Small Caps | Feb 17 2016
-Risks in contract renewals
-Competitor activity pressures prices
-Strong market growth ahead
By Eva Brocklehurst
Another broker has taken to the Tassal Group ((TGR)) observation decks, as Australia's largest vertically integrated producer of salmon has now broadened into other seafood through the acquisition of De Costi Seafoods.
This acquisition underpinned the numbers in the first half as excluding De Costi, earnings were flat. The integration of De Costi increases Tassal's addressable market to $4.3bn, annually.
Moelis, not one of the eight stockbrokers monitored daily on the FNArena database, initiates coverage with a Hold rating and $4.30 target. This is based on a valuation which offers modest upside to the current price amid risks around upcoming retail contract renewals and pricing pressure.
Retail supply agreements with Coles and Aldi mature this year and there is a risk supply is awarded to competitors, or on less favourable terms. Major competitor Huon Aquaculture ((HUO)) is ratcheting up its harvest and this may have a downward impact on prices, Moelis suggests.
Nevertheless, the Australian salmon market is forecast to grow at 10% per annum until 2020 and Tassal is automating its supply chain which should improve volume and margins over time. Capital expenditure for the next few years is in the range of $45-55m, Moelis observes. The company is also at an advantage over other foreign players as its salmon is typically of higher quality, with less antibiotics and better husbandry.
Domestic consumption of salmon continues to climb, based on increased awareness of the health virtues and the availability of convenience packs. The scale of aquaculture also is increasing, which provides more consistent product at lower prices.
First half results were weaker than Morgans forecast but growth is expected to be stronger in the second half on the back of the De Costi synergies. The broker suspects the mention of pricing pressure on retail contracts in FY17 may have spooked the market, downgrading to Hold from Add in view of the limited upside to its $4.20 target.
Ord Minnett suspects the market was also disappointed with the pull back in disclosure on salmon pricing and volumes and may have expected a more optimistic outlook based on the increase in export prices. Yet the broker retains a Buy rating, believing De Costi is on track to deliver a significant contribution.
On the subject of disclosure, Moelis highlights the company's intention to present the business as a whole rather than segmented via salmon and De Costi and, with the number of contracts up for tender this year, has not provided key operating metrics in order to protect commercially sensitive information. The decision makes it harder to assess and forecast operations.
The broker also notes that despite a primary focus on the domestic market, significant increases in the international price and a weaker Australian dollar render the export market as a profitable channel.
Morgans also believes the company will benefit from favourable export market conditions in the second half as well as the synergies from De Costi. The broker calculates an average retail price per kilo of around $13.44, down from $13.77 in the prior corresponding half. The average wholesale price is calculated at around $11.85/kg, down from $13.29/kg.
Although Tassal does not itself export, when export prices increase the companies major competitor often exports larger volumes, freeing up supply in the domestic wholesale market. Export prices have risen 25% in Australian dollars per kilo since the end of June 2015. Despite this, Tassal expects wholesale prices to remain stable.
Ord Minnett is puzzled by this, having expected a stronger outlook. The broker suspects a mismatch in export and wholesale pricing because of an oversupply in the domestic salmon market, despite some volume being exported. In the first half an extra 3,500-4,000 tonnes was released into the wholesale market by a competitor. Od Minnett suspects the market could remain slightly oversupplied for the next few years.
Credit Suisse expects FY16 earnings will be flat, with retail pricing weaker and fish meal prices rising. Still, the broker retains an Outperform rating and believes the stock is reasonably priced, given its track record and improved domestic conditions.
The broker does not agree with the decision to reduce disclosure on salmon farming metrics. While this could be viewed as raising a warning flag, Credit Suisse does not believe it offsets other positive investment attributes. Considering the recovery in wholesale prices and a lower import threat, Credit Suisse believes conditions are better than they were 6-12 months ago.
FNArena's database shows two Buy ratings and one Hold (Morgans). The consensus target is $4.40, suggesting 9.2% upside to the last share price. The dividend yield on FY16 and FY17 forecasts is 4.0% and 4.5% respectively.
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