Outlook Should Improve For Inghams

This story features INGHAMS GROUP LIMITED. For more info SHARE ANALYSIS: ING

The next six months are likely to be tough for poultry producer Inghams but earnings should then improve as the impact of the pandemic wanes.

-Earnings should improve substantially in FY22
-Significant volatility in demand across the industry
-Disruptions likely to remain a feature of first half of FY21
 

By Eva Brocklehurst

Poultry producer Inghams Group ((ING)) is navigating a difficult chicken supply chain amid heightened volatility from the impact of lockdowns and increased costs allied with the food service channel.

The next six months could be tough, Citi asserts, as concerns about the effect on Victorian demand from lockdowns remain uppermost for investors. Earnings should then improve substantially as reduced coronavirus impacts and lower feed costs contribute to forecast growth of 24.5% in FY22.

Lockdowns in Victoria could cut earnings by -$1m for each week of restrictions, the broker calculates, forecasting first half group operating earnings (EBITDA) of $83m, down -9%.

Lockdowns have hurt sales significantly and Citi estimates a -$10m drag in the first half across the nine weeks of lockdowns. Still, as production aligns to demand the effect should reduce. The company will also benefit from an unwinding of over-runs on manufacturing costs.

Morgan Stanley highlights the significant volatility in demand that has characterised both Inghams and the broader industry. Australian poultry volumes went from up 6.5% in the third quarter of FY20 to up 1.2% in the fourth quarter. This created excess supply that induced increased promotional and clearance activity.

In comparison, New Zealand poultry volumes increased by 3.8% in the third quarter before dropping -13% in the fourth quarter and the uncertainty is likely to continue, the broker suspects.

Costs

Costs, heightened because of the weakness in the Australian dollar, should now be mitigated by more favourable cropping conditions going forward. Feed is acquired 3-9 months forward so the benefits associated with the breaking of the drought are only likely to be evident from FY22, Morgan Stanley points out.

Credit Suisse, while acknowledging the pandemic had a greater impact on operations than previously expected, considers the FY20 result revealed resilience in overall poultry demand. The broker also singles out better feed costs in FY22 as rain and crop indicators support lower wheat prices.

Bell Potter highlights material compression in grain prices, as spot port prices are down -17% in the year to date. Importantly, a large portion of the correction has been driven by a rapid compression in the premium Australian wheat trades on relative to US wheat.

The broker finds no clearly defined linear relationship between feed and operating earnings but there is an observable expansion in operating earnings margins per kilo in a weaker grain price environment. Bell Potter, not one of the seven stockbrokers monitored daily on the FNArena database, retains a Buy rating and $4.10 target because of leverage available as disruptions from the pandemic ease.

On the other hand, Goldman Sachs, also not one of the seven, believes the disruptions will remain a feature of the business for the first half of FY21. This is because channel disruption, particularly in food service is heightened along with the complexity of dealing with oversupply.

There is also added costs in food service which may have a more lasting impact. This would stem from social distancing and PPE measures across the whole supply chain. Moreover, further disruption to production cannot be ruled out.

Nevertheless, Goldman Sachs likes the stock as it provides an attractive exposure to a stable product, generating reliable cash flow and a steady dividend pay-out ratio. The broker believes valuation is undemanding retains a Buy rating and $3.80 target.

Goldman agrees FY22 will be more reflective of normalised earnings and is careful to not over-capitalise pandemic-related estimates into the valuation.

Lease Liabilities

Ingham's balance sheet should improve as most concerns centre on issues relating to lease liabilities. Citi explains that within the lease liability of $1.4bn is $600m in grower contracts relating to the sheds for poultry production, included on a technicality.

Grower contracts are tied to bird volume and not fixed cost. The liability will also disappear as contracts are restructured over time. Importantly, debt covenants do not take into account leases.

Citi considers recent weakness in the stock an opportunity and reiterates a Buy rating. More clarity on the timeframe of the lockdown in Victoria should be positive for the share price as well. FNArena's database has two Buy and four Hold ratings. The consensus target is $3.57, suggesting 16.3% upside to the last share price. The dividend yield on FY21 and FY22 forecasts is 4.9% and 5.9%, respectively.

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