I. Sector Landscape
Australia didn't face food security issues during the height of the pandemic despite temporary shortages in some of the food items in supermarkets. The Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES), December 2021 quarter, estimates a history-making agricultural gross production value to clock at $78 billion, a $5.4 billion upward revision from the previous estimate. Higher export volumes and higher prices are estimated for almost every considerable export commodity, with a total export value of agricultural products being revised upwards by $6.5 billion to $61 billion, an all-time high.
Quick Snapshot of Australian Agricultural Industry
Growing Agricultural Production: In the last 20 years, the gross value of agricultural, fisheries and forestry production has expanded by 7% in real terms, from approximately $62 billion in FY01 to $67 billion in FY20.
Almost 70% of Agricultural Exports: Exports to Asia, one of the eight most important export markets, edged up by 62% and clocked $33 billion over the last 20 years to FY20. China remains Australia’s largest export market for agricultural, fisheries, and forestry products, exporting $16 billion export value in FY20.
Pursuit of FTAs with New Partners: Negotiations with potential trading partners, particularly with the European Union (EU), United Kingdom (UK), and India, to establish new Free Trade Agreements (FTAs) are underway. This would equip Australian agricultural markets with reduced tariffs and competitive products.
Figure 1: Agricultural Production Following an Upward Trend
Source: Based on Department of Agriculture, Water and the Environment Data, Analysis by Kalkine Group
Key Updates on Weather and Water Condition
Favourable Water Supply Conditions: For FY22, water allocations are estimated to remain higher than historical averages in an average scenario. On an aggregate level, 2,587 Gallon of water was carried over from FY21 (supporting volumes in FY22), which is the highest recorded since FY18.
Recent Changes in Climate Conditions: Australia’s climatic condition has warmed on average by 1.4°C since 1910. The ABARES estimates that subsequent changes in weather conditions over the 2001 to 2020 period have reduced the annual average farm profits by almost 23%, or $29,200 per farm.
Index Performance
The ASX 200 Consumer Staple (GIC) Index posted 5-year returns of +62.23% relative to +32.80% returns generated by the ASX 200 Index. Improving crop realization, resilient exports, favourable government support, and changing consumer preferences are the cornerstones for growth.
Figure 2: The ASX 200 Consumer Staple (GIC) outperformed the ASX 200 Index in the past five years by a whopping ~29.43%.
Source: REFINITIV as of 09 December 2021
Key Risks and Challenges
As the International freight supply chain adapts to changing trade dynamics in the wake of COVID-19, shipping containers and bulk freight vessels have become scarer on many routes. Bulk grain freight costs for Australia surged in October 2021 by 124% relative to January 2021. Higher costs of fertiliser, farm chemicals, fuel, and equipment may curtail farm profitability. The cost of fertilisers soared due to export restrictions and high energy prices imposed by the Russian Federation and China. ABARES estimates warmed climatic conditions, which has reduced annual average farm profitability by approximately 23%. The limited availability of labour will continue to challenge the Australian agriculture industry. Demand for skilled labour has elevated, adding additional pressure on Agribusinesses. Australia's agricultural sector exhibits an undiversified portfolio of trade partners while being highly dependent on the Chinese market.
Figure 3: Key Risks and Challenges
Source: Analysis by Kalkine Group
Outlook
Figure 4: Key Drivers
Source: Analysis by Kalkine Group
The rise in Agricultural Production: The gross value of agricultural production is estimated to clock a record of $78 billion in FY22. This represents a 5.4% uptick from the previous estimate due to improved domestic growing conditions, downgrades for key international competitors driving prices higher, improved logistics, and increased fertiliser costs worldwide.
Favourable Winter Crop Forecast: Australia is expected to harvest its most valuable winter crop and may clock an estimated $22.3 billion, primarily driven by a 35% increase in prices. At the same time, production stands slightly over the previous record of FY17.
Expanding Export Value: Agricultural export values are estimated to surge by 27% and clock $61 billion in FY22. Higher export prices and volumes for almost every considerable export commodity stands to be the key primarily driver.
Favourable Water Supply Conditions: Water allocation in FY22 is forecasted to stand higher than the historical averages. In total, 2,587 Gallon of water was carried over from FY21, supporting the volume of water available in FY22, the highest volumes realized since FY18.
