said, the Brazilian business enjoyed 8.0% sales growth in FY15 in local currency terms, largely because of market share gains and a focus on newer, higher margin products. Nufarm still expects profit growth in FY16 in Brazil but with crop protection volumes to be higher and prices and margins relatively flat.

The quality and strength of the earnings are a reason Morgans is a happy holder of the stock. The broker is pleased with the margin improvement. Results reflect a strong recovery in Australia and North America, a better-than-expected performance in Europe, and a commendable outcome in South America, given the conditions.

Morgans believes Nufarm provides investors with a solid exposure to global agricultural markets. Based on near-term multiples the broker considers the stock fairly valued, although, taking a medium-term view there is strong upside if the company delivers on its targets. Morgans retains a Hold rating.

The broker defends Nufarm as not yet in a position to quantify additional one-off type costs. The targeted benefits, along with underlying growth, should mean the company can generate earnings in excess of $350m by FY18 but, at this stage, Morgans is more conservative and forecasts FY18 earnings of $334.5m.

Goldman Sachs remains cautious about the medium term because of lower agricultural chemical demand, lower crop prices and currency headwinds from a lower Brazilian real and euro in FY16. The broker believes Nufarm will find it hard to secure and sustain the cost savings over the longer term when benchmarked to peers.

The broker, not one of the eight stockbrokers monitored daily on FNArena’s database, upgrades earnings forecast by 2.8% for FY16 and 1.8% for FY17. With the stock trading above its target of $6.63 a Sell rating is retained.

Five of the seven covering Nufarm on the database have updated on the results so far. In total, ratings include one Buy, five Hold and one Sell. The consensus target is $7.47, suggesting 3.7% downside to the last share price. Targets range from $6.25 (Deutsche Bank) to $8.30 (Macquarie).
 

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