Small Caps | Dec 06 2016
Leading Australian salmon producers, Tassal and Huon Aquaculture, are facing strong demand and rising prices for their fish in FY17.
-Global production of salmon constrained by sea lice, algal blooms and warm water
-Local demand rising amid strict import restrictions on fresh fish
-Significant margin expansion likely for both Tassal and Huon
By Eva Brocklehurst
Tassal Group ((TGR)) and Huon Aquaculture ((HUO)) are foremost in Australian farmed production of the increasingly desired pink-fleshed Atlantic Salmon. The Tasmanian based businesses – water temperatures in Australia restrict salmon farming to Tasmania – are benefiting from falling production in both Chile and Norway, which has driven international salmon price up 44% on average in 2016.
Sea lice, Norway's production headache, are likely to continue constraining global salmon production over the next 1-2 years, maybe longer. Algal blooms are the issue for Chile while domestic production is also constrained by warmer-than-expected water temperatures. Meanwhile, domestic salmon demand has doubled over the past decade and continues to grow as a result of the Asian influence on diets, the health benefits touted from eating oily fish and improving relative pricing.
Tassal is the larger producer and UBS initiates coverage with a Buy rating and $4.35 target. The company has invested heavily in order to double its productive capacity to over 30,000t per annum. UBS suspects the company will produce returns that will exceed pre-tax weighted average cost of capital from FY18 onwards and expects domestic salmon prices to increase further over the next 12 months.
The broker does envisage seafood will end up delivering less than 10% of the company's EBITDA (earnings before interest, tax, depreciation and amortisation) by FY19 without Tassel entering primary production of a white fish, which is considered unlikely. In Australia's top 10 seafood categories, barramundi is the only farmed fish other than salmon. The company's De Costi operations may increase processing capacity but this is also expected to add no more 1-2% to group EBITDA.
UBS would prefer incremental growth capital be used to expand production capacity where possible. De Costi was acquired in 2015 and operates two adjacent processing facilities, supplying seafood to food service, wholesale and supermarket customers.
Australia's Department of Agriculture has strict rules regarding imported fish, hence the vast majority of imported salmon arrives as portions and smoked product. Tasmania's marine leases are also strictly regulated and hard to establish. New Zealand can export fresh salmon to Australia but volumes are small and the particular breed is Pacific Salmon which is not considered a perfect substitute for Atlantic Salmon.
UBS believes the industry is set for low growth over the next four years. Over FY10-16 Huon Aquaculture increased its production by 89% while Tassal expanded by 40%. Based on marine lease opportunities and the lagged impact of a hot summer the broker forecasts industry output to fall around 4% in FY17 and growth at a compound rate of around 5% over FY16-20.
Ord Minnett believes the Tasmanian salmon industry offers attractive growth prospects from rising local consumption and the high barriers to entry. The broker suspects, if prices remain high, a normalisation of costs per kg could lead to significant margin expansion in FY18 and FY19. The broker's base case valuations for the two players suggest 20% upside for Tassal and 4% upside for Huon Aquaculture.
Ord Minnett forecasts Huon to grow its profit faster from a lower base but prefers Tassal, given its market position and stable returns. The broker initiates coverage on Huon with a Hold rating and $3.81 target and reiterates a Buy rating and target of $4.62 for Tassal. This broker also believes there is potential for significant industry margin upside in FY18 and FY19.
Average production costs are expected to rise in FY17, given the lag from poor growing conditions in FY16 attributed to warmer waters. Margin expansion in FY17 is likely to come from prices, which have caught up with conditions.
Credit Suisse, which also covers Huon, noted recently that the stock is leveraged to the domestic wholesaler channel where pricing is strong and the company had the advantage of re-directing 30% of FY16 volumes that were headed for export into domestic channels. Earnings per share growth is expected to be very strong the next three years. The broker has a Outperform rating and $3.75 target. Credit Suisse attributes a Neutral rating and $4.50 target to Tassal.
Tassal has two Buy rating and two Hold on FNArena's database. The consensus target is $4.41, signalling 11% upside to the last share price.
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