Event Core

MoU Established with DT Global: On 6 October 2021, the Department of Agriculture, Water and the Environment entered into a Memorandum of Understanding (MoU) with DT Global to advance agricultural trade between Australia and Pacific Island countries via better market access, improved food security, and biosecurity outcomes.

Figure 1: Key Considerations of the MoU

Source: Based on Department of Agriculture, Water and the Environment data, Analysis by Kalkine Group

Quick Snapshot of Australian Agriculture Industry

Growing Agricultural Production: In the past 20 years, the gross value of agricultural, fisheries and forestry production has edged up by 7% in real terms, from circa $62 billion in FY01 to $67 billion in FY20.

Almost 70% of Agricultural Exports: Exports to Australia’s eight most important export markets in Asia increased by 62% and accounted for $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, United Kingdom, and India, to establish new Free Trade Agreements (FTAs) are underway. This would equip Australian markets with reduced tariffs and competitive products.

Figure 2: Agricultural Production Following an Upward Trend

Source: Based on Department of Agriculture, Water and the Environment data, Analysis by Kalkine Group

Potential in Commodities Across Australia

Figure 3: Estimates for Key Commodities

Source: Based on Australian Bureau of Agricultural and Resource Economics and Sciences data, Analysis by Kalkine Group

Key Updates on Weather and Water Condition

Favourable Water Supply Conditions: FY22 water allocations are forecasted to remain higher than historical averages in an average scenario. On aggregate, 2,587 gallon of water was carried over from FY21, supporting volumes in FY22, the highest recorded since FY18.

Recent Changes in Climate Conditions: Australia’s climate has warmed by 1.4°C since 1910. The Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) estimates that changes in weather conditions over the 2001 to 2020 period have curtailed annual average farm profits by 23%, or $29,200 per farm. Due to robust global demand, the Australian average farmgate milk price is forecasted to incline by 7% to 53 cents/litre in FY22. Australian dairy processors secured export contracts at relatively high prices by the end of FY21.

Key Risks and Challenges

Figure 4: Key Driving and Restraining Factors

Source: Analysis by Kalkine Group

Delayed COVID-19 Vaccination Program: Downside risk for the economy stems from the potentially slow pace of vaccine rollouts. Delayed vaccine delivery would impede reopening.

Increased Cost of Supply Chain: The pandemic-related turmoil has considerably increased the shipping industry’s transmit times and freight costs. On average, the global shipping prices for containers almost doubled between May 2020 and June 2021.

Continued outbreaks of viruses: The recent outbreak of COVID-19 increases the risk of more resilient virus variants. This could slow the recovery in discretionary spending and travel.

Seasonal Labour Pressure: The limited availability of labour will continue to challenge the Australian agriculture industry. Demand for skilled labour has elevated, adding additional pressure on Agribusinesses.

Mice Present Management Challenge: Mice can have a devastating impact on production at a regional level or individual property. However, their effect on national production is unlikely to be significant.

Outlook

Global Economic Recovery Remains on Track: According to the International Monetary Fund (IMF), global economic growth is estimated to be 6% in 2021 and 4.9% in 2022. Progressive vaccination rates and high levels of monetary and fiscal support warrant an expansionary phase.

Record Gross Value of Production: Australia’s gross value of agriculture production is estimated to clock $73.0 billion in FY22. Production value is forecasted to incline by 7% and register $39.5 billion amidst solid price support for cotton, grains, and sugar.

Improved Livestock Production: For FY22, the value of livestock production is estimated to surge by 8% and register $33.5 billion, primarily driven by high volumes. This represents an $8.0 billion upward revision from the June 2021 estimate.

Improvements in Agricultural Exports: The value of agricultural exports is estimated to hit a record of $54.7 billion in FY22, up by 12%. Crop exports are estimated to make the most significant contribution to Agri growth due to improved forecasted processes and volumes.

Competitive Edge over Seasonal Conditions: Lack of rainfall and excessive heat have significantly affected the production potential of corn and wheat for some key grain producers – The US, Russian Federation and, Canada. This impact is expected to be offset by Australia, the EU, and Ukraine.

Considering the developments in Agriculture sector, we have figured out four stocks on ASX that are set to see the momentum.

(1) ­­­United Malt Group Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 1.24 billion, Annual Dividend Yield: 0.00%)

Approaching Pre-COVID Levels: United Malt Group Limited (ASX: UMG) operates in the distillery business and is involved in malt production, distribution, and warehousing. During FY20, revenue declined by a modest 2.1% and stood at ~$1.3 billion, and underlying EBITDA declined by 11.1% and stood at $156.1 million. The significant operational downgrade was warranted by changing the product mix to low margin products and lower sales volumes. Despite EBITDA shortfalls, operating cash flows improved to $101.7 million from $93.0 million in FY19.

