Nufarm Back In Clover But Europe Still Fragile

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Before the discount that Nufarm trades at relative to global peers is removed, brokers want greater proof that signs of a European recovery aren’t short-lived

-Nufarm's second half guidance could be too conservative
-Profit in second half to be materially lower than the first half
-Brokers say further evidence needed on sustained changes in product mix/cost reductions
-Greater earnings visibility would be a big plus

By Mark Story

Nufarm ((NUF)) is currently emerging from a tough set of agricultural and industry-related headwinds that have buffeted the company over the past three years. But with the cyclical factors undoubtedly more favourable now, the crop protection and seed technologies company appears to be considerably better positioned for future growth.

Given the magnitude of the very strong first half FY21 result which saw earnings jump 118% on the previous period, there’s mounting evidence to suggest the hefty discount Nufarm trades at relative to global crop protection peers is largely unwarranted.

Earnings growth was driven across all segments. Nufarm won market share across several of its key markets in the period, and also benefited from selling more higher-margin products. Nufarm also benefited from its Performance Improvement Program (PIP), which is lowering its cost base, plus an improvement in group margins.

Wilsons is encouraged by the margin improvement which benefited from improved product mix, plus lower raw material costs in Europe, and has upgraded earnings by double-digits.

Most pleasing to the market was a particularly strong result from Europe, especially given the recent underperformance from this division. Earnings growth in Europe was driven by double-digit volume growth as agriculture conditions improved, cost-outs and the significant reduction in raw material input costs.

Brokers expect the company to deliver a solid earnings recovery over the next couple of years, courtesy of improved seasonal conditions and high soft commodity prices. Underscoring renewed broker sentiment is the outlook for weather conditions which in Nufarm's key regions remains broadly favourable.

The emergence of upside risk in Europe could in hindsight make some forecasts looks decidedly undercooked.

Earnings skew

While acknowledging pull forward demand and a higher tax rate at full year – due to the earnings skew in 1H21 – Macquarie senses an element of understandable conservatism embedded in company management's guidance. Given Nufarm’s chequered history of earnings delivery, the broker suspects the company is looking to under-promise and over-deliver.

While Nufarm did not provide explicit guidance, the company expects earnings to be significantly weighted towards the first half due to early demand and channel restocking in Europe, APAC and Seeds. Driven by higher canola sales and royalties in Australia, seeds earnings increased 114% on the previous period.

Profit in 2H21 is expected to be materially lower than the first half with brokers expecting to see a loss. As a result, full year net profit is expected to end up being lower than first half net profit.

Morgan Stanley now forecasts 1H/2H earnings split of 60%/40%, and expects the primary driver of lower 2H21 earnings to be higher than expected costs in North America, and a more significant 1H21 weight in Seeds.

Despite much improved earnings, the broker believes the multiple remains elevated at 32x FY22 earnings. Based on a view that key factors like tax and Omega delays are limiting the leverage, the broker has downgraded Nufarm to Equalweight from Overweight, with the target price decreasing to $5.30.

Outlook could be understated

Management also reiterates an ongoing focus on products and markets where it can generate stronger cash returns. The management team is also progressing towards its PIP target of $35-40m by FY22.

While Credit Suisse equally suspects Nufarm’s full year outlook could be deliberately undercooked, the broker is mindful of the need to see the extent to which changes in product mix and cost reductions are sustained in the second half.

The main change to the broker's FY22 and FY23 forecasts relates to Nufarm not undertaking a commercial planting of Omega-3 canola in 2021.

Nufarm is expected to pause commercial plantings until customer demand improves along with an expected recovery in the Chilean salmon market in 2022-2023. As a result, Credit Suisse has deferred previously assumed profits from Omega-3, effectively pushing back the broker’s profit projection by two years.

JP Morgan (Ord Minnett white-labels JP Morgan research) is factoring in a recovery in earnings in the years ahead. The broker sees earning per share benefitting to a greater extent as the group tax rate normalises from the current elevated level.

However, on lack of earnings visibility, and with valuation metrics that appear fair on the broker’s estimates, JP Morgan retains a Neutral recommendation.

European recovery

UBS thinks the half-year result, which saw European earnings jump 127% on the prior period, further validates the broker’s thesis that Europe is at an earnings trough. This is driven by the reversal of cyclical factors and a re-basing of the European cost base driving the substantial earnings recovery.

However, Credit Suisse describes the European result as puzzling, suggesting a significant one off cost benefit in the period. Assuming standard product margins, non-repeat of the prior year rebate adjustment and both temporary and permanent cost reductions, the broker believes there is around $20m of the earnings improvement in the 1H21 unexplained.

Risks

Morgans upgrades forecasts to reflect improved seasonal conditions in Australia and Europe, reduced supply constraints and cost pressures. Also factored in the broker’s upgrades are improved product mix benefits, PIP benefits, a contribution from Omega-3 canola oil, and carinata as they scale.

Due to positive industry fundamentals and self-help measures to deliver a solid earnings recovery over the next couple of years, the broker maintains an Add rating, and is confident Nufarm can deleverage the balance sheet.

But given cashflow has been poor in recent years, Morgan’s believes Nufarm needs to demonstrate that it can generate an acceptable cashflow conversion rate.

Morgans reminds investors that Nufarm also faces the usual acquisition-related risks including paying too much, failing to successfully integrate the business and revenue/synergy forecasts not materialising as expected.

Macquarie also notes adverse climatic conditions and other natural events may reduce the output of relevant agricultural products.

JP Morgan remains cautious on the regulatory overhang facing synthetic crop protection portfolios in Europe with the Commission aiming to reduce the overall use and risk of chemical pesticides by -50% by 2023.

Analysts at Citi have come to the conclusion that Nufarm's earnings trajectory looks positive through to FY23. This assessment is derived from the observation Nufarm offers leverage to strong agricultural fundamentals across key markets on top of continued execution on cost-out initiatives.

The one negative, short-term, is a higher tax rate outlook for the second half which sees Citi analysts lowering their FY21 profit forecast by -9%. Citi has retained its Buy rating in combination with a $6 price target, up from $5.40 prior.

The FNArena database consists of seven stockbrokers monitored daily. Ratings from these seven translate into four Buy (or equivalent) ratings and three Hold (or equivalent) ratings. The consensus price target derived from the average of seven price targets has now risen to $5.67, circa 17% above today's share price.

JP Morgan and Wilsons are not included in the group of seven stockbrokers.

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