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Brokers Tip Better Brew for United Malt in FY23

Australia | May 18 2022

This story features UNITED MALT GROUP LIMITED. For more info SHARE ANALYSIS: UMG

A one-off tax loss and elevated gearing proved the standouts in a difficult FY22 first-half for United Malt, but analysts expect conditions and metrics will normalise in FY23 and the stock is shaping up as an attractive target.

-Tax Impost Drives FY22 Downgrades for United Malt
-Canadian drought and supply chain challenges hit costs
-Gearing jumps sharply
-Good times to come, say analysts

By Sarah Mills

United Malt’s ((UMG)) FY22 first-half result broadly met consensus forecasts, given disappointing pre-released March-quarter guidance had already been factored in.

But management and analysts are pegging a recovery, expecting volumes will outpace pre-covid levels by the end of FY22, and that the transformation program and strategic innovations should yield further benefits.

Management has retained earnings (EBITDA) guidance but the range is wide enough to drive a truck through ($103 to $128m) given variables such as freight, energy inputs, labour and malt prices are hard to nail down and some speculating that the pace of transformation could surprise.

United Malt is the fourth largest commercial malter in the world and operates plants across Canada, the USA, the UK and Australia, as well as a distribution business servicing craft brewers and distillers. The company is also establishing a presence in Europe and the Middle East.

One-off Tax Impost Drives FY22 Downgrades

UBS notes lower depreciation and amortisation in the March quarter was offset by a higher tax rate, due to a one-off Australian tax loss that could not be capitalised, but expects the tax situation will normalise in FY23.

Bell Potter downgrades net-profit-after-tax results to account for the above.

Macquarie observes the tax loss also incorporated a higher UK tax rate and downgrades FY22 EPS forecasts -6% to -8%. It too expects conditions will normalise and raises FY23 and FY24 EPS forecasts 1.1% and 0.8%.

Wilsons lowers EPS forecasts -3% to -12% across FY22 to FY24. Morgans joins the fray and downgrades FY22 forecasts accordingly.

Tax guidance was elevated, reflecting the higher UK tax rate.

Canadian Drought Hits Input Prices

At an operational level, rising input costs, particularly barley and freight costs, eroded margins.

Barley prices rose sharply over the period due to the Canadian drought, which cost up to -$25m not to mention the knock on effects on the supply chain of -$8m.

Macquarie and Bell Potter believe this too shall pass and expect malt-barley spreads to stabilise.

The analysts note pressure on processing margins, due in part from currency movements, the balance relating to mix and volume, believing these headwinds are cycling and will be resolved as malt-barley spreads normalise.

Management at the firm expects higher freight and barley costs will largely be passed on to the consumer over the next nine months.

All up, Credit Suisse perceives the situation to be a plus for United Malt, observing that tight malt supply will allow the company to pass through costs and expand margins in FY23 when supply conditions normalise.

The analyst says the drought creates a strong position for contract renewal heading into FY23 and believes this will more than outpace higher processing and freight costs – a plus for margins.

Wilsons assumes a full recovery.

Gearing Jumps Sharply 

The other sore point for analysts concerns the balance sheet.

First half gearing was toppy and sharply outpaced guidance, as inventory finance jumped due to higher barley and malt inventory prices.  

The leverage ratio is ranging near 3x, well above target.

Macquarie notes gearing remains within banking covenants and should return to the company’s target range in FY23.

The dividend also fell short of the company’s target payout ratio of 60%, management announcing a 1.5c dividend, down from 2c in the previous March half – a payout ratio of 44%.

Macquarie notes that management remains committed to a 60% payout ratio in the medium term with normalisation expected in FY23.

The analyst forecasts an earnings recovery and lower capital expenditure should drag down the leverage ratio to 1.9x by the end of FY23.

Morgans and UBS were particularly disappointed with the weak operating cash flow after the company reported an outflow of -$64.9m compared with an inflow of 22.8m in the previous March half.

Cash flow conversion slumped to -105%, compared with 43% previously.

Credit Suisse says the market wants to see sharply stronger cash generation and moderating capital expenditure ahead of normalisation and notes management has guided to peak capex in FY22. 

Wilsons believes this is likely, observing that the recovery combined with the transformation benefit suggest the quantum of impending revenue improvements will be substantial, resulting in a sharp jump in free cash flow.

A Revival In Consumption Post Covid

The company is also a small covid recovery play (given demand has generally held up well in the first half) and analysts generally concur that on-premise consumption in major western markets will continue to increase.

Management expects volumes will exceed pre-covid levels by June.

Macquarie notes the company witnessed no demand destruction despite the fact that malt comprises 5% to 7% of the value of a can of beer.

Credit Suisse believes inflation could prove a hurdle for on-premise recovery, although not large enough to alter the broader recovery prospect. 

Credit Suisse surmises that the lack of management commentary on volumes suggests second-half weakness. Bell Potter and Morgans are positive on volumes going forward, citing post-transformation benefits and capacity additions.

UBS reports strong global volumes in the first half, excluding EMEA, and expects the company will continue to struggle in that region given the Ukraine conflict but otherwise believes Europe remains a good prospect.

Strategic Plan On Track

Analysts are also placing their faith in the company’s strategic plan. The company’s expansion of its Scottish malt business is running to schedule and management expects it will be producing quality malt by June.

Macquarie expects this will generate $18m of earnings on a full-year run-rate basis.

Canadian canola crop planting has started, and management forecasts a 52% increase in the harvest (as the drought ends).

Meanwhile, the company plans to have completed its IT consolidation of five systems into a single enterprise platform by mid 2023 at a cost of -$24m over three years.

Credit Suisse expects transformation benefits will accelerate in FY23 to yield a sharp rise in earning in FY23 and FY24.

For now, the company is logging non-recurring FY22 estimated costs of $40m but the broker estimates these will disappear in FY23.

Meanwhile, UBS expects the post-transformation recovery to be achievable once conditions improve and funds start flowing from the Scottish expansion.

Corporate And Private Equity Eyeing the Group

Most brokers agree that the valuation of United Malt is sharply higher than the share price.

Macquarie casts an inquiring eye to the M&A front, suspecting that if all else fails, corporate interest is likely to support an ailing share price.

Analysts Plump To The Upside

Five of the seven brokers to report on United Malt in the FNArena database retain a Buy or Outperform rating, expecting a sharp improvement in FY23.

Bell Potter upgrades to Buy from Hold.

Morgans, the least optimistic, maintains a Hold recommendation.

While acknowledging the company is worth substantially more than the share price, Morgans spies few major catalysts on the horizon and finds the combo of above-target gearing and near-term earnings risk unattractive.

Combined, the average target price is $4.61.

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