In H1FY21, revenue declined by 11% and stood at $590 million, and EBITDA declined by 26.4% and stood at $52.7 million. Unfavourable currency fluctuations and COVID-19 impact were the major deterioration factors. In addition, COVID-19 related costs, processing costs and container disruptions contributed $1.8 million, $6.9 million, and a $2.2 million increase in operating expenses. In contrast, operating cash flows improved significantly to $22.8 million with a cash conversion of 43% because of favourable interest expenses and better working capital management.

Outlook: UMG witnessed an improving performance in the UK and North America and encouraged continuous counteractive COVID-19 disruptions affecting malt volumes in Australia/Asia. FY21 underlying EBITDA is forecasted to strike at ~$129-134 million. Significant items are expected to wander between $20 million and $22 million concerning grain storage inventory.

Valuation Methodology: EV/Sales Value Multiple Based Relative Valuation (Illustrative)

A-VIX vs UMG (Source: REFINITIV)

Stock Recommendation: Over the last three months, the stock of UMG went down by ~6.531%. The stock made a 52-weeks' low and high of $3.530 and $4.970, respectively. The stock underperformed the market volatility index. The stock has been valued using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit (in percentage terms). The company can trade at a slight premium compared to its peers, considering steady recovery to reach pre-COVID levels, high operating cash flows despite market turmoil and expansion strategies. For valuation purposes, peers like Elders Ltd (ASX: ELD), Huon Aquaculture Group Ltd (ASX: HUO), Costa Group Holdings Ltd (ASX: CGC) have been considered. Considering the positive long-term prospects, expansion strategies in Victoria, penetration into the Mexican market, and valuation, we give a 'Buy' rating on the stock at the current market price of $4.135, as of 11 October 2021, at 12:17 PM (GMT+10), Sydney, Eastern Australia. 

(2) Ridley Corporation Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 428.12 million, Annual Dividend Yield: 1.49%)

Favourable Outlook and Improving Cash Performance Driving Growth: Ridley Corporation Limited (ASX: RIC) is engaged in producing quality, high-performance animal nutrition solutions. During FY21, EBITDA before significant items for bulk stockfeed declined by 5% and stood at $32.48 million. Beef and sheep sales stood below the “draught feeding” record levels of FY20. However, EBITDA from packaged feeds & ingredients rose by 32% and stood at $46.51 million. Consolidated EBIT inclined to $39.5 million relative to a loss of $11.0 million committed in FY20, primarily driven by absence of significant items in the previous fiscal.

During FY21, the operating cash flows inclined to $82.4 million relative to $39.8 million, with a cash conversion of 119%, primarily attributed to the improved earnings, reduced inventory, and disciplined maintenance capex. Improved cash performance resulted in a $64 million decline in net debt, with the leverage ratio clocking 1.2x. Net debt will further be reduced by almost $55 million from the sale proceeds of the Westbury facility on 2 August 2021.

Outlook: RIC registered improved market share with pig and poultry customers and improved asset utilisation amidst marginal costing benefit. Narangba facility expansion, up by 20%, was completed on 19 July 2021. The Aquafeed Reset program is forecasted to deliver $2million in EBITDA. RIC aims to develop a resilient supply chain and reduce current $44 million freight/storage costs.

Valuation Methodology: EV/Sales Value Multiple Based Relative Valuation (Illustrative)

A-VIX vs RIC (Source: REFINITIV)

Stock Recommendation: Over the last month, the stock of RIC went down by ~4.029%. The stock made a 52-weeks' low and high of $0.785 and $1.430, respectively. The stock underperformed the market volatility index. The stock has been valued using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit (in percentage terms). The company can trade at a slight premium compared to its peers, considering improved cash performance and prudent debt levels. For valuation purposes, peers like Australian Primary Hemp Ltd (ASX: APH), Bega Cheese Ltd (ASX: BGA), Beston Global Food Company Ltd (ASX: BFC) have been considered. Considering the improved earnings, gain in market share, capacity expansion programs, the focus of resilient supply chain, and valuation, we give a 'Buy' rating on the stock at the current market price of $1.310, down by ~2.239% as of 11 October 2021. 

(3) Tassal Group Limited (Recommendation: Hold, Potential Upside: Low Double-Digit)

(M-cap: A$ 760.44 million, Annual Dividend Yield: 3.93%)

Financial Results: Tassal Group Limited (ASX: TGR) is engaged in farming Atlantic salmon and tiger prawns and processing and marketing salmon, prawns, and other seafood. During FY21, revenue touched $594 million, up by 5.6% because of a 16.3% surge in the salmon harvest, which handled 40,000 tonnes. Retail volume growth for MAP and smoked salmon stood at 27.7% and 19.5%, respectively. As a result of infrastructure upgrades and operation optimisation strategies cost of production stood at $0.33/kg, and production savings clocked $1.45/kg across both prawns and salmon.

