Nufarm Emerging From The Trough

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Better weather should drive improved profitability for Nufarm in FY21 and the company is also emerging from some of the problems that beset its business in Europe.

-Cyclical factors reversing in Europe, costs re-based
-Improved demand and seasonal conditions in Australasia/North America
-Omega-3 still significant for the growth outlook

By Eva Brocklehurst

The extreme agricultural conditions confronting Nufarm ((NUF)) over the past couple of years have eased and better weather should be a driver of profitability in FY21. Moreover, the company appears to be getting on top of problems with its supply chain in Europe.

Nufarm expects FY20 operating earnings (EBITDA) of $290-300m, or $230-240m for continuing operations. The latter represents a decline of -27%. Most of the earnings decline has stemmed from the European portfolio, which has been affected by severe drought and higher input costs.

Elevated inventory and margin pressure on Nufarm-manufactured products have also put downward pressure on European prices. Both structural and cyclical factors have affected earnings but the company asserts Europe may be at a trough.

With cyclical factors reversing and a potential re-basing of costs, UBS believes the opportunity in Nufarm is to the upside and the stock is trading at a discount that is too large, despite the subdued sentiment around Europe.

Macquarie also notes some potential relief coming from lower raw material costs in the past quarter, as Chinese manufacturing gets back to normal. However this will not benefit the company until the second half of FY21 because of lags in inventory and the timing of the main European season. A $10m benefit is expected from the closure of the 2,4-D synthesis plant at Linz in Austria.

Nevertheless, Ord Minnett assesses there are still structural challenges. The regulatory environment in Europe may be a hindrance in the longer term, with preliminary papers circulated that set a target for a -50% reduction in the use of chemical pesticides by 2030.

The broker is "not comfortable" with this risk in isolation and the possibility other regions may follow. Secondly, innovators in crop protection have expanded into the generic segment and the result is compression of the value chain, which could limit profitability upside and returns for Nufarm.

The path forward in Europe remains the key issue for Goldman Sachs and the impairment is indicative of the challenges to the operating base. However, the broker believes Nufarm is on the right path although it remains incumbent on management to prove its strategy for right-sizing the business. Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database, reiterates a Buy rating with a target of $5.40.

Bell Potter, also not one of the seven, agrees the challenge centres on determining exactly what is the base level of earnings in Europe following two disrupted years. The broker has a Hold rating and $4.40 target.

Australasia/North America

Meanwhile, conditions are improving in Australia and North America. Earnings in Australia more than doubled in the second half, as the drought appears to be breaking on the east coast, and there is now a better outlook for the summer cropping season.

Improved demand and more favourable crop conditions in North America have also meant an increase in planting. In Asia a strong second half in crop protection was underpinned by better weather, product launches and lower costs.

Omega-3

Omega-3 is still the key to Morgan Stanley's Overweight rating. The broker values this business at $2.10 a share, with a 50% probability. US Food & Drug Administration approval should provide a positive catalyst in coming months, the broker asserts.

Macquarie upgrades to Neutral from Underperform, given the extent of the recent decline in the share price. The challenges in Europe now appear to be priced in and the broker expects improved confidence should be the focus when the company reports FY20 results on September 23.

At 23x FY21 price/earnings estimates, Nufarm is trading at a 73% premium to global peers and Macquarie notes global peers are, in general, patented agrichemical participants compared with Nufarm, which is a generic agrichemical business. This means Nufarm should trade at a discount, although the broker acknowledges size and relative earnings growth are also relevant along with the long-dated Omega-3 potential.

Citi, on the other hand, reiterates a Buy rating, believing the stock now represents good value, underpinned by a balance sheet that is more robust after the sale of the Latin American business. The broker agrees the commercialisation of the Omega-3 provides a strong growth option for the long-term.

The database has four Buy ratings, two Hold and one Sell (Morgans, yet to comment on the update). The consensus target is $4.76, signalling 18.4% upside to the last share price. Targets range from $4.00 (Ord Minnett) to $5.60 (Citi).

See also, Treasure Chest: Nufarm Beats Down Costs on July 28, 2020.

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