Strength in Livestock Production Forecast: The value of cattle slaughtered is estimated to surge by 16% to almost $15 billion due to increased global meat prices, resilient domestic demand, and a modest increase in production.
II. Investment theme and stocks under discussion (ING, NZK, UMG, PTL)
After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on the ‘EV/Sales’ multiple methods.
1. ASX: ING (Inghams Group Limited)
(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$1.27 billion)
ING is producing and selling chicken and turkey products across its vertically integrated production system.
Valuation
Our illustrative valuation model suggests that the stock has a potential upside of 17.19% on 09 December 2021. Moreover, the stock might trade at a slight premium compared to its peers’ average EV/Sales (NTM trading multiple), given lower net debt levels and favourable cash flow from operations. For valuation, peers such as Elders Ltd (ASX: Elders Ltd), Ridley Corporation Ltd (ASX: RIC), Bubs Australia Ltd (ASX: BUB), and others are considered. Favourable financial performance, increased poultry volumes, production-specific initiatives, and upside indicated by valuation, we give a "Buy" recommendation on the stock at the closing market price of $3.400, down by ~0.585% on 09 December 2021. In addition, the stock has delivered an annualised dividend yield of 5.26%.
2. ASX: NZK (New Zealand King Salmon Investments Limited)
(Recommendation: Speculative Buy, Potential Upside: Low Double-Digit, Mcap: A$182.76 million)
NZK is involved in the aquaculture production of the premium king salmon species.
Valuation
Our illustrative valuation model suggests that the stock has a potential upside of 17.81% on 09 December 2021. However, given the surging threat from global supply chain disruptions and high susceptibility to FX movements, the stock might trade at some discount compared to its peers’ average EV/Sales (NTM trading multiple). For valuation, peers such as Bega Cheese Ltd (ASX: BGA), Inghams Group Ltd (ASX: ING), Costa Group Holdings Ltd (ASX: CGC), and others are considered. Considering the resurgence in the supply chain, move into the open ocean, and valuation, we give a “Speculative Buy” recommendation on the stock at the closing market price of $1.300, down by ~1.141% on 09 December 2021. In addition, the stock has delivered an annualised dividend yield of 2.92%.
3. ASX: United Malt Group (United Malt Group Limited)
(Recommendation: Hold, Potential Upside: Mid-Single-Digit, Mcap: A$1.25 billion)
UMG operates in the distillery business and is involved in malt production, distribution, and warehousing.
Valuation
Our illustrative valuation model suggests that the stock has a potential upside of 5.82% on 09 December 2021. Moreover, the stock might trade at a slight premium compared to its peers’ average EV/Sales (NTM trading multiple) given high operating cash flows despite market turmoil and expansion strategies. For valuation, peers such as Ridley Corporation Ltd (ASX: RIC), Elders Ltd (ASX: ELD), Bubs Australia Ltd (ASX: BUB), and others are considered. Considering the positive long-term prospects, expansion strategies in Victoria, penetration into the Mexican market, and valuation, we give a “Hold” recommendation on the stock at the closing market price of $4.320, up by ~2.857% on 09 December 2021. In addition, the stock has delivered an annualised dividend yield of 1.31%.
4. ASX: PTL (Pental Limited)
(Recommendation: Hold, Potential Upside: High Single-Digit, Mcap: A$66.47 million)
PTL is engaged in the manufacturing and distributing of personal care and home products.
Valuation
Our illustrative valuation model suggests that the stock has a potential upside of 8.35% on 09 December 2021. However, the stock might trade at a slight discount compared to its peers’ average EV/Sales (NTM trading multiple) given high working capital requirements due to the constantly changing product mix. For valuation, peers such as McPherson's Ltd (ASX: MCP), Elixinol Wellness Ltd (ASX: EXL), Metcash Ltd. (ASX: MTS), and others are considered. Considering high sales expectations, Duracell distribution agreement, low debt levels, and valuation, we give a “Hold” recommendation on the stock at the closing market price of $0.395, up by ~1.282% on 09 December 2021. In addition, the stock has delivered an annualised dividend yield of 6.66%.
Note: All the recommendations and the calculations are based on the closing price of 09 December 2021. The financial information has been retrieved from the respective company’s website and REFINITIV.
Investment decisions should be made depending on the investors' appetite for upside potential, risks, holding duration, and previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the valuation has been achieved and is subject to the factors discussed above.
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