Operating EBITDA was marginally up by 0.6% and stood at $139.4 million. The uptick was primarily driven by an increase of $6.8 million in export salmon volume, $8.3 million in prawns’ volume and an astonishing $12.4 million in production cost efficiencies, offset by $21.4 million salmon price variance and $3.0 million in prawn price variance. Operating cash flows were up by 22.4%, recording $61.0 million due to biomass growth translating to a higher top-line. Inventory balance was greater on 30 June 2021 as a sustainable level of prawn inventory was built, and frozen hog in salmon was held. As a result, capex reduced to $105.9 million relative to $138.7 million in FY20.

Outlook: The company expects prawns’ production to remain on track for 5,000 tonnes in FY22 with a limited growth capex requirement. TGR expects to achieve ~40,000 hog tonnes of salmon production in FY22 and ~41,000 in FY23. TGR involved in salmon replacement and capex upgrade of ~$45-50 million/annum to house the expected production levels.

Valuation Methodology: EV/Sales Value Multiple Based Relative Valuation (Illustrative)

A-VIX vs TGR (Source: REFINITIV)

Stock Recommendation: Over the last month, the stock of TGR went down by ~3.090%. The stock made a 52-weeks' low and high of $3.160 and $3.970, respectively. The stock underperformed the market volatility index. The stock has been valued using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit (in percentage terms). The company can trade at a slight premium compared to its peers, considering improved production levels and sustainable inventory levels. For valuation purposes, peers like Elders Ltd (ASX: ELD), Bubs Australia Ltd (ASX: BUB), Australian Agricultural Company Ltd (ASX: AAC) have been considered. Considering the cost-efficient strategies, improved cash flow scenario, and valuation, we give a 'Hold' rating on the stock at the current market price of $3.450, down by 3.090% as of 11 October 2021. 

(4) ­­­Synlait Milk Limited (Recommendation: Hold, Potential Upside: Low Double-Digit)

(M-cap: A$ 758.47 million, Annual Dividend Yield: 0.00%)

Key focus on Top-line Improvements to Bring Operating Performance to Pre-COVID Levels: Synlait Milk Limited (ASX: SM1) is engaged in manufacturing, packaging, and commercialising dairy and nutritional products. In FY21, revenue inclined to NZ$1.4 billion, up by NZ$65 million PcP. EBITDA stood at NZ$37.3 million, considerably down by NZ$132 million PcP due to contraction in volume. NPAT for the period stood at a loss of NZ$28.5 million, considerably down from the profit of NZ$74.3 million committed in FY20. Primarily responsible factors for the drained bottom-line are a NZ$55.7 million decline in infant volumes, a NZ$33.3 million decline in stock balancing, and a NZ$20.5 million decline in ingredient performance.

The period's operating cash flows eroded to NZ$15.9 million, down by NZ$87.9 million, due to reduced volumes in consumer-packaged infant formula and inventories exceeding target levels by circa 13,000MT. Net debt decreased to NZ$479.4 million, primarily due to a NZ$196.1 million equity raise, partially offset by NZ$136.8 million net capex. Investment activities declined to NZ$86.4 million following the Dairyworks and Talbot Forest Cheese acquisitions in FY20.

Outlook: New total debt/EBITDA covenant limit stands at 4.5x for FY22, and SM1 estimates to remain below 4.0x. The working capital facility is expected to renew on 1 October 2022, and the revolving facility will be extended for two years. SM1 expects improved ingredients margin performance, inventory sell-down, increased Dairyworks contribution and benefits from sale and leaseback of Synlait Auckland.

Valuation Methodology: EV/Sales Value Multiple Based Relative Valuation (Illustrative)

A-VIX vs SM1 (Source: REFINITIV)

Stock Recommendation: Over the last month, the stock of SM1 went up by ~16.000%. The stock made a 52-weeks' low and high of $2.640 and $5.550, respectively. The stock underperformed the market volatility index. The stock has been valued using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit (in percentage terms). The company can trade at a slight premium compared to its peers, considering diversified operations in a niche market. For valuation purposes, peers like Ridley Corporation Ltd (ASX: RIC), Elders Ltd (ASX: ELD), Clean Seas Seafood Ltd (ASX: CSS) have been considered. Considering the high expectations from margin performance and Dairyworks’ contribution, decent debt levels, and valuation, we give a 'Hold' rating on the stock at the current market price of $3.480, up by ~0.288% as of 11 October 2021. 

Note 1: The reference data in this report has been partly sourced from REFINITIV.

Note 2: Investment decisions should be made depending on investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock of the Target Price mentioned as per the Valuation has been achieved and subject to factors discussed above.

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