Ingham’s Perched To Ride Cost Headwinds

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This story features INGHAMS GROUP LIMITED, and other companies.
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Chicken producer Ingham's is facing higher feed and electricity costs but strong volume growth evident in FY17 is expected to help the well-placed business ride out the headwinds.

-Stock benefitting from a market leadership position, leverage to positive industry fundamentals and upside from efficiency improvements
-More normal volume growth should translate to profits as the supply chain adjusts
-Will retailers allow full passage of higher prices stemming from both electricity and feed costs?
 

By Eva Brocklehurst

Chicken producer Ingham's ((ING)) is facing higher feed and electricity costs but strong volume growth evident in FY17 is expected to help the business ride out the headwinds.

The impact of rising electricity prices has been factored into the company's Project Accelerate strategy, and improved energy efficiency is expected to offset approximately 50% of the increased cost. The remainder should be passed on to customers through higher prices.

The company's debt position is expected to be lower in FY18, supported by strong cash flow and further non-core asset sales. Morgans estimates additional asset sales of around $20m in FY18, which should help alleviate ongoing restructuring costs.

Goldman Sachs offers two possible reasons why, despite the company beating prospectus estimates, the stock fell. Around 47% of the shares on issue are held by the major shareholder and these have been released from escrow. Secondly, the market questioned the quality of the result, given the $6.9m profit on the sale of assets was booked above the line, offset by restructuring provisions.

If the profit on the sale is excluded, operating earnings (EBITDA) would have missed prospectus by -1%. Hence, the broker asserts, this is still a solid result. Goldman Sachs, not one of the eight stockbrokers monitored daily on the FNArena database, has a $3.70 target and Buy rating.

Ingham's has two thirds of its business contracted for three years on average. This results in a lower-risk business as it includes a recovery of movements in feed costs. The company has also extended its national supply contract with Woolworths ((WOW)), as the primary supplier until 2021.

Following significant capital investment in recent years, Ingham's is believed to have enough capacity across its network to cater for several years of solid growth. Credit Suisse suspects the higher growth in FY17 probably caused supply chain challenges, resulting in some volumes being unprofitable. Normal volume growth should mean profitability improves.

Project Accelerate

The company maintains a long-term target to increase Australian operating earnings margins to 10.0% from 7.9%, similar to New Zealand, and Project Accelerate is central to this target. Ingham's has confirmed its initiatives are being delivered, with benefits of improved processing yields and reduced costs. Labour productivity is also improving. No numerical guidance was provided.

Morgans expects continued strong demand for poultry and the benefits of Project Accelerate should drive margin expansion. The broker considers the stock attractively priced, given a market leadership position, leverage to positive industry fundamentals and the significant upside from efficiency improvements.

FY17 Australian poultry volume growth was 8.8% although management expects future growth to be closer to the historical average of 3-4%. The New Zealand division returned to growth at 2%, and second half margins were up 50 basis points. Second half volume growth of 4.2% compared with -0.8% in the first half. The NZ market appears more rational now, Citi observes, as both major players look to a stable market share in FY18.

Solid demand for a consumer staple that remains competitive against other proteins along with margin efficiency benefits should translate to profits as the supply chain adjusts, Credit Suisse suggests.

Chicken demand is sensitive to changes in pork, lamb and beef prices and volumes have benefited from this situation for more than 20 years. Yet, brokers point out, one of the risks inherent in the business is that a change in the productivity rates of the other proteins may lead to a narrowing of relative pricing and could result in a decline in demand.

Costs

Citi calculates the impact of higher feed costs will build in late FY18, while electricity costs could rise by $20m over two years. Nevertheless, both issues confront the whole industry and Ingham's is well-placed because it has cost savings to soften the impact and a longer hedge book than some of its competitors.

The company could fail to pass the increases on but Credit Suisse believes the industry supply dynamic mitigates this risk, as there are only two large national producers and no imports of fresh chicken.

On the other hand, in an increasingly soft consumer environment, Morgan Stanley questions whether retailers will allow the full passing through of higher prices resulting from higher costs of electricity, on top of the higher feed costs. The broker calculates electricity costs accounted for around $30m in FY17, and are expected to increase 60-70%.

FNArena's database shows five Buy ratings and one Hold (Morgan Stanley). The consensus target is $3.79, suggesting 11.5% upside to the last share price. The dividend yield on FY18 and FY19 forecasts is 5.9% and 6.3% respectively.
 

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