Stock of the Day – Nufarm (HOLD)
In congruence with our earlier report and forecast for Nufarm Limited (NUF), the world’s leading crop protection and specialist seeds company with manufacturing & marketing operations based in Australia, New Zealand, Asia, Europe and the Americas, the FY2014 result is not very encouraging in view of the unfavorable seasonal conditions in some of the NUF’s target markets. Primarily, the prevailing climatic conditions bring a jolt to the pre-plant applications, seed treatment demand and turf & specialty sales. Another area of concern is the waning soft commodity prices which could reduce crop protection and seeds demand.
With the FY14 (12 months ending 31
st July 2014) results out, the Company has declared revenue of A$2,622 million, 15% increase from A$2,277 million of 2013; underlying EBIT of A$201 million, 7% increase from A$187 million of 2013; underlying NPAT of A$86 million, 4% increase from A$83 million of 2013; net working capital of A$842 million, 17% decrease from A$1,011 million of 2013; net debt of A$513 million, 19% decrease from A$633 million of 2013; and a full year dividend of 8 cents, partially franked, vis-à-vis 8 cents, fully franked, in 2013. NUF’s market capitalization is A$1.17 billion.
The Company reported some level of progress on working capital efficiency with initial focus on inventory management.
Inventory Bridge FY13 to FY14 (Source – Company Reports)
Further, the Company considers rebuilding of Australian business on top priority to set up more flexible cost base and portfolio development. With the Sumitomo strategic partnership (e.g. Valent distribution deal), NUF aims to assess additional opportunities and to consolidate its position in the US market which otherwise is diminishing. Further, the Company’s growth may be influenced by NUF’s expansion into rice and vegetables segments in Indonesia; building market share gains in Australia Canola segment, optimizing ANZ manufacturing footprint, etc.
However, NUF admits that the
gross profit margin is adversely impacted by reduced manufacturing throughput in ANZ, EU and US; and change of selling arrangements for seeds in China. Also, there is only small increase Return on Funds Employed, which is still well below the Company’s longer term target of 16%. A sneak-peek at the financial metrics through July-half reflects a probably decrease in the net debt driven by the working capital management. However, it is anticipated that the gearing metrics may gradually turnaround which may take some time and great efforts though.
Although the stock may look attractive, Nufarm faces issues from earnings uncertainty due to high level of competition (from BASF, Sinochem, etc.) and structural breezes in Australia, uncomfortable levels of gearing and poor cash flow change. Further, key factors that act as headwinds constitute potential corporate activity, seasonal conditions/rainfall, farmer incomes and confidence, global soft commodity prices, cost of chemical intermediates used for manufacturing crop protection products, technology risk from competitors for superior/alternate technologies, regulatory risk, and so forth. Sales and growth may also vary with the loss of BASF and Round up distribution agreements in Australia, varied contribution from South American business due to favorable or unfavorable weather conditions, and changes in Australia’s gross margins’ scenario.
Operating and Tax Expense (Source – Company Reports)
In view of the fact that USA experienced unusual long winter and reduced demand, the contributions have reduced. For instance, North American contribution appears to be low in FY14 reflecting a flat 2H14 result. This has resulted in delayed spring demand. FY15 forecasts may, however, not witness much ups and downs in the weather. Similarly, the seasonal conditions in Australia (which otherwise has been a key profit centre for NUF) also call for a low forecast along with a vigilant look at Nufarm’s outlook owing to heightened competition. Nonetheless, the Australian market is little fickle wherein market sales are hit by dry weather conditions, thereby affecting NUF’s earnings. In addition, NUF’s sole reliance on key premium products with 65% of Nufarm’s Australian sales originating from just five products, and 75% of its portfolio is commoditized, may pose a further risk vis-à-vis its key competitors.
In South America, which is the key contributor to NUF profits, Brazilian crop protection market’s results have been quite encouraging. NUF estimates the total market in South America to reach US$13bn by 2016. The declining crop prices may still pose a threat.
Brazil Key Metrics (Source – Company Reports)
NUF is banking on increased proportion of crop protection sales in off-patent space. Its seeds business is influenced by the adverse operating conditions in North America.
The Company’s restructuring efforts, primarily by streamlining its manufacturing facilities (including site reduction from 4 to 2) and headcount reduction (including reduction by 160 personnel), as announced in March 2014 in Australia and NZ, are forecast to deliver $16m p.a. savings by FY16.
Sales Revenue by Region (Source – Company Reports)
On another note, NUF witnesses knock-backs from its competitors - FMC recently announced acquisition of Cheminova for US$1.8bn which gives a modest premium to Nufarm. The entity may become dominant in Latin America and FMC may also intend to become sizeable in Australia and Europe as well, which may be lethal for NUF’s health.
Daily Chart (Source - Thomson Reuters)
With cyclical up-down trends, the overall scenario needs to be monitored vigilantly. For instance, NUF anticipates growth in European branded sales but lower overhead recoveries likely to generate flat segment result. Similarly, the growth trends are not very stable in Australia and the US. Accordingly, we retain our recommendation as ‘HOLD’ at the moment.
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